University of Phoenix Research Hub



Systems Theory and Unintended Consequences of Government Motivated Currency Wars: A Multiple Case StudyDr. Craig Martin, University of Phoenix, Northcentral University, Walden University, USAABSTRACTAlthough the actions initiated by Governments and Central Banks are intended to produce positive outcomes for the host country, financial implications for markets and the macro economy often produce uncertainty and detrimental consequences for consumers and investors alike. Using a foundation of Systems Theory and Complexity Theory, the multiple case study conducted sought to further understanding about why these unintended factors arise and to explore how financial risk for investors emanating from the uncertain future of a currency war may be mitigated. The research suggests that market volatility during and post the currency war is expected, that inflation and/or deflation will arise and that upheaval of the system of global currencies occurs as a result of the currency wars. By furthering understanding about the derivation of these economic consequences, long-term, retirement-planning investors can manage portfolio asset diversity to mitigate risk for expected returns on investment.Keywords: Currency Wars, Complexity Theory, Systems Theory, Unintended Consequences, Inflation, Deflation, Financial Collapse.INTRODUCTIONAlthough international currency wars have proven to produce one of the most destructive set of outcomes, the Government actions leading to a currency war do not occur for the purpose of initiating economic conflicts (Rickards, 2011). Central Governments seek full employment for national constituents; economic theory has posited that employment growth follows from growth in production of goods and services (GNP). Growth in exports contribute positively to GNP growth and Governments employ fiscal and monetary policy to achieve growth in exports (Hill, 2013).Unintended consequences from the Government actions to foster growth in trade have ranged from the theft of market share in exports from trading partners and the resultant retaliation by those partners to sequential bouts of inflation and deflation and recession to collapse of currency systems. Such are the outcomes from the currency wars from the twentieth and twenty first centuries (Rickards, 2011).While the research suggests that unintended consequences in aggregate are predictable as outcomes from currency wars, the specifics of these occurrences are not predictive. The resultant uncertainty promises an environment that does not suit the long-term, retirement-planning investor whose proclivity is to seek a return certain on one’s investments (Dent, 2014). However, if the investor understands the likely boundaries of outcomes for values of paper currencies operating in context of economic currency wars, said investor should be able to rationally plan a diversified portfolio that mitigates risk to the potential return on investment (Taleb, 2012). LITERATURE REVIEWThe review of literature will explore the operating factors resulting from Government actions found in the three international currency wars occurring since the early 1900s. Literature reviewing how the investor is influenced by economic outcomes to currency wars and Governmental tactics taken to combat said wars will be considered. Foundational theories of risk and uncertainty incorporated into systems theory as applied to economics and theories about use of complexity theory to explain factors and behavior found in complex systems will be explored.Currency Wars as a PhenomenaThere have been three economic, global currency wars since the early 1900s (Rickards, 2011). The first arose after the end of World War I (WWI), commencing in 1921 as Germany sought to develop a plan to satisfy requirements of War reparations dictated unilaterally by the Allies at the Treaty of Versailles and ending in 1936 as the World moved toward military confrontations. The second currency war began in 1967 with the attacks by speculators on the value of Sterling, ending in 1987 as the US dollar was bolstered in value as a result of the Plaza Accord. Currency War number three, featuring the dollar, the euro and the Yuan, is precipitated by the Federal Reserves’ Quantitative Easing Program, which officially began in 2010 and which as yet has not reached a conclusion.Central Government leaders have a primary objective to achieve full employment for its citizens who want to work to provide for one’s family (Ohmae, 2005). Citizens able to satisfy microeconomic needs peacefully have no reasons to pursue policies to extract needed goods from country neighbors and/or to seek a new Government through revolution (Sowell, 2004). In the early 1900’s, Western Central Governments adopted concepts introduced by Karl Marx and John Maynard Keynes to actively foster macroeconomic growth, which was thought to be correlated to achievement of full employment (Lewis, 2009).The United States (US) Government and the Federal Reserve, as well as other Governments and other Central Banks, have been primary agents for actions taken that led ultimately to the formation of each of the three post-1900 economic currency war (Stockman, 2013). Germany in 1921 purposefully devalued the Mark post WWI in order to enhance the exports of chemicals to raise hard currency to pay reparations dictated by the Treaty of Versailles, led primarily by France and England and to a lesser degree by the United States. The German action alone likely would not have led to currency war; however after the 1928 stock market collapse in the United States, both the US and France inflated- through actions to purposely devalue the currency relative to those of trading partners- their