Comments (113)

• Michael

  From June 2006:

  The U.S. national debt now stands at more than $8.3 trillion, of which more than $2 trillion is owned by foreigners. Since 2000, the percentage of U.S. public debt owed to foreigners has doubled.

  Take China for example. As of March of this year, China held over $321 billion worth of U.S. Treasuries, up from the $60 billion it owned at the end of 2000. Similarly, Japan now owns $640 billion worth of U.S. Treasuries, up from $317.7 billion in December 2000. Lately, however, America has also borrowed heavily from oil exporter nations (as defined by the Department of the Treasury), which include many nations that despise America. Luminaries such as Venezuela, Ecuador, Iran, Libya, Algeria, Indonesia and Iraq, and several other primarily Middle Eastern nations, now own $98 billion worth of U.S. debt.
  

  Published: April 9, 2007 12:01 PM

• Sudha Shenoy

  1. Following these figures, 'foreigners' -- ?central banks? ordinary investors? both? -- own just under a quarter of Federal govt debt. Just over three-fourths is held in the US.

  Note also that I've taken in the years upto & including _2004_.

  2. $US 98 thousand million is about 1.2% of $US 8.3 million million.
  

  Published: April 9, 2007 12:21 PM

• David White

  A truly wealthy people sells its products not its productive capacity. The US is trending rapidly toward the latter, however -- http://www.reuters.com/article/ousiv/idUSLAU86960620070408 -- and when the dollar is finally so devalued as to be not worth holding, expect China to ease out of the US bond market and let the yuan appreciate in hopes of going on a "Buy America" shopping spree targeting the tech sector.

  Expect the USG to implement capital controls to thwart this, however, in the run-up to the creation of an EU-like North American Union that will effectively naturalize the Mexican workforce -- http://www.humanevents.com/article.php?id=15233 -- papering over the dollar's collapse with the issuance of a euro-like currency -- http://www.amerocurrency.com

  Published: April 9, 2007 12:41 PM

• Gabriel Giménez Roche

  "The US capital account has been in net deficit since 1983. That is, foreigners have been sending more capital into the US than Americans have been sending out."

  Therefore, the situation described is one of net capital inflows into the US economy, thus, there is no net deficit in its capital account, but net surpluses.

  Nevertheless, I read many times in the Economist and other media about China and Japan holding together way more than 1 trillion dollars (http://www.imf.org/external/np/sta/ir/jpn/eng/curjpn.htm;
  and http://news.bbc.co.uk/2/hi/business/6106280.stm), in reserves which can play a role in massively devaluating the dollar and putting many portfolio positions at risk worldwide--if not simply provoking a financial meltdown.

  I believe, then, that there is possibly some reason to worry about massive dollar reserves outide the US...

  Published: April 9, 2007 1:58 PM

• Sudha Shenoy

  Gabriel:
  1. Yes you're right, my mistake; the _current_ a/c is in deficit, the _capital_ a/c is in surplus.

  2. As comment 1 pointed out, the Federal govt debt is estimated to be $US 8.3 million million. And foreign central banks are estimated to hold some $US 2 million million. So, as I mentioned above, that still leaves some 75% of the Federal debt _inside_ the US.

  D White:

  1. That 'productive capacity' is the _result_ of savings: 'foreign' savings entering the US. Take out imported savings & Gross Capital Formation in the US would _fall_. GCF is the combined result of both domestic _&_ imported savings.

  2. The Bank of China is imagined to hold around $US 1 million million, mostly in US$ but also in other currencies. Average _daily_ (daily) turnover on global foreign exchange markets is put at $US 2.7 million million. So the BoC reserves could, at best, influence a day or so of foreign exchange trading. After that, it would have nothing more to trade with. _NO_ govt can beat the foreign exchange market.

  Published: April 9, 2007 3:09 PM

• David White

  Sudha Shenoy,

  1. There are no savings, properly speaking, in a fiat currency regime, since by definition the "money" is created ex nihilo via the issuance of non-asset-based credit. That is, no work is done to produce a good that could accordingly be saved and with which the credit would be secured.

  That’s why the credit grows ad infinitum and why the global financial system must eventually collapse, as a point must come when the credit simply can’t be absorbed.

  2. The USG must borrow $2-3 billion a day from foreigners to finance its operations. Take the Chinese government’s purchase of US bonds away, then, and the Fed will have no choice but to step in and make up the difference, doing so with more ex nihilo money creation. As this would be highly inflationary, it will deliver a body blow to the already reeling housing market and hence the economy as a whole.

  That’s why the Chinese are in control and why they will pull out of the US bond market when the dollar is no longer worth holding, as vendor financing its US exports is rapidly reaching the breaking point.

