Re: Article in THE ECONOMIST by Davidson

["Schulte-baeuminghaus" <schulte.baeuminghaus@xxxxxxxxx>]

OLD INFLATION NEVER DIES; IT SEEMS ONLY TO FADE AWAY


As we all know, the rest of the world is crazy - and therefore wrong.
Only each one of us is, in his or her view, NOT crazy - and, ipso facto, has
the brilliant insight to be right.

On that basis, I have the "right" to tell those who have been contributing
to the discussion of the United States trade deficit, that none of you has
come even close to a true and reliable analysis of the dollar situation and
that huge - should I say massive? - US dollar trade deficit.

So let me enlighten you.

The huge dollar trade deficit is not unique.
It has its little-cousin equivalent down there in Australia - a country
whose currency has never dominated world markets, never been a reserve
currency, never done any of those grand things that are customarily
attributed to its big cousin across the Pacific.

The huge US dollar deficit - and the smaller but still not inconsiderable
Australian $ deficit - are both due to the inflation - domestic inflation
which then spread internationally - the inflation that started in 1969 and
whose "remedy" produced the even greater inflation and stagnation which
followed throughout the 1970s and into the 1980s.
The inflation plus stagnation came to be known, reasonably enough, as
"stagflation."

Most people have come to believe that it was some sort of clever policy -
possibly founded on some variant of monetarism - and the "discipline" of
central banks, including the Fed, which brought about a cure to this
inflation and stagnation and delivered us into the mind-bogglingly
prosperous 1990s.

None of this is true.

First, anything resembling "monetarism" has been/is an unqualified disaster.
Not only did it not cure inflation, it made inflation worse, indeed, made it
chronic.

Second, there were no other clever policies that had anything to do with
providing a cure for "stagflation." Almost without exception, US policies
and the equivalent elsewhere, again for example in Australia, made things
worse, if not in the short term, then not much later. The policies did
result in a lowering of the living levels - or at least a stagnation of
those levels - for the workers and the middle classes. This was accompanied
by a stagnation or even an absolute reduction of social services, including
such things as unemployment benefits, invalid and old-age pensions and so
on.

Third, the reduction of social-services expenditure tended, ceteris paribus,
to stabilise inflationary pressures. Unwillingness of governments to
undertake essential infrastructure expenditures and eagerness to sell off
the family silver to private enterprise also gave the impression that
something closer to a match between demand and supply was being achieved.
However, these savings were made in a context in which investment generally
was limited, in which disinvestment took place through failure to replace
depreciated assets, and in which the economy exported much of its industry
overseas or across the national borders.

Fourth, while all this was going on, inflation in the US (and Australia,
remember) was offering a juicy market to anyone who could get in there and
sell. For a while, in the 1970s and 1980s, only countries like Japan and
West Germany, who maintained their real investment and their export
capacity, could help meet these needs but the Asian Tigers and their kin
gradually and quite quickly came into their own. Their unprecedented
economic growth was the other side of the United States coin which,
comfortingly, showed a decline in levels of domestic inflation. At the same
time, there came into being those famous trade deficits - which have, after
so many years, become chronic trade deficits.

That's a rough and brief outline.

I don't want to go on with this too long but I would just suggest that the
above account confirms that inflation has never been conquered. All that has
happened is that its superficial character has changed.
It no longer looks like a duck, seems to walk like a duck or can be heard to
quack like a duck.
But, make no mistake, it is as it has always been - a duck.
All that has happened is that a shift has occurred from domestic inflation
to trade-deficit inflation.

Just to put that into very simple terms - I hope not into too simplistic
terms: the excess demand over supply that caused domestic inflation after
1969 has been transformed into a continuing excess of demand over supply
which has, over time, expressed itself in having the excess supplied from
beyond the national borders.

Now, we can make all sorts of points about creditor countries being more
willing to hold US dollars than Australian dollars or other people's
currencies. Many of these points may well be valid but they have little or
nothing to do with basic, underlying causes.

Neither for the United States nor for Australia is the position sustainable
in any "permanent" way. Sooner or later the disequilibrium has to be
corrected.
In Australia's case, one of the levers of correction has been a slide in the
value of the Australian dollar. As late as 1973, the Australian dollar was
worth more than the US dollar. Recently, it has been struggling to remain
above 50 US cents. Right at this moment, it is worth, I think, about 54
cents.

I am writing this from Austria. About twenty years ago, the Australian
dollar would buy between 25 and 30 Austrian schillings. Now we're using
Euros but, to make the comparison easier, the Australian dollar would now
buy between 7 and a half and 8 Austrian schillings.

I might just add that the US dollar is now lucky to buy 14 Austrian
schillings, about half what it would buy twenty years ago.

So the chickens have come home to roost for Australia.
For the United States, the chickens are not yet quite roosting; but be
patient. Those chickens might already be well on their way.

What will that mean?

