Archive for November 8th, 2010

The US Needs a Weaker Dollar

I’ve been particularly bearish on the economy in my last couple posts, calling this the equivalent of a depression and a crisis that risks civilizational failure.  However, there are signs that we can avoid the worst.   The news came out today that Consumer debt fell by 7.4%, or nearly $1 trillion dollars in the last two years.   Though the pace of repaying that debt is declining, it means that our total consumer debt now stands at $11.6 trillion.   There are also fewer credit cards, and in general it appears that at least the American public has come to grips with the fact that the wild consumerism of the 00’s cannot continue.

So, a piece of good news hits, and my first reaction is to rethink my position about this crisis.  Is it possible that I’m far too bearish and concerned, under estimating the capacity of a country as large and rich as ours to bounce back and recover from the long debt-driven party of the last thirty years?

Some signs of sanity are real: people are paying down mortgage debt, delinquencies in consumer loans are down, as are home foreclosures.    Families across the country are starting to put their household finances back in order,  adapting to the uncertainties of the recession.   Home lending practices have been tightened, as has credit access to the sub-prime market.   In fact, this is how a recession should look — the economy is slow as we recover from a credit binge.

A best case scenario would involve a gradual increase in economic growth,  and a tightening in what to me is still the most important statistic: the current account.   In the second quarter of 2009 the current account deficit hit a ten year low, at $84.4 billion.   However, the latest figure (released in September, Q2) is $123.3 billion, the fourth quarterly increase in a row.     The current annual GDP is $14.73 trillion.    The current account deficit now is at about 3.4% of GDP, up from 2009, but still a sustainable number compared to the 7% of GDP hit back in 2006.   We’re still consuming more than we produce, but not to the extremes of a few years ago.

Ultimately I think the US needs to see this number stabilize closer to 0.   Treasury Secretary Timothy Geithner recently proposed that the G-20 set targets capping current account surpluses at 4%.   The argument the US is making is that China bears some fault for the current global crisis by how it has kept its currency under valued while running constant trade surpluses.  One could even accuse China of engineering a mass transfer of wealth from the US to China, using our belief in free trade to flood the market with cheap consumables we’d go into debt to keep acquiring.  They were, however, simply playing by our rules (and we’ve been willing consumers).

Yet the US can’t play hardball with China because we do still need them to buy our bonds, and if they got really made and started dumping bonds, stocks, and US currency, they could do severe damage to the US economy.   Arguably they could weather such a storm better than we could.  So what does the US do?  Quantitative easing.

To do this the Federal Reserve board created $600 billion out of thin air, put them on their accounting sheet, and then used that money to purchase US bonds.  That, of course, has the impact of driving down the interest rates on those bonds, which negatively impacts countries like China who holds them.    China originally complained about this, but apparently in exchange for Geithner to quiet down on current account surplus targets, they’ve also muted their criticism.   This also isn’t the first time the Fed did this; since the crisis began nearly $2 trillion have been “created” in that manner.

Colloquially “quantitative easing” is simply “printing money.”  The risk, of course, is inflation and even hyperinflation.  It is a form of stimulating the economy that is often used when lower interest rates fail to generate more economic activity.   In the US that and a fiscal stimulus have so far failed to generate growth.   That’s seen as bad, though given the rate in which consumers have been paying down debt, one wonders what would be happening to the economy without the stimulus!   Quantitative easing was used by Japan a decade ago, but didn’t work to stop Japanese deflation.   Indeed, Japan’s high government debt, low interest rates and then quantitative easing should have risked inflation.   It hasn’t because  low unemployment means there is not a reserve of new workers ready to go into the system and generate income.

Japan has maintained its industrial base (unlike the US), has vast foreign capital reserves, and has had a current account in surplus (meaning it invests in the rest of the world).  The relative “comfort” of Japanese deflation — it remains a wealthy low unemployment country — isn’t cause for comfort here.   The key for us remains to increase production.  Without increasing production the only way out of the recession is through consumption of foreign goods, and that would require more debt.   In other words, the problem would intensify and set up another crisis.

Paying down the debt is an important step — and private debt is perhaps even more important than worrying about government debt at this point.   My fear would be that quantitative easing could induce more consumption of foreign goods, thereby increasing the risk to the dollar moving forward.   My hope would be that somehow we find ways to increase production at home so that ‘new’ money is spent improving America’s productive capacity rather than just causing more consumption.

Ultimately, I don’t see any way that can happen without a decline in the value of the dollar.

A falling dollar would mean foreign goods would get more expensive, and we’d consume less of them.   American goods would get relatively cheaper, and there would be incentives to produce more of them.  More Americans and even people abroad might find it cheap to “buy American.”     This would produce problems in emerging markets, many of which rely on the US to buy their goods.  This also would wreck havoc with the bond markets and the US ability to sustain debt and deficits.   The result could be such global uncertainty that a call for a “new Bretton Woods” would be quite persuasive.

The Bretton Woods system is the monetary and institutional system of free trade and fixed exchange rates created after WWII, named for the location in New Hampshire of a July 1944 meeting setting the framework for the post-war system.  Bretton Woods II is often used to discuss the changed nature of the system after the end of the fixed exchange rate system in 1973.   Robert Zoellick of the world bank has talked opaquely about an internationalization of capital accounts, perhaps a “Bretton Woods III,” that could even reintroduce gold as a benchmark against which currencies are measured.   Though this is not necessarily a call for a new ‘gold standard,’ it does reflect growing concern about the ability of humans to successfully handle fiat currencies.    To me this signals recognition that currency instability is likely in our future; a dollar crisis may be the next phase of this global slowdown.

