US buying bubble could burst the world economy

The Mail & Guardian ^ | Monday, July 28, 2003 | Larry Elliot

[Willie Green]

For education and discussion only. Not for commercial use.

Everything´s going to be all right. No, not Bob Marley, but every policymaker from Alan Greenspan to Wim Duisenberg. The A side of 2003 was a bit grim, but turn the record over and the second half will be better. The controls are set to go, the policy framework is solid, better times are ahead.

Sound familiar? It should do. This has been what policymakers and their bullish camp followers in the markets and the media have been arguing in each of the past three years. Every year, they say the good times are coming back, and every year so far, they have been wrong.

This time, they say, it´s different. Stock markets have rallied since the end of the war in Iraq, oil prices are lower and the United States´s economy is showing signs of revving up. Once the US juggernaut has really started to roll, so the conventional wisdom goes, the global economy will be dragged along behind.

But what if the conventional wisdom is wrong, not just about the imminence of recovery but about the underlying health of the global economy altogether? As one correspondent put it, is there a chance that we could be heading for the “big one”, an economic crisis the likes of which has not been seen since the 1930s?

It´s certainly worth considering, and the place to start looking is the US trade deficit, at present running at more than $50-million an hour. Far too little attention has been paid to the giant tab the US has been running with the rest of the world in order to satisfy demand for goods and services that cannot be provided domestically, with economic logic turned on its head to argue that the spendthrift habits of the world´s biggest economy are actually a good thing.

The difficulty, however, is that there is no mechanism for bringing the US current account back into balance, and it has been the absence of such a mechanism since the break up of the Bretton Woods fixed-exchange-rate system that has contributed to the growing problem.

In essence, the Bretton Woods system was an updated form of the gold standard; both ensured there was a self-stabilisation mechanism whereby countries running either surpluses or deficits were forced to take remedial action.

In the case of the gold standard, a country´s money supply was linked directly to its stock of gold. Nations that ran trade surpluses would accumulate more gold, which allowed them to expand the money supply by creating more credit. Easier money fuelled booms, which in turn fuelled inflation. Higher prices relative to other countries made exports dearer, thereby reducing the trade surplus.

The system worked in the opposite way, of course, for countries with trade deficits. The gold standard was suspended during World War I, revived in the 1920s and collapsed in the 1930s. Bretton Woods was seen as a substitute for the gold standard, and pegged the dollar to gold at $35 an ounce, with every other currency linked to the dollar at fixed rates.

Bretton Woods was more flexible than the gold standard but the premise was the same: trade imbalances led to flows across national borders of gold, or more usually dollars, and this forced domestic adjustment.

The breakdown of Bretton Woods, following Richard Nixon´s decision to suspend convertibility of dollars into gold, means there is no longer an adjustment mechanism. The US has permitted itself to run bigger and bigger trade deficits, a cumulative $3-billion since the early 1970s, financing them by printing more dollars.

The fact that the dollar has traditionally been the world´s reserve currency of choice has helped, because central banks in other countries have seen little point in sticking their stash of US currency in a bank vault but instead have sought to get a return on them by investing in US assets.

As Richard Duncan points out in his book, The Dollar Crisis (Wiley), the result of this has been to create a reservoir of global liquidity, growing bigger and bigger all the time. The extra liquidity sloshing around in the global financial system lay behind the explosion of credit, not only in those countries running trade surpluses but in the US as well, because that was where the creditor countries reinvested their dollars. This is obviously a far cry from the gold standard-Bretton Woods mechanisms.

“The current international monetary system has three inherent flaws that will eventually cause it to collapse in crisis,” Duncan says. “First, it allows certain countries to sustain large current account or capital and financial account surpluses over long periods, but it causes those countries to experience extraordinary economic boom and bust cycles that wreck their banks and undermine the fiscal health of their governments.´´ Here he means countries like Japan in the 1980s and Thailand in the 1990s.

“Its second flaw is that this system has made the well-being of the global economy dependent on a steady acceleration in the indebtedness of the US.´´ At some point this will have to stop.

“The third flaw is that it generates deflation.´´ Why? Because the credit bubble has encouraged overinvestment in just about every global industry, which has created an imbalance of supply over demand, bearing down on prices. The upshot was the dotcom bubble and its collapse. The remedy of global authorities has to be to pump in more liquidity, thereby inflating new bubbles in the US in house prices, mortgage refinancing and bonds. One way of looking at this is that Greenspan has learned from the 1930s and is determined that easy money is a vaccination for depressions. The other is that pumping up liquidity is like handing an alcoholic a bottle of whisky.