  Published: April 9, 2007 3:39 PM

• Sasha Radeta

  Dr. Shenoy,

  When it comes to American capital account surplus, can we really be optimistic about it, considering our artificial credit creation policy at the beginning of this decade? As you know better than I do, artificially lower credit tends to take our resources away from consumers good (which would contribute to our current account balance) - toward capital goods and factors of production market (the source of a capital account surplus). "Increased length" of production structure is not compensated by its "reduced width," since money incomes increase... Production no longer reflects people's real time preferences and market readjustment to real market interest rate reveals malinvestments...

  Anyway, how comfortable can we be when it comes to capital balance data, in the absence of genuine market signals that would guide the production (and knowing that we were subjected to false market signals that could have produced an artificially large capital structure)?

  Regards.

  Published: April 9, 2007 3:54 PM

• Sudha Shenoy

  D White:

  1. Production contd even under the German, Hungarian, & Austrian hyperinflations after WWI. 'Hyperinflation' is defined to occur when the price index starts doubling every month. (Work it out.) Production requires _real_ goods, 'saved' from consumption & used for investment. Savings-investment & production contd in Germany even under price controls after WWII because of black markets.

  2. In 2004, Federal govt borrowing from all foreign official bodies came to some $US 1,081.4 million _per day_.

  (If I may say so: even ignorant comments are useful, since they mean more facts have to be dug up every time.)

  Sasha:

  1. The US trades in the _entire range_ of goods it produces: it exports _&_ imports _all_ types of goods. Consumer goods are only a minor part. In other words, foreigners buy from, _&_ sell to, the US -- _all_ sorts of goods: machinery of all kinds, raw materials, semi-finished goods, etc., etc. All this has been the same since the 1950s.
  It's worth having a look at the statistics: they come from customs declarations, so they refer to what people are actually doing.

  2. People invest their savings where they find investment opportunities. Since 1983, savings have increased esp. in Western Europe. Hence they have increased their investments in the US.

  Foreign investment in the US has come overwhelmingly from Western Europe since the late 19th century. This situation has contd since then; for over a century.

  Trade cycles are short-term. Production continues even through the most severe disruptions; see above on hyperinflations.

  I hope this has helped.

  Published: April 10, 2007 1:31 AM

• Gabriel Giménez Roche

  An additional comment: just China and Japan hold nearly 2 trillion dollars in reserves, but this does not mean that the other 75% of dollar emissions are wholly in the US. There is also Europe, Mexico, Brazil, Argentina, India, South Korea, etc... I would not dare say that the US holds only 50% of the rest, but it does not appear to be 75% as mentioned.

  Now, the interesting point is this. Although it is true that the US indebts itself massively in the foreign marketplace, the US indebts itself in dollars, but I got info that it then invests in a portfolio consiting in other currencies and other kinds of assets non-determined in dollars, effectively hedging itself against any dollar devaluation possible.

  The question then is this: can this hedge scheme really be successful if it is taken into account that any massive dollar devaluation could also drag other countries' currencies with it?

  Published: April 10, 2007 1:43 PM

• Sasha Radeta

  Dr. Shenoy, thank you for your response and your wonderful work.

  It is true that we sell goods other than consumers goods (it is also true that we import more than we export) and you made an important point about western European savings that fuel our higher stages of production... In other words, you pointed out that western European savings are not victims of an artificial, credit-induced boom that attracted them (Hayekian "forced saving" in introductory stages of an artificial boom)... Rather, you could argue, it was the Western Europeans since 1983 who created a genuine boom, and that central bank tried to follow the reduction of the real market interest rate (messing up on couple of occasions, though).

  However, according to IMF, savings rate of the Western hemisphere remains almost unchanged since 1983 (it was declining from 1983 to 1999 and with some fluctuations it went up since then). World's savings rate is also almost unchanged since then. The Japanese savings rate sharply went down since 1983, with some modest recent increases that Bernake overemphasized in his famous "savings glut" speech. In other words, the increase of European future consumption is countered by a reduction in savings in America and recently in Japan. Any increase in investment to the U.S.A. from western Europe was hence counter-balanced by a decrease in investment from the rest of the western hemisphere and Japan.

  When we observe the international economy in which we market our goods, it seems that larger future consumption -- at which this capital build-up is aimed -- is not supported by real increase in savings in this same area. That's why some people conclude that this capital account surplus in the U.S.A. and Europe is the result of typical malinvestments that keep on going as our powerful central bank keeps its loose monetary policy with some short breaks (recessions).

  Regards.