So yes, Americans paying down the debt is a good thing.   But we also have to increase production and stop  growing the current account deficit.  I doubt that can happen without a weaker dollar — perhaps substantially weaker.   Now that it’s clear that the Euro is not in existential crisis, I would not be surprised to see the dollar start to decline in value.   How hard and how far the fall is uncertain.   Whether or not the global system can handle all this in a stable manner may determine how deep this global economic crisis ultimately becomes.

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The Nature of This Crisis

“Each time we bathe our reactions in artificial light
Each time we alter the focus to make the wrong move seem right”
– from “Stick it Out” by RUSH (lyrics Neil Peart), Counterparts LP, 1992

For all my posts on the economy, I’ve not spent a lot of time on the underlying cause of this crisis.   The true nature of the current crisis is far deeper in our culture than most people realize, and although it sounds alarmist, the US and perhaps western civilization in general may be on the verge of something akin to civilizational failure.

This is not due to outsiders.  Many point to China, Arab Muslims, India, or even Russia as doing things globally to undercut the US.   No, we can’t blame others.   This also is not due to nefarious insiders.   When Hitler rose to power he blamed socialists, internationalists and liberals, saying that these folk were betraying German values, internal traitors against a “real” Germany.   Jews were also a convenient scapegoat.   Some extremists on the far right use similar rhetoric against the left, with Hispanics replacing Jews as the “parasite” destroying the country from within.   No group inside the country is bringing us down.  This is also not due to Republicans or greedy corporations either.   Many on the left want to dismantle corporate America, and blame banks and business for greed and taking a far greater portion of the pie.  Yet blaming big money is wrong too.

The reality is that this crisis comes from how we think.  It is a cultural crisis, with its roots in the enlightenment.   It is also not a new flaw.   We can look back and see colonialism, bureaucratic socialism, fascism, world wars, and a Cold War where in which the world hung under threat of nuclear annihilation.

The enlightenment gave us a world view that allows us to interpret reality in whatever way suits our interest.    By positing reason and rational thought as the ideal, it gives us a tool to twist reality and construct meanings that justify what we do.  Colonialism is spreading civilization to the benefit of the “primitives.”    Bringing war and chaos to Iraq is ‘removing Saddam’ and “spreading democracy.”  Destroying indigenous cultures is “bringing them Christianity,” and living off cheap resources and labor from the third world is “using free trade to help them develop.”

We are very good at rationalizing things; we do it in politics and in every day life.    Should we cut taxes to the wealthiest when the gap between the rich and poor is at its greatest in 100 years?   Sure, some will say, it will help the economy and the poor will benefit.    And if there is a real danger, such as global warming — well, we’ll find a couple naysaying scientists and then use media and propaganda to make it seem like the deniers are brave critics against “big science.”   We are to believe that the vast majority of climate scientists are simply lying to ‘try to get grants.’   And on the left people rationalize increasing the scope and size of government programs, even though the economy is in recession and we have an unsustainable level of debt.

Yes, we are always able to rationalize what we want to believe.   There are enablers built into our society — bankers who sold and often pressured people to take subprime loans they really couldn’t afford, advertisers telling people “you deserve” this — go a little more in debt, this product is worth it.  Credit card companies pushed cheap easy credit on us, and the cultural insanity was defended by simply blaming those who lost out.   When the subprime mortgage goes bad or credit card debt buries someone, “well, they should have known better.”   Shifting blame allows us to keep alive arguments, beliefs and ideas that justify convenient cultural delusions.

We do this to ourselves all the time.   That is why we gain weight, rationalize mistreating or cheating on friends and family, purchase goods we don’t need, and produce massive amounts of trash even as we say something has to be done about pollution.   We also create cultural narratives to rationalize and make seem “normal” something which is anything but.  The narratives hypnotize, they are with us from birth, they speak to our basic desire to pursue our interests while avoiding cognitive dissonance in justifying the cost.  They are narcissistic and myopic, and our culture reflects that.

The enlightenment gave us the ability to create rational arguments by use of reason.  In science this, of course, allowed the development of new technologies and knowledge about the world.  But in culture and politics it is a dangerous capacity.  The problem is that reason needs to be grounded — there need to be core values and principles underlying the use of reason, otherwise it is literally sophistry — building arguments to justify whatever we want to justify.   And our sophists are more sophisticated than was the case in Socrate’s time!

Although colonialism was rationalized through a variety of discursive strategies (persuasively argued by David Spurr in Rhetoric of Empire), tradition, religion and custom were strong enough to keep the most negative forces in check.   Starting in the 20th century and aided by the rise of propaganda and mass media, our ability to create narratives to rationalize anything became unhinged.   Be it Communism, Nazism, Consumerism, Libertarianism, class warfare, interventionist foreign policies, or the recent rise in debt due to easy credit, we’ve learned to use reason like a drug — it can cause us to see as good and rational anything we feel like we want to believe or do.   Moreover, we don’t even know we’re doing it, we really think our arguments are correct!   It’s emotion that gives us that certainty, but we believe it is our rational thought.

That’s why we’re in such deep trouble.  It’s not primarily the economy, or militarism, culture wars, or anything else.  Unless we can find a way to ground reason and use it wisely, we’ll rationalize and see as good and necessary the very things which will bring down our civilization.    The key for individuals is to recognize and understand the danger, and try to resist the tempting self-serving justifications.   We can do that, though it takes practice.  For our culture, though, there needs to be a shift in values.   We won’t bring back traditional society, nor will religion play the same role it did in the past.  But somehow we have to find a way to humble the use of pure reason and rediscover values, principles, and ethics outside of using reason as a tool.   Reason can be used to rationalize any ethical belief, after all.

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