Monday, December 22, 2008

The Almighty US Dollar

The American Advantage: The Right To Print Dollars The American advantage is that the U.S. debt is almost entirely in dollars, not foreign currency. That Americans owe dollars to Japanese is no worse than New Yorkers owing dollars to Floridians. America's windfall of having the world reserve currency feeds the uninhibited spending of Baby Boomers, living high on foreign savings and free from the restraints of gold. The graph shows how the U.S. trade deficit increased after cutting the last tie to gold in 1971. Without a periodic reckoning of accounts with other central banks, the U.S. government was able to inflate the dollar, allowing Americans to buy abroad without restraint, with the savings from the rest of the world flowing in to cover the deficit. As long as foreigners were willing to finance trade, why should Americans worry? A country that borrows in its own currency need only repay on its own terms The advantage of a country that borrows from other countries in its own currency is that the debt need only be repaid on the debtor's terms. For example, if the Japanese decide they no longer want to hold U.S. Treasury bonds, preferring debt in Euros, they cannot demand payment in Euros from the U.S. Treasury. When Treasury bonds come due, the U.S. government will pay Japanese investors by crediting dollars in a U.S. bank. The Japanese investor may sell these dollars and buy Euros, but the dollars stay in a U.S. bank. The bank will invest these deposits and may buy U.S. Treasury bonds if rates rise as foreigners switch to Euro bonds. When assets are contractually named in the currency of the debtor, it is not easy to convince the debtor to switch to another currency (although creditors may swap currencies among themselves). A German may sell a U.S. dollar bond, but the obligation will continue to be in dollars – not the currency of the buyer. Macro-economists sometimes forget this essential micro-economic truth. Fuzzy Statistics, Cloudy Thinking Most statistics on international trade do not clearly identify the currency of the transactions, clouding a key element needed to understand currency risks. Because the American trade deficit and most U.S. foreign debt is denominated in dollars, this debt can only be settled when the rest of the world spends money in the United States for American goods or services. The dollar trade deficit is unemployment insurance for future American generations In this sense, the trade deficit and corresponding debt is unemployment insurance for future American generations. As long as the U.S. dollar is the international currency, Americans have a free pass to spend more than they produce. Most exporters will not sell goods in exchange for the currency of the importer. A Brazilian coffee exporter doesn't want to receive Argentine Pesos or Thai Bhats. An Indonesian seller of shrimp isn't interested in receiving Botswanian Pula, Cambodian Riel, Croatian Kuna, Eritrean Nakfa, Georgian Lari, or Kazakhstan Tenge. However, both Brazilian and Indonesian exporters will gladly receive U.S. dollars in payment, even over their own currencies. Because the rest of the world has been eager to accumulate dollars, there has been a tendency for competitive devaluation of currencies against the dollar, making foreign goods appear to be ever-cheaper to Americans. Frittering Away Technological Advantage In selling manufactured goods to Americans, offshore factories have competitive advantages that go beyond price. Even when the technology comes from the United States, international producers can easily acquire this know-how, through licensing or joint-ventures, or by hiring consultants, engineers, or industrial spies and reverse engineering. Foreign engineers teach on U.S. campuses and work in the laboratories and production lines of the most sophisticated technological companies in Silicon Valley, often with special visas provided by an obliging State Department. Americans are not shy about transferring technology abroad to produce goods in a more business friendly environment. Curious and ambitious young people in Asia with a technological bent can acquire tens of thousands of dollars of advanced (but bootleg) software for a few dollars in the local bazaar and supplement these tools with a world of knowledge available on the Internet. Excessive regulation, taxes, legal perils, high labor costs, unionization and strikes, falling educational standards, and government backing of free trade and globalization, have led to a steady, relentless decline in the percentage of Americans engaged in manufacturing. The above graph shows that from a high of thirty-five percent in 1953, the percentage of Americans working in factories had fallen to fourteen percent by 1999. By 1990, more Americans were employed by the government than in manufacturing. If current trends persist, the U.S. will no longer be an industrial power by 2050 If these trends continue, less than seven percent of Americans will work in factories by 2050 and the United States will no longer be an industrial power. The United States is self-sufficient in food, water, housing, medical and legal services, and transportation. However, the country is not self-sufficient in many critical raw materials, manufactured goods, and petroleum. As deindustrialization continues, the rest of the world will become less willing to grant Americans the benefits of the dollar franchise. As Americans produce fewer goods to exchange in the international market, the dollar will weaken and eventually fall. For Better or For Worse: A Service Economy Some of the decline in industrial workers has been due to increased productivity. However, to put deindustrialization in perspective, we need to look back to the movement of agricultural workers from fields to factories in the nineteenth century. This was associated with real productivity gains. Farm output increased so much that now only three percent of the work force grows food for the entire country with a surplus for export. This has not been the case with deindustrialization. Manufacturing employment has fallen because the factories have gone overseas. Americans must now import what used to be produced domestically. As industrial jobs have disappeared, the nature of the United States has changed. The above table shows that employment in capital intensive activities (manufacturing, mining, transportation, and utilities) have declined from 44.6% of the work force in 1950 to only 20.0% in 1999. On the other hand, activities that require less fixed capital (services, trade, finance, insurance, and real estate) have become the new center of economic activity, employing 59.4% of Americans in 1999, as compared with 36.8% in 1950. Steady Demand for Government Jobs In the last half of the twentieth century, an average of only sixty-five thousand industrial jobs were created each year, compared to a yearly increase of two hundred eighty-eight thousand government jobs and one million three hundred forty eight thousand new jobs in services, trade, finance, and insurance. The chart shows that variation in demand for industrial jobs fluctuated wildly in the last half-century, while government hiring was steady. In twenty of the last fifty years, the number of industrial jobs fell. Government positions dropped only