  PS
  I lived through a Yugoslavian hyperinflation of 1993/94 (I think it was the highest ever recorded), so I know how production keeps on going when central bank's printing press works 24/7. Even economy that suffers malinvestments continues with production, through painful readjustment. Primary emission of currency (the printing press) artificially increases current prices. However, inflation through credit expansion is different because its effects come with a time lag and they last longer (artificial credit increases prices of future goods) and it changes the structure of production in a different direction. Trade cycles are short-term, but our policy of artificially low interest rates follows every market readjustment, hence business cycles keep going and we always have a new bubble after the old one bursts.

  Published: April 10, 2007 2:49 PM

• David White

  Sudha Shenoy,

  As Business Week reported recently, "during all of 2006 the U.S. needed, on average, more than $70 billion a month in foreign funds to finance its current account deficit" -- i.e., over $2.33 billion a day -- adding that "In a speech in 2004, then Federal Reserve Chairman Alan Greenspan said: 'It is difficult to imagine that we can continue indefinitely to borrow savings from abroad at a rate equivalent to 5% of U.S. gross domestic product.' " -- http://www.businessweek.com/magazine/content/07_10/b4024037.htm

  And speaking of "ignorant comments," Ron Paul's piece today over at LRC must, by your standards, be the most ignorant of all:

  "The greatest threat facing America today is not terrorism, or foreign economic competition, or illegal immigration. The greatest threat facing America today is the disastrous fiscal policies of our own government, marked by shameless deficit spending and Federal Reserve currency devaluation. It is this one-two punch -- Congress spending more than it can tax or borrow, and the Fed printing money to make up the difference –- that threatens to impoverish us by further destroying the value of our dollars."

  Lastly, as for hyperinflation and production, yes the latter continues to some extent amid the former, but the former is the result the same corruption of money that has our trade deficit growing exponentially and indeed suicidally.

  Deficits matter. And we are going to find out all too soon just how much.

  Published: April 10, 2007 3:53 PM

• Sudha Shenoy

  Gabriel:

  1. As of Jan 2007, the entire US Federal debt came to $US 8.1 million million. _All_ (all)foreign holdings came to $US 2 million million. So around 75% of Federal debt is held in the US. The quickest source is the 'Skeptical Optimist' blog, of a professional economist; it has links to the US Treasury data.

  2. All central banks hold 'foreign exchange reserves', i.e., quantities of currencies other than their own. So the appropriate US entity does the same. This is simply standard central banking practice.

  3. 'Devaluations' occur when there is a 'fixed' exchange rate, a govt price control. Exchange rates have 'floated' since 1972, i.e., they are determined in the foreign exchange market, like any other price. Yes, the US$ may float down ('depreciate') against other currencies. But with floating rates, it is more likely to do this gradually, rather than suddenly.

  The foreign exchange market operates 24 hours a day, 5 days a week, from Sydney's Monday opening time to San Francisco's Friday closing time. So any drop -- or rise -- in the US$ will be determined by one of the most active markets on earth.

  Published: April 10, 2007 4:50 PM

• Sasha Radeta

  David said:

  the same corruption of money that has our trade deficit growing exponentially and indeed suicidally.

  Not trade deficits... they are irrelevant. Current account deficits.

  Also, I have a correction in my text (italicized):
  "When we observe the international economy in which we market our goods, it seems that larger production of future goods -- at which this capital build-up is aimed -- is not supported by real increase in savings in this same area."

  Published: April 10, 2007 4:55 PM

• Sudha Shenoy

  Sasha:

  1. Household savings ratios have certainly gone down, but GCF (Gross Capital Formation) ratios have remained reasonably steady. What I should've said is that _more_ of Western Europe's savings have been invested in the US since 1983. As I mentioned, this has contd since the late 19th century: it is not new.

  These investments are chiefly in specific areas of specialisation, eg, the Germans have invested in chemicals since the 1880s, the French in tyres, & so on.

  2. The capital structure has been gradually extended since Palaeolithic times. Trade cycles are superimposed on an extending capital structure. Cycles disrupt _some_ (not all) investments. But the longer-term extension continues.

  Mises points out repeatedly that the real world is çomplex'-- the result of many different influences all acting at the same time. The difficulty is to separate these various influences. Not at all easy.

  Published: April 10, 2007 5:06 PM

• Sudha Shenoy

  D White,

  1. The balance of payments refers to all transactions between the residents of one country & the rest of the world. When current payments 'out' exceed current payments 'in', the current a/c is said to be in deficit.

  The counterpart of a current a/c deficit is the capital inflow from abroad, which appears on the capital a/c.

  2. Govt raises revenue & spends monies. When govt spending exceeds revenue, the budget is said to be in deficit.

  Same word, two _different_ situations.

  3. As pointd out above, the US budget deficit is largely covered by borrowing within the US: slightly less than one-fourth of the Federal debt is held abroad.