Remember that the US deficit has been running recently at the rate of about
$US500 billion, certainly well above $US400 billion. That is greater than
the GDP or GNP of most of the countries, members of the United Nations or
the WTO.
If there is a sudden reduction to, let's say, to $US250 billion, the impact
on those dependent on the US market could, indeed will be severe. If the
deficit is wiped out, it could be catastrophic, for example, for some Asian
countries.

The complex of effects is quite simply too difficult for me - and I suppose
for most of us - to define with any accuracy or in any detail.

The value of the US dollar would seem likely to fall, perhaps to something
like the present level of the Australian dollar. However, anything that
happens to or in or with the largest economy in the world has impacts
elsewhere. So the Euro, for example, might not stand tall and strong when
the US economy collapses. Similarly, while the Australian dollar has already
fallen so far, it might still collapse further with the fall in the value of
the US dollar, the reduction of US imports and the impact of those changes
on Australia's major markets in Asia.

We cannot, in this account, go through all aspects of the situation which is
with us now or which will confront us soon.

The first step to understanding the present situation - and in formulating
"remedies," however belated and inadequate - is to acknowledge how the US
deficits came about and the broad nature of their transition quality. In
other words, we need to acknowledge that, with present policies, they cannot
last and that the end of another glorious "bubble" may now be just about in
sight.

If I have succeeded in advancing that understanding, that will be a giant
leap forward.
On the other hand, you might think that I am the only one who is crazy!!




James Cumes
http://VictoryOverWant.org
http://creditary-economics.org/



----- Original Message -----
From: "Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>
To: <pkt@xxxxxxxxxxxxxxxx>
Sent: Sunday, September 15, 2002 4:42 AM
Subject: Re: Article in THE ECONOMIST by Davidson


>
>
> William F Hummel wrote:
>
> >
> > The US didn't engineer the dollar supremacy.  It was the only
> > currency in which international exchange could readily take place
> > in the period immediately after World War II.  The Bretton Woods
> > monetary system that formalized the dollar as the international
> > currency was freely joined by other nations because it was in
> > their own interest.  It worked well for almost every nation until
> > its demise in 1971.  During that period the US in effect lent
> > long and borrowed far less short from the rest of the world,
> > thereby providing the dollar assets needed by other countries.
> > Nobody objected to the large current account surplus that the US
> > ran at that time.
>
> This is either a distortion or an ignorance of history.  Bretton Woods
> died in 1971 a slow death of contradiction between US fiscal
> irresponsibility and the gold standard.  The fact was that until the
> collapse of the USSR, world trade was primarily Western trade subsidized
> by the US.  The two separate segmeents of the global economy operated
> through aid by each of the superpowers.  Trade was in all practical
> terms non-existent.  The was true for the Japanese and German economic
> "miracle."  The Marshall Plan was a political program, not a trade
> regime, though trade served a function.  Trade friction developed
> between the US's new allies and former enemies as the US grew confident
> about winning the Cold War.  That trade friction was resolved with the
> trade off between currency account deficit and capital account surplus
> in favor of the US through dollar reserve status.  After the Cold War,
> when globalized trade took off, this formula was expanded to cover the
> entire world.
>
> Prior to 1971, "Nobody objected to the large current account surplus
> that the US ran at that time" because they all felt they earned their
> trade deficit by being US allies and got paid for serving US
> geopolitical and ideological interests.  It was payment for being
> anti-communist.
>
> >
> >
> > The dollar standard became so useful to other countries by 1971
> > that it remains to this day, That's true in spite of the fact
> > that since about 1980 the US has been providing dollars on
> > balance through current accounts deficits rather than capital
> > outflows.
>
> I suggest that you study the political economy behind the Plaza Accord.
>
> >  I don't advocate the US continuing large current
> > account deficits, but it's a two way street.  Other countries
> > fight hard to maintain their trade surpluses with the US since it
> > means better employment conditions at home.  The opposite side of
> > the coin is the steady hollowing out of the manufacturing sector
> > in the US.
>
> More and more policy makers in the exporting economies are beginning to
> understand the futility of expert coupled with  capital account defict.
> It distorts domestic development.  Also, "better employment condition at
> home" is not factually operative in any exporting economy, as the
> AFL-CIO will tell you.
>
> >  Major trading partners also erect barriers to US
> > capital outflows that could help reduce its current account
> > deficit.
>
> I don't understand this statement.
>
> >
> >
> > It's understandable that many outside the US look at its current
> > account balance and equate that to lavish over-consumption.  It's
> > true that the US has a unique advantage in terms of borrowing in
> > its own currency, making it much easier to avoid financial
> > crises.  However I suggest that those who envy the US position
> > take a closer look at their own policies.  They should also
> > consider how much less efficient world trade would be if there
> > were no international monetary standard.  The inequities that
> > folks outside the US see may then appear more superficial than
> > real.
> >
>
> No one is arguing for the absence of an international monetary standard,
> only a more equitable one. The last sentence above is the equivalent of
> "tyrany is tolerable because it delivers order".
>
> Henry C.K. Liu
>
>