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After reading what I've written below - I find it sounds like a pitch for this book. Trust me - it's not. But I highly recommend it for anyone who's curious about how we got into the economic situation we find ourselves in, and what we may face in the near future. I will warn you now - it's not pretty. Some people will find it too pessimistic, but when I consider all the BS that we know is being shoveled our way by the pundits at CNBC, Bloomberg, etc, I can't help but agree with our future prospects. And interstingly enough, Lou Dobbs (yes, THAT Lou Dobbs) is now talking up many of the same points made in this book.
It's amazing when you read something that ties in with a bunch of other seemingly unrelated stuff, and something goes 'click'. NAFTA, Wal-Mart, the Asian crisis, the Dow and Nasdaq bubbles, the coming real estate bubble, going off the gold standard, Greenspan and his wage pressure comments, interest rates - these are all slowly coming together in my mind, and it's very scary. A number of financial websites are followed by people on DU (www.financialsense.com , www.safemoneyreport.com are a couple), and what I see on those websites reflects much of what is in this book.
(from the inside cover)
The world economy is sinking into the worst industrial and financial downturn since the 1930s. Stock markets are plunging, major corporations are going bankrupt, and governments are begging for bailouts from the IMF. In the Dollar Crisis, Richard Duncan explains the nature and the origin of the imbalances that have destablized the global economy.
The book's theme is that the global economy has been destablized by the United States' enormous trade deficit which now exceeds US$50 million...an HOUR or 1.5% of Global GDP per annum. That trade imbalance, financed through debt, has created tremendous disequilibrium in the global economy and an economic bubble in the United States. When that bubble pops and the global economic disequilibrium unwinds, the world will not be able to avoid a very serious economic slump.
(exerpted from pages 144-149)
The blowout in the trade deficit in the second half of the 1990s was due, in part, to the strong U.S. economy. The large currency devaluations by many of the United States' trading partners played an equally important role, however. Between 1990 and June 2002, the dollar rose 75% against the Chinese yuan, 211% against the Mexican peso, 72% against the Korean won, 41% against the Malaysian ringgit, and 60% against the Thai baht. Over that 12-year period, the dollar actually fell 23% against the Japanese yen, However, the yen peaked in June 1995 at a rate of 84.6 per dollar. Between then and June 2002, the dollar rose by 39% against the yen.
By the mid-1990s. U.S. policymakers appear to have come to the conclusion that U.S. trade deficits could be used to support the economic growth of its trading partners at little to no cost to the United States. One must wonder when the realization set in within Washington that US trade and current account deficits actually benefited the United States - at least in the short term - since surplus nations were compelled to reinvest their dollar surpluses in US dollar-denominated assets if they were to avoid the appreciation of their own currencies and the disappearance of their trade surpluses, which a conversion of their dollar surpluses into their own currencies would have caused. Thereafter, it could be said that the United States adopted a trade deficit policy.
Every recent US administration has trumpeted the benefits to be derived from trade liberalization while simultaneously protecting selected industries. Farmers are heavily subsidize, and the textile industry is sheltered behind trade barriers. The American automobile industry survived only because Japan agreed to accept "voluntary" import quotas in the 1980s. The semiconductor industry enjoyed similar protection. Most recently, in 2002, quotas were required to resuce the US steel industry. Despite the rhetoric that free trade benefits consumers by lowering prices, apparently some industries are too politically important to be subjected to the full discipline of international competition.
Nevertheless, the influx of cheap imports was sufficient to bring about disinflation at the same time that the US economy enjoyed its longest-ever period of uninterrupted expansion.
In earlier business cycles, wage pressures would have mounted as full employment was reached; and wage-push inflation would have forced the Fed to increase interest rates in order to keep inflation in check. Higher interest rates would have caused the economy to cool down and would have taken the upward pressure off wage rates. That was the typical post-World War II business cycle pattern.
The pattern in the 1990s' expansion was very different. The possibility of relocating manufacturing facilities to countries with low-cost labor kept wage rates under pressure despite the strong economic growth. With low levels of inflation at the consumer price level, the Fed saw no reason to increase interest rates, even though the economy was expanding at a rate considerably above what had been considered to be a sustainable, non-inflationary trend rate.
