There’s a growing body of thought that chronic trade imbalances and manipulated currencies used to support export industries in the developing world are the root cause of the Great Recession in the US and Europe.
This isn’t the 800lb Gorilla, this is what the Gorilla is about to break. The Gorilla is the United States, more specifically the Federal Reserve of the United States.
It is suspected that the Federal Reserve is about to embark on a huge quantitative easing effort, dubbed QEII. Essentially the Fed has decided it will start buying assets, mostly Treasuries, in the trillions of dollars. This will result in dollar depreciation, even lower interest rates in the US, and it is hoped enough inflation to finally get money moving into capital investment instead of being stuffed in the virtual mattress.
The primary goal is to break a currency regime that has been in place for more than two decades. That regime depended upon a strong dollar beneath which export markets could peg their own currency. QEII will put pressure on that strong dollar and the more the dollar devalues the greater the strain on economies who depend upon exports to grow.
Why is the 800lb Gorilla doing this? Because it is now believed the old arrangement crippled the US economy by inducing Americans to buy much of what they use from foreign manufacturing. In effect, American productive capacity was idled because American demand was being satisfied by other country exports. The result is chronically high unemployment in the US and chronically high demand for the dollar and Treasuries coming from exporters who are flush with dollars.
In short, America has been induced into an artificial output gap where demand is satisfied by exports instead of domestic manufacturing. The Great Recession and its stubbornly high unemployment showed the real underlying consequence of global trade flows that were manipulated by mercantilist export led nations such as China.
Tim Duy writes a well respected blog called Tim Duy’s Fed Watch. In a recent post he writes:
“How has it come to this? To understand the challenge ahead, we need to begin with two points of general agreement. The first is that the US has a significant and persistent current account deficit, which implies that domestic absorption of goods and services, by all sectors, exceeds potential output. In other words, we rely on a steady inflow of goods and services to satisfy our excess demand, a situation we typically find acceptable during a high growth phase when domestic investment exceeds domestic saving. The second point of agreement is that high unemployment implies that actual output is far below potential output. We clearly have unused capacity.
Points one and two appear that they should be mutually exclusive, but they are not. The fact that they are not begs an explanation. Paul Krugman sends us to Paul Samuelson to provide that explanation:
Here’s what he [Samuelson] wrote in his 1964 paper “Theoretical notes on trade problems”: “With employment less than full and Net National Product suboptimal, all the debunked mercantilist arguments turn out to be valid.” And he went on to mention the appendix to the latest edition of his Economics, “pointing out the genuine problems for free-trade apologetics raised by overvaluation”.
I think Samuelson is correct; an excessively high dollar is the explanation for the simultaneous existence of a sizable current account deficit and excessive unemployment. Indeed, there appears to be a externally determined downward limit to real value of the Dollar, and we are close to pushing against it:”
Duy quotes another blogsite, Angry Bear, to explain why becoming so reliant on foreign production eventually results in persistently high unemployment.
“Since the early 1980′s when the US started borrowing abroad to finance its two structural deficits — federal and foreign–trades share of consumption has risen from about 6% to some 16%. Normally this has a small negative impact on the US economy, but sometimes you get quarters like the last quarter. Last quarter real domestic consumption rose at a 4.9% annual rate. That was an increase of $162.6 billion( 2005 $). But real imports also increased $142.2 billion (2005 $). That means that the increase in imports was 87.5% of the increase in domestic demand.
To apply a little old fashion Keynesian analysis or terminology, the leakage abroad of the demand growth was 87.5%. It does not take some great new “freshwater” theory to explain why the stimulus is not working as expected, simple old fashioned Keynesian models explain it adequately.
Years of current account deficits – deficits induced not by the decisions of private savers looking to maximize returns but by foreign public sector entities seeking to maintain export growth – has literally resulted in a US economy that, on net, is unable to produce the goods its citizens want to consume. Hence a blast of stimulus flows overseas , the rising trade deficit heralded as a sign of strong US demand despite the inconvenient truth of little net job creation.”
Beezer here. In other words most of the increase in demand stimulus might create becomes stimulus for foreign, export led, economies. The money is just passed on out of the country. Which is why we’ve recommended domestic infrastructure projects. That money doesn’t just flow out to another country. It’s real stimulus.
Meanwhile, Paul Krugman points out we didn’t really have much in the way of stimulus anyway.
“Here’s the narrative you hear everywhere: President Obama has presided over a huge expansion of government, but unemployment has remained high. And this proves that government spending can’t create jobs.
Here’s what you need to know: The whole story is a myth. There never was a big expansion of government spending. In fact, that has been the key problem with economic policy in the Obama years: we never had the kind of fiscal expansion that might have created the millions of jobs we need.
Ask yourself: What major new federal programs have started up since Mr. Obama took office? Health care reform, for the most part, hasn’t kicked in yet, so that can’t be it. So are there giant infrastructure projects under way? No. Are there huge new benefits for low-income workers or the poor? No. Where’s all that spending we keep hearing about? It never happened…….
Consider, in particular, one fact that might surprise you: The total number of government workers in America has been falling, not rising, under Mr. Obama. A small increase in federal employment was swamped by sharp declines at the state and local level — most notably, by layoffs of schoolteachers. Total government payrolls have fallen by more than 350,000 since January 2009.
Now, direct employment isn’t a perfect measure of the government’s size, since the government also employs workers indirectly when it buys goods and services from the private sector. And government purchases of goods and services have gone up. But adjusted for inflation, they rose only 3 percent over the last two years — a pace slower than that of the previous two years, and slower than the economy’s normal rate of growth.
So as I said, the big government expansion everyone talks about never happened. This fact, however, raises two questions. First, we know that Congress enacted a stimulus bill in early 2009; why didn’t that translate into a big rise in government spending? Second, if the expansion never happened, why does everyone think it did?”
Beezer again. Krugman is obviously correct, but so what? His opinion, although powerful, is being swamped by a huge flood of advertising/marketing money coming from supra-national corporate treasuries and the wealthy who depend upon them for their wealth. And much of that money was unleashed by the recent decision of the US Stupid Court overturning a century of regulations aimed at controlling the power corporate treasuries could wield on government if not restrained.
These are corporations that benefit from our current account imbalance. Think China Mart. Or oilmen like the Koch family, a primary contributor to several of the secret ‘fronts’ being used now to defeat Democrats and install compliant Republicans.
Meanwhile, the Federal Reserve is ready to begin a new phase of currency battle. This development may be far more important than whether or not Republicans can gain control of Congress.