Is the puny dollar a sign of America’s decline?

Yesterday, the pound and the euro hit their highest levels in a generation against the US dollar. The dollar, meanwhile, collapsed to a record low against an average of all the world’s major currencies. It is tempting to interpret the flight from the dollar in financial markets as the clearest, most objective, indicator of America’s relative decline.

Europe has long been derided as an ageing, sclerotic continent, doomed to irrelevance in a world dominated by America and Asia. But could it actually be America, not Europe, that is failing to compete in the globalised world economy and is now threatened with long-term decline?

Much that is happening in the world today certainly seems to belie the hubristic assumptions about American hegemony that were so prevalent a few years ago. It is not just the military debacle in Iraq and the geopolitical setbacks suffered by American diplomacy from the Middle East to Venezuela to North Korea. Less prominent in the media headlines, but in some ways more troubling, are the indicators of economic underperformance: the reliance on foreign borrowing (now equivalent to $2,000 annually for every American man, woman and child); the loss of Wall Street’s global dominance in financial services to the City of London; and now to cap it all, the dollar collapsing to record lows. Surely this is the ultimate vote of no confidence in the US economy by people who are best placed to know?

Sadly, for those of us who live in Britain and Europe and would like to believe that the strength of our currencies reflects our superlative economic prospects, the answer is an emphatic “no”. There was a time in the 19th century when the strength of sterling reflected Britain’s unparalleled prosperity and imperial power. But since the deregulation of currencies and financial markets in the 1980s and 1990s, currency strength has conveyed almost no information about the health of a national economy – and none at all about a country’s competitive position in global trade. For example, anyone who believes that the falling dollar reflects America’s huge trade deficit and foreign borrowing should consider that the one leading currency even weaker in the past three years than the dollar has been the yen; yet Japan has the world’s biggest trade surplus and is the greatest creditor nation the world has ever seen.

To the extent that any relationship has existed between currencies and economic performance, it has usually been the “wrong” way round – rising currencies usually preceded periods of economic decline, while weakening currencies have presaged economic strength. Think, for example, of the collapse of sterling in 1992, which ushered in the strongest and longest period of economic expansion in British history.

Or consider the strength of the US economy in the late 1990s, just after the dollar fell to its previous nadir in 1995. Even more spectacular has been the decade of growth in China since its currency collapsed to a record low in the Asian crisis of 1997. On the other side of the ledger, there has been Japan’s stagnation after 1995, when the yen hit a record high, and Germany’s lost decade after the surge in the mark that followed German reunification and the eurozone’s dismal economic performance from 2003 to 2005, as the newly created euro appreciated by 60 per cent against the dollar.

There are many explanations for the apparently perverse relationship between currencies and economic performance, though none of them is watertight. For example, currencies tend to strengthen in response to rising interest rates and fears of inflation – which are obviously bad for economic performance – but also in response to strong economic growth.

On the other hand, a currency may weaken because inflation prospects are improving, as they are in the US at present, or because investors fear a financial collapse, which some believe to be a looming in the US mortgage market. But if the causes of currency strength are ambiguous and contradictory, the consequences are clear. A currency that keeps rising, as the euro and sterling are at present, will eventually do serious damage to almost any economy, hurting export competitiveness and stunting growth.

This is what happened to Britain and America after the pound and the dollar appreciated excessively in the early 1980s and again in the early 1990s. It happened to Germany and Japan in the mid1990s and again in the middle of this decade to the eurozone. Europe and Britain enjoyed some relief in 2005, when the euro and the pound temporarily weakened.

But now they will have to bear the full brunt of excessive currency strength. In Britain’s case, the strength of the pound may not do too much harm, since it will forestall or at least delay any further rate rises from the Bank of England. On the Continent, however, the European Central Bank seems determined to keep raising interest rates, thereby exacerbating the damage done by the euro’s excessive strength.

Americans, meanwhile, will enjoy the benefits of a super-cheap currency, which will more than offset falling property prices and problems with a small minority of mortgage loans. American politicians, for all their faults, instinctively understand this, which is why they have generally welcomed a falling dollar and have been pressuring China and Japan to let the dollar weaken against the yen and the renmimbi – not just, as at present, against the euro and the pound.