own paper currencies by straying from the quasi gold standard agreed to as part of Treaty of Versailles (Rickards, 2011). Shortly thereafter, Great Britain released the British Pound from the silver standard in order to continue to compete in the France-Great Britain-USA trade triangle. As the Gross National Product (GNP) of England and the US continued to fall and deflation appeared, President Roosevelt introduced tariffs to make popular imports more expensive, confiscated US gold held by citizens and devalued the paper dollar further by buying gold on the British currency exchange. World War Two (WWII), and not the cumulative actions by the Governments of Germany, France, Great Britain and the US, enabled the Countries to escape the disruptive economic outcomes of the first currency war (Hill, 2013).The formation of a gold exchange standard for the World’s dominant currencies at Bretton Woods in 1944 enabled a stable currency system for trade until the late 1960s (Eisen, 2013). During that period, the US dollar evolved as a reserve currency serving alongside the British Pound Sterling. With the decline of the British economy relative to global economic leaders and with the US economy over-burdened with President Johnson’s “guns and butter” policy for supporting the Viet Nam War and the US consumer, speculators began to attack first the value of the Pound relative to Sterling in 1967 and subsequently the value of the dollar relative to gold. In 1971, President Nixon devalued the currency indirectly by ending the gold exchange privilege for the dollar, effectively establishing the floating currency system that remains in existence in 2015. The devaluation set the stage for the second currency war of the 20th century, which lasted until 1987 (Rickards, 2011). The primary Governments involved in this second currency war included the major developed countries of Europe – West Germany, Italy, France, England – and the US and Japan. During much of the 20 year period 1967 – 1987, the United States experienced inflation and low, stagnant growth in GNP. Japan and the Western European countries economically grew during the period as the US shifted from a leader in net exports to a leading net imports nation (Stockman, 2013).Currency War III began in 2010 when the Federal Reserve Bank in the United States began its quantitative easing program established to enact monetary policy established by the Government (Rickards, 2011). The intent of the monetary policy, which ended in 2014, was to influence indirectly the reduction in long term US interest rates to accompany the short-term rate US reductions directly influenced by Federal Reserve interbank rate policies (Lowenstein, 2011). Driving interest rates down toward zero enacts a reduction in periodic interest payments due to other countries and in real value of dollar denominated debt owed to other countries – primarily England and the Republic of China (China). The reduction in interest rates also influences the relative value of the dollar downward (devaluation of dollar) versus those countries with relatively higher long-term interest rates for national securities. Devaluation of a currency favors exports and inhibits imports for the country undergoing devaluation of its currency (Appleyard and Field, 2014).The above actions have not gone unnoticed by the euro currency countries (primarily Germany, France and Italy), Japan and China, who are major trading partners with US. Along with England, each of these Governments are engaged making decisions which intent are to counteract effectively the monetary moves fostered by the US. Although the latest war is still in progress, outcomes visible to date include reductions in growth in GNP in Japan, China and most of the European Union, and very slow growth (1.5-2.0%) in the United States (Rickards, 2014). Due to Central Bank actions, inflation in China has slowed; however there are signs of deflation occurring in European Union and in United States (Dent, 2014).Currency Wars and the US InvestorThe United States investor, whose plan is to invest in securities to plan for retirement, considered in the research is the person with a long-term objective for return earned on one’s invested monies in open securities markets (Dent, 2014). Many of these investors include 401-k and similar tax advantaged plans as an effective platform for maximizing the earned return on investment sought through the practice of compounding interest, dividends and growth in principle in order to effectively grow one’s portfolio (Dent, 2014).Factors of importance to the long-term, retirement planning investor include the risks inherent in investment, which are manageable (Fox, 2009), and the uncertainties about probable outcomes from the present to future periods, which are not manageable but can be mitigated by application of statistics and the understanding of the principles in Systems and Complexity Theory (Taleb, 2010). Investors balance the potential risk of loss of principle value for any investment made and the potential gain possible from the invested capital. The value of investments in securities are influenced by financial factors present in companies which issue the securities (Dent, 2014). The value of the securities are also related to overall value of the securities market in which traded (Brealey, Myers & Allen, 2013). Government, including directed Central Bank, actions influence the value of investment markets directly and indirectly the values of one’s investments (Lowenstein, 2011). The Government actions with which this research is concerned include those made following fiscal and monetary policies. Fiscal policy may influences securities markets, and thus the investor, in