in two of the early Reagan years. Observing the instability of factory employment and the long-term increase in government opportunities, the young now see that government offers a more stable career. Government jobs, like diamonds, are forever It seems that government jobs, like diamonds, are forever. To those managing cash flows for the Democrat Party and labor unions, the growth of government is a positive sign. Deindustrialization reduces employment volatility because of less strikes in good times and fewer layoffs in poor years. No one longs for the periodic financial panics of the nineteenth century. Fewer factories also mean less pollution, which makes environmentalists happy. Congress Examines the Trade Deficit In 1998, Congress established a commission to review the trade deficit, saying, “The United States is once again at a critical juncture in trade policy development. The nature of the United States trade deficit and its causes and consequences must be analyzed and documented.” In 2002, the Trade Deficit Review Commission reported its understanding of the causes of the deficit along partisan lines (cited from the report): Republican Explanation: “U.S. and foreign macro-economic performance primarily cause trade and current account deficits. In the 1990s, the relative strength of the U.S. economy led to substantially increased imports, while the relative weakness of many of our trading partners led to much slower growth in exports. Republicans see the trade deficit as a sign of relative economic strength The long-standing tendency for U.S. imports to grow faster than U.S. income adds to this faster growth in imports compared to exports. Trade barriers are objectionable, but not because they are a major cause of trade deficits. International capital flows are also a consequence of the relative strength of the U.S. economy. With a higher rate of return on investments here than in other countries, the United States is an attractive target for investment. This brings substantial benefits to the United States. In particular, since total saving in the United States is less than total investment, capital inflows help to finance investment that otherwise could not occur. Furthermore, the large net capital inflows have been keeping the dollar stronger than it would be otherwise. The strong dollar makes U.S. exports less price competitive and U.S. imports more attractive, contributing to the trade deficit.” Democrat Explanation: “The U.S.' large and growing trade and current account deficits are caused by a number of long- and short-term factors. Key long-term factors include : • Unequal relationships with America's major trading partners. The U.S. market is more open to imports than any other country in the world. High non-tariff barriers to trade in foreign markets are an important cause of this problem. These include quotas, private trading arrangements (such as the Japanese keiretsu groups) and other restrictions that reduce U.S. exports (i.e., restricted access to foreign exchange) to China and many other countries. • Predatory practices, such as dumping, that have increased U.S. imports. The Democrats blame the trade deficit on weak labor and environmental laws in other countries • Foreign government subsidies to foreign companies for research, development, and production that have not been effectively challenged or countered by the U.S. government. • Multinational corporations driving globalization. U.S. firms have been world leaders in eliminating jobs at home and moving production technology and production offshore. • The loss of competitiveness of U.S. firms on the one hand, with developing countries that depress workers' rights, environmental standards, and workers' wages so as to lower costs and unfairly compete for larger shares of the U.S. market, and, on the other hand, with those from Europe and Japan because they often have higher levels of productivity growth than the United States. • The failure of other nations, especially in developing countries, to enforce their labor and environmental laws and observe internationally recognized labor standards. • Low rates of saving in the United States, which have also contributed to trade and current account problems. Short-term factors have also contributed to the recent growth of the trade deficit. These include: ( 1) higher oil prices, ( 2) the twenty-three percent increase in the value of the dollar since 1995 that has made imports cheaper and the price of our exports more expensive to foreign buyers, and ( 3) slow economic growth in other countries. The U.S. manufacturing sector accounts for most of our trade deficit. Manufacturing industries will have to expand significantly if the United States is going to respond effectively to trade deficits and globalization. To do this, the United States will need new trade and development policies that will help rebuild manufacturing and reduce unfair barriers to trade around the world. We also need new tools to encourage U.S. multinationals to maintain jobs, technology, and production here in the United States.” Neither Party Knows What To Do Neither Republicans nor Democrats acknowledged that the trade deficit was linked to the supremacy of the dollar as the international medium of exchange. Economists of both parties sometimes failed to tie deficits to the lack of monetary controls after the gold standard was abandoned in 1971. The Republicans' optimistic view was that trade deficits were the natural result of superior investment markets in the United States and a strong U.S. economy. Republicans were content to put on a smiley face, claiming that everything was fine. However, the Republicans were mistaken in saying that the trade deficit was financed by foreign “investment”, which would imply capital or equity. Most foreign holdings of dollar assets are in the form of dollar debt – U.S. Treasury bonds, bank deposits, CDs, and corporate bonds. Most foreign holdings of dollar assets are in the form of dollar debt The incentive was not investment yield, but the strength of the dollar and the safety of the principal. The Democrats correctly pointed to the lack of competitiveness of U.S. factories that faced foreign producers that benefited from lower labor costs, fewer environmental restrictions, easier labor rules, and business-friendly governments that enticed U.S. industries abroad. However, the Democrats blamed foreign governments for not following the U.S. example of bureaucratic meddling and hostility towards business, rather than admit that it was the Democrat's own destructive policies that were driving U.S. manufacturing jobs offshore. The report of the commission showed that neither the Democrats nor Republicans had any idea of how the trade deficit might be stopped or how deindustrialization could be reversed. The political postures of the parties precluded any solution. Democrats could not reverse positions on minimum wages and unionization, nor could they turn against supporters that were environmentalists, tort lawyers, and defenders of consumers' rights. To avoid attacks by Democrats, Republicans did not want to be tagged as favorable to business, nor did they favor industrial policy, since this would offend party factions that oppose government intervention in any form.

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