European policymakers, by contrast, seem to have no idea of how currency markets operate. In contrast with Americans and Asians, German politicians in particular still see a “hard currency” as a virility symbol – not as a threat to economic performance or an indicator that interest rates are probably too high.

There is only one leading European politician who seems to understand the dangers of an overstrong euro. This is Nicolas Sarkozy, who travelled to Brussels this week to plead for a more expansionary economic policy in Europe. But his pleas were met with ridicule from the other governments and the ECB. Within two months of promising to spark an economic revival, the new French President has already been paralysed by the rules of the eurozone.

That is the reality of life in today’s Europe – and one of the main reasons why America, despite all its problems, will continue to dominate the world economy in the decades ahead.

A lot of Americans think Europe is some sort of economic basket case. The reality is a number of Euro states are now wealthier then America per capita in real terms.

They have more socialism, but some have well ran government programs. I’d rather see my healthcare dollars go to a doctor or nurse who was working for the government.. then to a mega-millionaire trial lawyer.

Another example is education. America and Europe have socialized education. Yet I believe every Euro nation scores above America in math and sciences. Some well beyond. I’ve read the long report on the oecd rankings in math and science. America came 29th. That matters in today’s ultra competitive world having a highly skilled workforce into the future.

The reality is a number of Euro states are now wealthier then America per capita in real terms.

You're talking nations barely the size of American states, and some no larger than most American metropolitan areas. The greatest dynamic in the creation of wealth is the power of competition and its destructive creativity. American wealth cannot be measured by averaging GDP per capita. That's more useful only in places with redistributive economies and where there is, supposedly, no poverty.

A far better way to understand the power of the American economy is the measure it absent those who don't participate in the economy. Take out the so-called 12% of Americans designated in poverty (30 million: measurements of American poverty are problematic at best) and the U.S. per capital GDP rises $10-$15,000, thereby pushing $50-$60,000. Even with the full population included, for a nation of this size there's no comparison to be made, anywhere.

Below is a good explanation of the core difference between the U.S. and European economies. And remember, this is all true give the far from perfect state of American politics and economic policy. Our successes are despite leftwing efforts to ruin the economy by europeanizing it.

From Cato:

Rethinking the Company We Keep by Arnold Kling

[excerpt]
....Edmund Phelps is the 2006 winner of the Nobel Prize in economics. Shortly after his award was announced, Phelps published an essay on how capitalism in the United States differs from the system in continental Europe. Phelps wrote:

"There are two economic systems in the West. Several nations – including the U.S., Canada and the United Kingdom – have a private-ownership system marked by great openness to the implementation of new commercial ideas coming from entrepreneurs, and by a pluralism of views among the financiers who select the ideas to nurture by providing the capital and incentives necessary for their development. Although much innovation comes from established companies, as in pharmaceuticals, much comes from start-ups, particularly the most novel innovations."

The other system – in Western Europe – though also based on private ownership, has been modified by the introduction of institutions aimed at protecting the interests of "stakeholders" and "social partners." The system's institutions include big employer confederations, big unions and monopolistic banks.

In continental Europe, large banks control the bulk of investment. The United States has a more vibrant stock market, many more banks, venture-capital firms and other financial channels.

In continental Europe, large established firms have access to funds from the large banks, but newer enterprises have a much more difficult time raising money. In the United States, the more competitive financial system gives more opportunity for entrepreneurs to raise start-up capital. In continental Europe, labor market regulations serve to keep small businesses small and to ossify the work forces at larger companies. In the United States, it is much easier for new businesses to expand and for old businesses to shed unnecessary workers.

European government policies sacrifice economic dynamism to other goals....

Continental Europe is set up to preserve large public sectors, large banks, and large corporations. For individuals, the promise is stable jobs, a stable business environment, and collective sharing of the costs of unemployment, retirement, and health care. For the economy as a whole, however, the result is stagnation, inefficiency, and a burden on the working population to support the unproductive sector that is becoming increasingly unsustainable.

Over time, Europeans with entrepreneurial inclinations will be increasingly tempted to emigrate to the United States or other English-speaking countries. Among the remaining Europeans, political support for welfare-state policies will solidify, even as the economic viability of those policies slips further.

And remember this: by its competitive presence alone the American economcy lifts the rest. Were the U.S. to follow the European model, Europe would collapse. The U.S. creates and accounts for a significant part of European wealth.

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