two ways. If the Government spending incorporates construction or development, the spending translates to growth in GNP which is a positive influence on growth in equity securities markets (Fox, 2009). If that spending requires an increase in Government debt, the resultant debt increase may lead to an interest rate increase for the Government debt and a corresponding decrease in current value of debt instrument (Fox, 2009). However, Government spending has been shown to provide a future return in GNP growth of less than one dollar ($.94) for every dollar spent while private investment returns about $7 dollars in the future for each dollar invested (Sowell, 2010). Monetary policy may influence securities markets positively or negatively depending on the policy applied (Thornton, 2012). The Federal Reserve is the agent for enacting Governmental monetary policy in the US. The Federal Reserve is charged following the Full Employment Act of 1978 (Humphrey-Hawkins Act) to balance US employment and price stability in enacting monetary policy. In actual practice the Federal Reserve seeks to balance growth in GNP and price stability, although research in 1968 by Friedman and Phelps demonstrated no clear relationship between employment and unemployment rate and GNP growth (Thornton, 2012).Systems and Complexity TheorySystems thinking enables one to consider a structure or event as a whole rather than consideration of a set of linear components or actions (Ackoff, 1998). A system is defined as a whole that is both greater than and different from its parts. A principle of systems thinking is that the understanding of behavior within a system can’t be advanced by analysis conducted of its components or elements. System behavior is posited to be a function of the whole rather than to be influenced independently by any one part of the system.Systems theory is used to understand the boundaries of a holistic system and, once the boundaries are known, to advance understanding about the interrelationships existing between entire systems (Wallerstein, 2011). The theory has been applied to systems that nest one within another in order to understand entire societies and even the World as a whole. Patton (2015) has been a leader in use of systems theory for the study of behavior found in economic systems, real-world markets and within the real-world intersections and interrelationships found between horizontal systems and nested systems. Patton (2015) notes that employing a systems orientation can be of assistance in framing questions of exploratory inquiry and, later, in advancement of understanding from the data collected using qualitative inquiry.Melanie Mitchell (2011) defines a complex system as a large network of components with no central control and simple rules of operation, which give rise to unpredictable collective behavior, sophisticated information processing and learning by the system through adaptation and /or evolution. Patton (2015) posits that the flexibility, openness and adaptability found in qualitative inquiry enables the use of complexity theory as a framework for qualitative research –inquiry – for the understanding of behavior in complex, dynamic situations and phenomena. A phenomena for which the application of complexity theory has proved especially useful to advance understanding include world securities markets and Governmental macroeconomic applications of monetary policy (Taleb, 2012).METHODOLOGYResearch was conducted using a design of multiple case study (Yin, 2014). The boundaries adopted for each case are the primary countries taking actions contributing to a respective currency war and the years in which outcomes for the securities markets influenced by these actions were unexpected and unintended (Rickards, 2014). Each of the three currency wars described above is considered in context of a case.As the currency wars studied extend over 90 years and the third, current war is yet to reach conclusion, the source of data for the research are texts and journal articles found in business libraries and data bases. Document analysis and content analysis, each employing the principle of triangulation for data collection, are tools described as specifically effective in case study research for data collection and analysis (Yin, 2014). Triangulation of data retrieved from the authors, who are experts in analysis of securities markets and the factors influencing market performance, was the strategy employed to achieve credible analysis (Patton, 2015). The foundational framework employed for the multiple case studies includes systems theory and complexity theory to seek understanding of behavior found to be operational in the US economy and the National securities markets of the United States. Complexity Theory will be used to advance understanding about interrelationships which emerge between the actions of the US Government and it central bank, the Federal Reserve, and the resulting outcomes found post such actions which emerge within the macro-economy and the New York securities markets (Patton, 2015).INTERRELATIONSHIPSIn each currency war described, the Federal Government employed fiscal policy of Government spending (Einhorn &Lewis, 2009) and monetary policy of currency devaluation to influence growth in Gross National Product (GNP) and employment. Okun’s Law, which posits that employment growth is correlated directly with growth in GNP, was incorporated into Federal law and adopted as a policy principle by the Federal Reserve (Thornton, 2012). Using classical economic theory (Hill, 2014), Government spending increases one of the four factors making up GNP and linearly increase GNP. Similarly, devaluing the dollar leads to more exports and less imports, which