  The US Federal govt certainly borrows abroad to help cover its budget deficit. These borrowings, as already pointed out, are a fraction of the foreign capital inflows into the US. These foreign inflows are the counterpart of the US current a/c deficit. This last refers to the balance-of-payments, not the US govt budget deficit.

  3. Ron Paul spoke throughout about the US budget deficit. He made _no_ reference to the balance-of-payments.

  Published: April 10, 2007 5:23 PM

• David White

  Sudha Shenoy,

  The fact that you don't understand the connection between budget deficits and trade deficits -- and completely misunderstand what Mises so well understood about the "balance of payments" -- makes it clear that you, like Robert Murphy, do not understand what the corruption of money is all about.

  Prepare to watch your savings wiped out accordingly, as you stand on the beach staring at the tide being sucked out, oblivious of the massive wave on the horizon.

  Published: April 10, 2007 8:09 PM

• Sasha Radeta

  David White,

  Take it easy and be thankful that you got the opportunity to have a corespondence with someone like Dr. Shenoy, who probably heard and considered all our arguments many times before.

  I think that it is obvious that Dr. Shenoy understands the effects of corruption of money, but she disagrees that our capital structure is so significantly pushed into malinvestments as some of us suggest. Dr. Shenoy explained why she believes that we underestimate real savings-investments, which would under normal circumstances lead to smaller investments in consumption goods (not making this area less competitive, since present consumption goes down) - but it would correctly increase the investments in higher stages of production. Hence, price differential between stages of production would go down, making returns on savings-investments lower (genuine interest rate goes down)...

  If you object to Dr. Shenoy's arguments, you have to ask the right questions about savings and nature of our lenghtened capital structure.

  
  =====================

  Even if gross investment figures were accurate and showed a rise, there is still an issue of falling household or “plain” savings (future consumption of present goods) that are also a part of investment base… As we know, other types of investments can be induced by artificially low interest rate (‘forced saving” as Hayek called it, and many economists misunderstood that term) and I wish we can be cheerful about them in a centrally planned monetary system.

  Dr. Shenoy said:

  Household savings ratios have certainly gone down, but GCF (Gross Capital Formation) ratios have remained reasonably steady.

  In other words, saving-investment is not increasing (??), but interest rates went down (with some periodic time outs). Wouldn't these decreases in interest rate lengthen the production structure, without narrowing it (lowering present consumption and prices of final goods)? Without increases in savings, why would we even think about genuine lengthening of the capital structure? Decreases in interest rate would only lead to overinvestment in highest stages of production and underinvestment in lower stages.

  Yes, Germans and French are investing their genuine savings into their areas of specialization (toward satisfaction of their real future consumption), but our economy consists of much more than that, as you also pointed out. You were correct in noting that production structure has lengthened since Paleolithic time, but it has also narrowed. There were, however, times when production structure shortened and widened, like after the decline of Neolithic cultures (demise of Vinca-Starcevo culture and influx of Kurgans, or dark ages that much later occurred after the demise of Minoan civilization, etc.)... Anyway, our concern is never a genuine change in length of production structure, but the accompanied adjustment in current consumption.

  Mises was correct in stating that he world is complex... You raised many important issues for further consideration. Thank you for your response.

  Published: April 11, 2007 1:02 AM

• Sasha Radeta

  Just to correct and clarify my statement before the blockquote:

  bank credit cannot increase genuine investments by one iota, but the hidden inflation can cause overly optimistic figures... I guess that time will tell.

  Published: April 11, 2007 1:29 AM

• Sudha Shenoy

  Sasha:

  1. You want to have a look at Monetary Theory & the Trade Cycle, pp. 200-203, in which Hayek discusses why: "In the economic system of today, interest does not exist in the form in which it is presented by pure economic theory." There are (he goes on) a variety of interest rates in the real world, none of which corresponds with the rate discussed in economic _theory_. Also see p.207: "the height of interest rate...expresses itself in the whole structure of price relationships..."

  Also see his discussion in Prices & Production on the 'price fan'.

  Theory is a tool which has to be used. The real world doesn't just fit neatly into theoretical slots. Theory rather is a guide to looking for the essential. As Hayek says, the latter is an art in itself.

  2. Trade: as I mentioned, the _entire_ range of goods is traded, ie. goods that enter into _every_ stage of the production structure. The latter ignores _political_ boundaries (see the table in my piece on 'The Global Division of Labour' (I think that's the title) on this site.)

  3. Extension of the production structure cannot be read off simply from GCF ratios or some other immediately available statistic. As the table shows, it's a bit more complex.

  Good luck.