The American analyst Kurt Richebacher says the authorities are looking in the wrong place for the cause of the problem. “For the first time ever in the post-war period, many countries around the world, not only in the US, are experiencing a prolonged economic downturn in the absence of any monetary tightening. In essence, there must be causes other than the credit crunch. Nobody questions the need for action. But it should be clear that easy money can only be the cure for tight money, not for any other causes depressing the economy. For us, the real and disturbing story about the US economy is that with all its imbalances it has reached the stage where it requires permanent, massive monetary and fiscal stimulus to garner just a tepid economic response — and to prevent the bubbles from deflating.´´

This is certainly true. The interesting thing about the easing of policy in the past three years is how ineffectual it has been. Between 2000 and 2002, the federal budget moved from a surplus of $295-billion into a deficit of $257-billion, and is heading towards a $500-billion shortfall in 2003. During the same two years, credit expanded by $4,4-trillion. “And what was the effect of this credit and debt deluge on the economy?´´ he asks. “Gross domestic product grew in real terms by $248-billion and in nominal terms by $621-billion. To us, this is an outright policy disaster.´´

The dangers should be obvious. The dollar might act as a gradual adjustment mechanism but is more likely to come down with a crash. US consumers could decide to tighten their belts rather than face savage retrenchment if they continue on their rake´s progress. But the chances are they will not, and that a plunging dollar will spread the US´s recession to the rest of the world. There is no global financial system worthy of the name, merely a Potemkin village. Could this be the big one? You bet.

[ArneFufkin]

I have no idea where the last two sentences came from! Hot key voodoo. LOL. Gibberish are Us!

[ArneFufkin]

Thank you!

[eno_]

Can't. It's collateral for the National Debt. We have mortgaged our grandchildrens' future, education, infrastructure, and land. Isn't much left that isn't in hock.

Bull. We could, and should, sell as much federally owned land as possible. It is very unhealthy for the paower of states for the fedgov to own so much.

[Uncle Bill]

Industry Leaders Warn Bush
"If the administration does not act beginning in mid-2004, a new, enormous wave of plant closures and worker layoffs is certain to occur in the country’s major textile areas, such as the southeast, as orders for yarns, fabrics, home furnishing products and apparel are diverted to China,...China could gain control of approximately 70 percent of the U.S. market once quotas are removed,”

U.S. Departing The First World

Boeing can't act like British colonialists extracting wealth from other countries and exporting it all back home....the United States has no divine right to our standard of living,"
Alan Mulally, president of Boeing Commercial Airplanes Group - Source

SOURCE FOR BELOW: BUSH DECLARES NOTHING WRONG WITH ECONOMY

George W. Bush Quotes:

"Look around you," Bush implored his audience. "You've all got jobs. I've got a job. Dick Cheney has a job. I don't see what all the fuss is about."

"I may not be an economist, but anyone can see that things look pretty good from here. Besides, we're at war."

"And if there were problems with the economy, I'd be on it. Don't you think I would? The simple truth is that there are no problems. Not a one. Not an iota of problem."

"And we're not going to be suckered into a rope-a-dope with this whole recession game by the Democrats. We've got a war to fight."

"When have you ever heard me say there was a problem with the economy? When? Never. That's because there has been no problem since this administration took office.

"Did I mention we're at war?"

"Economies are about money," the President stated. "And I feel . . . I believe that money . . . I like money. And I like this country. Money is good and this country still has a lot of money."

Ari Fleischer Quotes:

"If the President declares that there is nothing wrong with the economy, then I'm sure there is nothing wrong with the economy."

"To turn our attention away at this time from the threat posed by Iraq to focus on the U.S. economy would be un-American."

"Obviously, our Republican mandate from the recent elections shows that the American people are more concerned with Homeland Security than whether their 401(k)s have gone down a few measly points. Get over it."

[arete]

That's pretty funny.

Richard W.

[RightWhale]

It is very unhealthy for the paower of states for the fedgov to own so much.

An hypothesis. Fed Gov does not agree, and the states after the original 13 colonies have a different deal where they never owned federal land in the first place. Who will buy all this federal land?

[eno_]

For a "Right" Whale you sure do like the post New Deal shape of FedGov power.

How about autioning fedgov land and seeing who buys it? The U.S. has a very large and liquid market in real estate.

[RightWhale]

How about autioning fedgov land and seeing who buys it?

Guarantee this: most of the land won't be sold anywhere near its valuation. There won't be enough money raised to pay for the auction. The FedGov will also retain the right to tax the property, and will retain subsurface rights. They also won't auction national parks, wildernesses, or forests. Doesn't leave much that anybody would be interested in. Maybe later, when there are 6 billion people living in America it will be worth something, but not now. It's just $6 trillion collateral.

[y2k_free_radical]

rotflmao

[Tauzero]

"I've been worrying about this stuff for a while, but what are small-fry like us to do other than practice our subsistence gardening technique?"

General rule: whatever the government is doing, do the opposite.

[Tauzero]

bump to that