increases GNP in a linear manner. In each currency war period explored, the growth expected in US GNP has been less than forecast by economists (Rickards, 2011). From 1929-1938, the US suffered a reduction in GNP of approximately 30%, an unemployment rate averaging 18.2% while witnessing net exports increase from 5-10% as a percentage of total GNP and Government spending increase as an outcome of the Roosevelt New Deal (Samuelson, 2014). Deflation occurred in the US prices during most of the 1930s. Although the US benefitted from devaluation of the floating dollar and increased the use of Foreign Direct Investment (FDI) in the 1970s, GNP averaged 1.75% during a period in history known as stagflation as unemployment rose to 7.5% (Bureau of Labor Statistics, 2013). A period that expected export-driven growth in GNP and low unemployment experienced exactly the opposite (Rickards, 2011). Partly due to continued devaluation of the dollar since 2008 and the implementation of the Federal Reserve quantitative easing program, net exports have increased. However, growth in GNP has remained about 2.0% average and unemployment has remained stubbornly over 6 percent for 6 years while the US worker job participation rate declined from 67% to under 63% in December, 2014 (Bureau of Economic Analysis, 2014). Dent (2014) demonstrates that the both the employment and GNP time series correspond more closely to movements in demographic time lines representing volumes of births and family formations than do the movements correspond to those forecasted from applying influences of monetary or fiscal policy directly.Assuming that the macroeconomic actions of fiscal and monetary policy by the Federal Government (Government) during the currency wars emanate from a system enables exploration of unexpected outcomes as the result of behavior in another system (Taleb, 2012; Rickards, 2014). Incorporating complexity theory enabled the author to make sense of the unintended consequences observed in both the New York securities markets and in GNP of the United States (Patton, 2015). Viewing the macro-economy as a dynamic, adaptive system suggests that it is too simple to expect a single action from one system (Federal government and/or the Federal Reserve) to direct a predetermined outcome in another system (macro-economy of GNP and/or US employment) as demonstrated by Taleb (2012). The US economy is a system nested in a larger global economy, which itself is comprised of the set of other national economies and Governments (Hill, 2014). Thus the actions of the US Government and/or Federal Reserve do not occur in a vacuum (Rickards, 2014). In the 1930s, Germany, France and England each took turns taking actions to position favorably exports and to counteract the steps taken by the US Government. During the 1970s, countries in the European Union (EU) and Japan were major players along with the US in the currency war. Further, the OPEC oil cartel raised prices of petroleum to counteract the rising US inflation while increasing the volume of oil sent to Japan, the EU and the US. The national players in the present currency war are the Chinese led bloc (the Yuan), the euro portion of the EU and United States. Each player has taken steps to maintain the relative value of its currencies within a range, thus diminishing the impact of the dollar-led devaluation occurring (Rickards, 2014).Classical financial theory posits that the equity securities market, which is measured using the Standard and Poor market index (the index), will correlate positively with the US economy measured by GNP (Rickards, 2014). In the currency war of the 1930s, the index as expected remained basically flat mirroring economic activity measured by the GNP. While growth in GNP averages only 1.75% in the period 1968-1980, the index did grow from 103.1 to 107.9, an average growth of 5%. In the latest currency war beginning in 2008, a paltry growth rate of about 2% in GNP has been accompanied by growth in the index of over 100% (938 to 2058 Standard and Poor index). Incorporating systems theory and complexity theory into one’s thinking in reviewing these outcomes allows the analyst to make sense of the unexpected outcomes by recognition that outcomes in a system are unpredictable when exploring the relationship to inputs only considering a linear relationship (Patton, 2015).CONCLUSIONSThe primary concepts evolving from complexity theory posit that the interrelationships among systems influence the emergence of patterns that are highly unpredictable (uncertain) and which result from adaptation to the environment present by independent, interacting agents functioning within the phenomena (Taleb, 2007). The outcome from adaptation and emergence of patterns can incorporate highly unpredictable turbulence and lack of coherence in actions by the systems’ agents within the interacting systems (Patton, 2015). Adaptation is defined by Gleick (1987) as “changing the rules of the game” while one is functioning as an agent. Applying complexity theory enabled the researcher to make sense about the outcomes emerging in securities markets and in the macro economy during each of the three currency wars, during which actions by the Federal Government and its agent the Federal Reserve suggested that outcomes observed should be orderly growth in GNP and employment in the US (Rickards, 2014). There are observed changes which occurred in GNP and level of employment/ unemployment during the time that the dollar was being purposefully devalued and Government spending increased; however no specific pattern or relationship between the variables in the respective systems emerged (Rickards, 2014). My interpretation about the reasons for these