  Published: April 11, 2007 3:20 AM

• David White

  Sasha Radeta,

  The bottom line is that, regardless of credentials, apologists for trade deficits are apologists for money corruption and the perpetuation thereof. And were they true to Austrian economics, they, like Peter Schiff and Michael Panzer -- http://www.safehaven.com -- not to mention Ron Paul and Alan Greenspan, would be arguing vehemently against our thoroughly corrupt monetary system and helping people prepare for its inevitable collapse.

  Published: April 11, 2007 7:01 AM

• Gabriel Giménez Roche

  There is a confusion going on here. The almost 2 trillion dollars Japan and China hold are not US debt, but actual dollar reserves. Hence, it is probable that the other countries could easily have between 1 to 2 trillion dollars in reserves too.

  Added to the reserve question, is the debt question. According to Prof. Shenoy, there is a US debt which is held by foreigners amounting to 2 trillion dollars.

  Of course, perhaps a part of the reserves are being used to buy US debt which would forbid plain addition of US debt held by foreigners and dollar reserves held by these same foreigners, but I doubt that the foreign-held US debt equals their dollar reserves. Thus, the problem is much bigger than just 2 trillion dollars.

  Regarding those savings being invested in the USA. Come on, how can we know that those savings are really derived from real money? That is, how can we know that we are talking about real credit (fully covered by money) and not just more fiduciary credit? In most parts of the Western world, wage-earners receive their wages in form of bank deposits or checks. We cannot easily say that any savings they make out of their wages will then be real savings originating real credit.

  One of the great problems of the modern fractional-reserve monetary system is that once you have a deposits account (and today even savings accounts are prone to be "fractionalized") there is no way to say that your account will be covered or not. This really is corruption of money.

  PS: You are right Prof. Shenoy, the term I should have used is "depreciated" and not "devaluated", sorry.

  Published: April 11, 2007 7:23 AM

• libertyfirst

  Some time ago I believed that the most convincing evidence of US fiduciary folly was the low saving rate: americans are selling their capital structure because they want to consume everything here and now, thanks to monetary policies.

  But I read that the saving rate is computed differently in the US and in EU, for in the US it does not take into account certain elements in the retirement system. So, I'm actually not sure about the fact that the US is ina a consumption/driven indebtment boom, a huge problem that causes the otherwise irrelevant trade deficit.

  The fact that capital accumulation keeps on is the result of capital imports from foreign countries, but the problem that americans are becoming in a real sense "proletarians", living thanks to the savings of japanese and chinese "capitalists", is a risk whose validity I cannot judge withouth a deeper understanding of the saving rate figures.

  If it is true that americans are saving too little and consuming too much, and it is not a statistical/accounting illusion, than the problem exists. Even though the trade deficit is only a symptom of the problem, there is nothing to be happy about losing all capital properties and live on the other people's savings.

  Published: April 11, 2007 7:38 AM

• adi

  I see problem here as many participants of this discussion have used aggregate analysis to justify their points of view.

  Problem is that Austrian economics is not well suited for aggregate analysis since it deals with the level of individual choices. Macroanalysis is more properly Keynesian and so when arguing we are forced to use statistical conventions and rules which are often based on totally different theoretical foundation.

  It's pure accounting convention to say when country imports more than it's exporting that it has trade deficit. And when it's importing capital (foreigners investing in securities and so on) it has surplus in capital account. But we cannot say what happens in the economy just by looking these statistics.

  It's no crime for the profitable business venture to loan funds from abroad to make productive investments in home even if foreigners are getting their share of ownership of this business. This has nothing do the with residents of this country being wealthy or not.

  Published: April 11, 2007 9:17 AM

• Sudha Shenoy

  Composite comments:

  1. US dollar 'reserves' _are_ Federal govt debt: US Treasury securities, short- & long-term. Foreign central banks don't hold bundles of US dollar notes, or other foreign currency notes. Central banks buy securities that give them some interest earnings. These are known as 'foreign exchange reserves'.

  2. To repeat what I said in the blog: I looked at the period 1983-2004.(See later for why that period.)I looked at all capital coming into the US. This consists of both private & central bank capital.

  Three-quarters (75%) of the capital coming into the US is private (private) capital, being invested in the private sector. This private capital comes overwhelmingly from _Western Europe_, & it has been coming into the US since the 1880s at least. Also, _private_ Japanese (& other) investment has been coming in over the same period.

  Thus such foreign private investments have in fact been coming into the US for some 125 (125) years now. They are not(not) new.

  In short: Since the 1880s, capital accumulation inside the US has _included_ foreign investments sent in mostly (but not entirely) from Western Europe.

  So no American is in the slightest danger of becoming a wage-slave to a thin Japanese capitalist. Americans have been using mostly Western European (& Canadian) capital, in addition to their own, for 125 years.