There can be no question that the United States gained in the short term from the disinflationary impact of rapidly rising imports from low-wage countries. Consumers benefited from lower prices. Perhaps even more importantly, low inflation rates permitted low interest rates, and low interest rates spurred economic growth by lowering the cost of borrowing. The housing market gained, in particular. Share prices also rose, since investments in shares appeared relatively more attractive than the low interest rates available on bank deposits.
In retrospect, however, it is now clear that very low interest rats also created serious longer-term problems - namely, economic overheating and the stock-market bubble. The Fed had no mandate to prevent asset price inflation, only consumer price inflation. Consequently, the FOMC (the Fed's Federal Open Marrket Committee), left interest rates unchanged or even reduced them as the stock market inflated to ridiculous heights. Moreover, even after the bubble in share prices began to deflate in mid-2000, an aggressive series of interest rate reductions by the Fed over the following 18 months brought about a bubble in the property market.
The problems arising out of the government's trade deficit policy are now reaching a new, and potentially much more dangerous, state. As the overheated US economy falls deeper into recession, there is a very high chance that disinflation will mature into deflation. There is no built-in mechanism within the current trade regime that stops low-wage imports from exerting additional downward pressure on product prices just because the inflation rate has fallen to zero. So long as the United States continues to support the economic growth of the rest of the world through its trade deficits, the downward pressure on product prices will persist. Furthermore, disinflation could be transformed into deflation very quickly should the over-indebted US consumer be forced to rein in his spending, resulting in a sudden lurch down in aggregate demand.
There is no reason to believe that the US trade deficit will return to balance if left to market forces. In fact, the trade deficit is very likely to continue widening. American consumers will carry on buying the cheaper imported goods made with low-wage labor. The devloping countries are too poor to afford to buy sufficient amounts of the technologically advanced products in which the US has a competitive advantage. So long as the existing trade regime is in place, more and more US manufacturing will be shifted to low-wage countries such as Mexico and China. The differential in wage rates between the United STates and the developing world is simply too immense to allow any other outcome.
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The Bush administration is currently seeking to establish a free trade zone with all of South America. (As can be seen in Figure 8.5), GDP per capita in South America ranges between US$1,000 and US$4,000 , with the exeption of Uruguay where per capita income is US$5,800. In eight out of the 10 countries shown in the figure, per capita income GDP has fallen since 1995 - from 3% in Uruguay to 45% in Argentina. It is difficult to understand how further trade liberalization with the poor countries of South America could fail to exacerbate the US current account deficit.
For all of these reasons, the current account deficit of the United States can only continue to widen in the years ahead, unless and until the dollar falls very significantly against the currencies of all the United States' major trading partners. As the imports from the low-wage nations flood into the US, they are very likely to cause the current disinflationary trend to continue and to mature into deflation.
It has become sacrilege to cast doubt on the sanctity of free trade in recent decades. To question the benefits to be derived from free trade is to invite ridicule in much the same way as it was considered contemptible to question the invulnerability of the New Paradigm economy as recently as 2000. Sadly, the fact of the matter is that existing trade arrangements are destablizing the global economy and cannot continue without ending in economic disaster.
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About the Author
Richard Duncan has worked as a financial analyst in Asia for more than 16 years, conducting research and publishing investment reports on companies, industries, and economies from India to Korea.
In 1993, Mr. Duncan was one of the first to warn of the impending collapse of the Thai economy and the Thai stock market in a series of published reports and speeches directed at institutional investors. At the height of the Asian crisis, he worked as a consultant for the International Monetary Fund in thailand. Subsequently, he joined the World Bank in Washington DC as a Financial Sector Specialist focusing on issues related to the economic crisis in Asia.
Mr Duncan studied economics and literature at Vanderbilt University and business and finance at Babson College. His interest in history developed during a year spent traveling around the world after graduation. He and his wife, Jareeyu, currently reside in Hong Kong.
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