unexpected outcomes occurring in each of the three currency wars is that one is observing complex systems in action,Similarly, one makes sense from observations of unexpected outcomes emanating from the New York securities markets as compared to outcomes flowing from the US macro-economy during the three studied currency wars. Exploring the outcomes by applying complexity theory suggests that what is being observed are the emergence of non-linear patterns which are the result of interactions between independent, adaptive agents (Taleb, 2012).That currency wars will occur again appears likely due to development of global financial networks and the motivation of countries to advance one’s own economic position at the expense of trading partners (Rickards, 2014; Taleb, 2012). While advancing growth in volume of goods and services (GNP) is not predictable using a predictive model, Governmental actions appear to influence a cycle of inflation or deflation within the macro economy (Rickards, 2011). Adopting a framework of complexity theory enables the exploration of risk of securities market and macroeconomic market collapse during a time of financial currency war. Further each national market is nested in the global security markets, which implies the maximum value of a market collapse in either the bond or stock markets is a non-linear, exponential function of a scale that will dwarf the collapse that happened during the 1930s (Dent, 2014). A maximum collapse in any markets is unlikely and unpredictable; however a principle within the theory of complexity is that collapse of a system will occur at some point in time (Patton, 2015).Given the unpredictability of events, which can vary in scale of value as well, emerging in interrelated systems, the individual long-term investor can’t plan with confidence about investments’ performance in the future. Dent (2014) prescribes maintaining a diverse portfolio that includes securities –high-grade corporate bonds and equity stock – and quality real estate. Ramsey (2014) suggests the use of Mutual and ETF funds to enact further diversity in holdings. Dent (2014), Rickards (2014) and Ramsey (2014) recommend that each investor have a goal to reduce one’s debt liabilities to zero as quickly as is feasible.Fiedler (2014) introduced contingency theory in the 1960s which posits that there is no one best way to lead or to organize. Incorporating the principles of Fiedler’s theory enables the investor to continually scan the global financial environment with commitment to remain flexible and adaptable for adjusting the mix of one’s portfolio in light of changes observed in the external, global economic forces. While not being confident of direction of movement of these external forces, understanding and applying the concepts of complex systems to the global financial markets enables one to consider a limited number of variables that are outcomes to significant currency wars of the future.REFERENCESAckoff, R.., 1998). Reflections on systems and their models. John Wiley and Sons, 13(1). Retrieved from onlinelibrary. ? ... ? Vol 13 Issue 1Appleyard, D., & Field, A., (2014). International Economics, 8th ed. McGraw-Hill Companies, Inc.Brealey, R., Myers, S. & Allen, F. (2013).?Principles of corporate finance?(10th ed.). New York, NY: McGraw-Hill Companies.Bureau of Economic Analysis (2015). Retrieved from Dent, H., Jr., (2014). The demographic cliff: How to survive and prosper during the great deflation of 2014-2019. New York, NY: Portfolio/Penguin Group.Einhorn, D. & Lewis, M. (2009). The end of financial world as we know it. In Carter, G. (Ed), The great hangover: 21 Tales of the new recession from pages of Vanity Fair. New York, NY: Harper Collins Publisher.Eisen, S. (2013). Currencies after the crash. New York, NY: McGraw-Hill Companies, Inc.Fox, J. (2009). The Myth of the rational market: A History of risk, reward, and delusion on Wall Street. New York, NY: Harper Collins.Gleick, J., (1988). Chaos: The making of a new science. New York, NY: Penguin Group.Hill, C. (2014). International business: Competition in the global marketplace, 9th ed. New York: McGraw-Hill.Latham, A., (2014). The Advantages of Fiedler’s contingency model. Demand Media. Retrieved from , H., (2009). Where Keynes went wrong: And Why world governments keep creating inflation, bubbles and busts. Mount Jackson, VA: Axios Press.Lowenstein, R., (2011). The End of Wall Street, 2nd ed. New York, NY: Penguin Books.Mitchell, M., (2011). Complexity: A Guided tour. Oxford, England: Oxford University Press.Ohmae, K., (2005). The Next global stage: Challenges and opportunities in our borderless world. Upper Saddle River, NJ: Pearson Education, Inc.Patton, M., (2015). Qualitative research & evaluation methods, 4th ed. Thousand Oaks, CA: SAGE Publications, Inc.Ramsey, D., (2014). Dave Ramsey’s guide to investing [radio]. Retrieved from elp/investing-guide/?...investinggui...Rickards, J., (2011). Currency Wars: The making of the next global crisis. New York, NY: Portfolio/Penguin Group.Sowell, T., (2004). Applied economics: Thinking beyond stage one. New York, NY: Perseus Books Group.Stockman, D. A., 2013. The Great Deformation: The corruption of capitalism in America. New York, NY: Perseus Books Group. Taleb, N., (2012). The black swan: The impact of the highly improbable. New York, NY: Random House, Inc.Thornton, D., (2012). Greenspan’s conundrum and the Fed’s ability to effect long-term yields. Retrieved from , I. (2011, March). Structural crisis in the world system. Retrieved from 2011/.../structural-crisis-in-the-world…Yin, R. (2014). Case study research: Design and methods, 5th ed. Thousand Oaks, CA: Sage Publicati ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download