  3. For the years 1983-2004 (22 years), less than 14% of the total capital inflow consisted of central bank purchases of Federal debt (='reserves'.) An additional 9% or so consisted of private foreign purchases of Federal debt.

  The Bank of Japan has been holding US Federal debt for some 55 years or so, ie for over half a century. The Bank of China has done so for around ?10-15? years. In Jan 2007, their holdings came to around 11.5% of total Federal debt. Other foreign central banks hold somewhat more than that. And remember: over 75% of Federal debt is held within the US.

  So no American _can_ be held to ransom by the Bank of China or the Bank of Japan. Look at the figures.

  4. Why the years 1983-2004? Because in 1983 capital coming into the US exceeded that going out for the first time. Some 15 or so years _later_, journalists & politicians suddenly saw this & the sky began falling. I thought a little perspective -- & the facts -- would help.

  
  

  Published: April 11, 2007 10:37 AM

• Sudha Shenoy

  Correction: Private Japanese investment in the US dates mostly from the 1980s. Japan has been _buying_ American timber & wheat since the 1880s.

  Published: April 11, 2007 10:47 AM

• Sasha Radeta

  And yet again, from the standpoint of Austrian school of economics, we wouldn’t expect a net capital outflow of an artificially booming economy. Quite the contrary, in such scenario we would see more recorded dollar investments after the credit is created out of thin air (more investable paper in circulation). As the interest rate goes down, rising prices in early stages of production misinform investors about the real prices of future goods in America. Just like our own investors, foreigners also get lured into bidding up our factors of production and capital, redirecting savings-investments from productive uses into malinvestments. At the same time, the genuine saving (future consumption) does not seem to be going up, as foreign goods replace our own in consumers goods, our final goods prices still keep increasing, and household saving is dropping dramatically (especially after the housing bubble)…

  I guess the time will tell. I hope that Dr. Shenoy is right, with all my heart.

  Published: April 11, 2007 1:22 PM

• Paul Edwards

  This has been an extremely challenging thread to attempt to follow, and i have to admit, i haven't done a very good job of following it. But the general topic interests me, and i'm interested to see if people feel that what Rothbard has said here is related at all:

  - from Making Economic Sense -

  Myth 4: A major cause of the crash was the big trade deficit in the U.S.

  Nonsense. There is nothing wrong with a trade deficit. In fact, there is no payment deficit at all. If U.S. imports are greater than exports, they must be paid for somehow, and the way they are paid is that foreigners invest in dollars, so that there is a capital inflow into the U.S. In that way, a big trade deficit results in a zero payment deficit.

  Foreigners had been investing heavily in dollars—in Treasury deficits, in real estate, factories, etc. for several years, and that’s a good thing, since it enables Americans to enjoy a higher-valued dollar (and consequently cheaper imports) than would otherwise be the case.

  But, say the advocates of Myth 4, the terrible thing is that the U.S. has, in recent years, become a debtor instead of a creditor nation. So what’s wrong with that? The United States was in the same way a debtor nation from the beginning of the republic until World War I, and this was accompanied by the largest rate of economic and industrial growth and of rising living standards, in the history of mankind.

  Published: April 11, 2007 3:47 PM

• David White

  Paul Edwards,

  Hmmm, a surprisingly contradictory passage by Rothbard. Yes, it would be nonsense to have a trade deficit, but only in a sound money economy, as payments would always balance out, precisely as Mises said. Not so in an economy based on a non-asset-based (work-free) currency, as ALL trade is accordingly "in deficit." For as credit is its basis, so must debt be. And however much a poor (relative to Europe) emerging nation needed to borrow to expand production, the borrowing that the US is now engaged in is altogether different from its pre-WWI, gold standard debt. And if anyone's going to try to tell me that Rothbard would, were he alive today, approve of the fact that the US government's operations depend on over $2 billion a day, and counting, in foreign purchases of its bonds, then I've got trillions in mortgage-backed securities to sell you. (Speaking of which, the National Association of Realtors just predicted the first nationwide decline in housing prices in 38 years (a rather nice correlation with Nixon's closing of the "gold window" 36 years ago, no?)

  And lets' face it, amid the massive foreign "investment" in the dollar in recent years (i.e., buy US Treasuries or watch your own paper nothings appreciate, stifling your exports), what we have witnessed isn't a stronger dollar but a vastly weaker one, and indeed a dollar that seems destined to decline to the vanishing point. It can only be saved at the expense of the economy, after all, as the Fed can only do so by raising interest rates, delivering the knockout blow to housing, hence the knockout blow to an economy dependent on the consumption that has been driven by a "housing ATM" that is rapidly disappearing.

  Bottom line: An economy based on a work-free currency is an economy based on a credit Ponzi that, as Greenspan himself admitted, is unsustainable, the only question being how long the powers that be can perpetuate it.

  Published: April 11, 2007 4:46 PM

• Paul Edwards

  David,

  So it sounds as if you think his comments relate to the topic of this thread. Based on this, i will put forth my view which is this: Whenever people complain about balance of trade deficits etc, what they are really fundamentally observing is that fiat money, and monetary inflation is bad for the economy, and possibly they are also observing that it is also criminal.

  My view is that a discussion of trade deficits obscures discussion of the real problem of inflation, by discussing an issue that is fundamentally neither good nor bad: a trade deficit.

  One can point to inflation and demonstrate through praxeological reasoning, how it is bad. It is not similarly possible to point to a trade deficit or low personal savings rates and show that these things are bad, other than to show that it has been influenced as a consequence of central bank interference with the money supply in the market.

  So for these reasons, I think it is optimal to keep discussions focused on monetary inflation, since it is truly and necessarily the problem, and leave the question of trade deficits, which will also occur and are not a fundamental problem, in a free market.
  

  Published: April 11, 2007 6:13 PM

• David White

  Paul,

  Trade deficits would not be "a fundamental problem in a free market," the problem being that a free market cannnot exist without a free market in money. Which is to say that since inflation, per se, could not exist in any meaningful sense in a truly sound-money system, debate about trade deficits does indeed "obscure discussion of the real problem."

  That's what I mean when I say, repeatedly, that the issuance of non-asset-based currency ifso facto creates a "deficit" no matter whether the debtor is "them" or "us." By its nature, it is inflationary and therefore inimical to the social enterprise. Acccordingly, it cannot but end in disaster, the more so the longer it is perpetuated.

  Published: April 11, 2007 8:36 PM

• Paul Edwards

  David,

  It sounds like you are advocating the ABCT, to which i also subscribe. Then i must now expose my ignorance and ask the following: amongst the austrians participating in this discussion, is there any dispute over your position and the nastiness of a fraudulent fiat currency, or central bank inflation, or bank credit expansion? I would think we would all be on the same page in this respect. What i mean is, surely the validity of the ABCT is not controversial amongst austrians.

  Published: April 11, 2007 8:52 PM

• Sasha Radeta

  Paul,

  You can see Rothbard refuting the "trade deficit" as a cause of the crash... yet, "trade deficit" is irrelevant measure (exchange of goods only, without services or unilateral transfers) and we focused on current account defects instead.

  Anyway, if we imagine our economy as a household, it is perfectly logical what Rothbard said... We can easily imagine a farmer who forsakes his present production of goods and services, (he buys more than he sells in dollar value -- with money going out of his pocket in that respect) and also reduces his present consumption, BECAUSE he wants to invest his saved money on revolutionary new technology that will improve production of final goods -- and with inflow of investment he is able to compensate for that outflow of money from trade.

  HOWEVER, imagine that this farmer did not reduce his consumption and actually spent more money on goods and services than before -- on credit. At the same time, imagine that his investment in new technology did not come from his savings (he is a lousy saver), but from artificially created credit. Imagine that he spent this easy "money" on investments not really needed for future consumption (there is no increase in savings), simply because an asset bubble made him think it is very profitable... Suppose that neighboring farmers (foreign investors) were also lured by that artificial growth in value of his capital and factors of production, which further fuels that malinvestments and neglects his production of consumers goods (which further increases his current account deficits)...

  Do you see how these scenarios are completely different. Do you think that America is more like that careful farmer, who uses his genuine savings (reduced consumption) to invest in higher stages of production.... OR do you think we resemble more to this carefree farmer, who doesn't sacrifice his consumption (far from that) and he fuels investments with fraudulent credit, investing in something that's not really needed for the future consumption -- but he actually got lured by artificially increased prices and profits?

  Think about it...

  Published: April 11, 2007 10:36 PM

• Sasha Radeta

  Just for other folks who may be not so familiar with Austrian theory, I owe a response…

  Dr Shenoy said:

  Sasha: 1. You want to have a look at Monetary Theory & the Trade Cycle, pp. 200-203, in which Hayek discusses why: "In the economic system of today, interest does not exist in the form in which it is presented by pure economic theory." There are (he goes on) a variety of interest rates in the real world, none of which corresponds with the rate discussed in economic _theory_. Also see p.207: "the height of interest rate...expresses itself in the whole structure of price relationships..." Also see his discussion in Prices & Production on the 'price fan'.

  I actually subscribe to Rothbard’s response to that (Man, Economy and State, Ch 6, p. :

  “…suppose that the uniform interest rate in the economy is 5 percent. This is 5 percent for a certain unit period of time, say a year. A production process or investment covering a period of two years will, in equilibrium, then earn 10 percent, the equivalent of 5 percent per year. The same will ob­tain for a stage of production of any length of time. Thus, irregu­larity or integration of stages does not hamper the equilibrating process in the slightest.”

  ----

  We have to differentiate pure rate of interest from risk factors and other differences between goods? Why? Because we’re concerned what will increased credit do to interest rates and all structures of production, ceteris paribus. Just like any other inflation, credit infusion does not change these other, inherent, differentiating factors like risk, so we can focus on common factor behind any interest rate.

  Rothbard’s passage was difficult for me after the first reading a while ago, but after the second one -- I actually realized this is quite intuitive. Yes, we have a variety of price differentials between stages of production in the economy, but what causes differences in prices between different stages of production - in all goods? The common factor is: time preference, which determines capitalist savings (investment). Just like all human beings, capitalists value present goods more than future goods. When they buy factors of production (land, labor, higher order capital), they are actually buying future goods at some discount. It is just like when a saver decides to give someone loan, buying future money with a discount. Capitalists’ lower time preference indicate that they decide to invest more, bidding up the prices in higher stages of production, hence reducing difference between these different stages (return on their saving is smaller -- interest rate is decreasing).

  Imagine an evenly rotating economy, in which there is no uncertainty (we’re trying to isolate the effects of time preference). Suppose that for car manufacturers, the differences in prices of different production-stages are 5% -- while at the same time these price differentials for trucks are 10%. Naturally, capitalists will shift their resources from inputs of car manufacturing, toward inputs of truck manufacturing. Consequently, inputs for cars will become cheaper, while inputs for trucks will become more expensive. Consequently, the interest rate will tend to equilibrate. Now you can factor in the risk for each industry…. Prices of final goods fluctuate, but that also reflects in demand for inputs and pure interest rate is restored.

  What’s my point? Well my point is that the effects of credit infusion cannot only stay isolated in one particular good or an asset bubble. Normal equilibrating process occurs even after the credit expansion, but now with the abundance of artificially created funds As a consequence, we have widely dispersed malinvestmets (production that does not relate to a real future consumption, i.e. savings). Specific bubbles are created when consumer’s credit propels the prices of some types of good (increasing the returns on inputs of that good and luring producers there), but credit injections are never limited to one specific area and you can’t argue that other sectors are healthy and in correspondence with real time preferences of consumers.

  Published: April 11, 2007 11:56 PM

• Sudha Shenoy

  Sasha:

  1. "...foreigners also get lured into bidding up..."

  As I just pointed out, foreigners have been doing this since the 1880s. That is, they have been lured into making investments in the US for some 125 years now. If (if) we're talking about happenings in the real world, this has to be borne in mind.

  2. Hayek was pointing out the _complexity_ of the real world. Rothbard was developing 'pure' theory -- ie, _without_ real world coplications.

  Published: April 12, 2007 12:31 AM

• Sasha Radeta

  Dr. Shenoy,

  1. The fact that foreigners have been investing in the U.S. economy during the good old days could actually suggest that they could be slow to realize if we are indeed subjected to an artificial boom. Our tradition of success, stability, the rule of law... all that could lure foreigners into malinvestment induced by the FED... I'm not claiming that this is happening today, I'm just generally hypothesizing.

  2. Rothbard's "pure" theory was necessary to isolate pure interest rate and to determine the effects of credit injections. Another example of pure theory are the laws of supply and demand, which are equally true. The fact that we have more complex workings in the real world does not change economic axioms that still work in the real world, although some other factors can mask them (hence, we have many economists who try to prove that law of demand does not hold).
  

  Published: April 12, 2007 12:46 AM

• Sudha Shenoy

  Sasha:

  1. Foreign investment patterns in the US have remained unchanged (more or less) since the 1880s. That is, they have contd (more or less) in the same lines as before. Note also that the investing has contd without any break, ie, continuously (except, of course for wars.) So _if_ we're talking about foreign investment coming into the US in the early 21st century, _then_ we're looking at a development which has contd for 125 years & more. We're not considering a development which has just begun, or is only a few years old. -- Pure theory of course cannot tell us this.

  2. Hayek was saying that real world complexities have to be included when discussing the real world.(See above.) He was _not_ saying, economic theory stops working once you go to the real world. He points to the fact that there are millions of real-world interest rates, _none_ of which correspond exactly with "the" interest rate of pure theory. So if (if) we look at the real world, this _has_ to be taken into account. Pure theory cannot _also_ tell us about the specific developments already going on in the specific real world situation we may be looking at. (see above.)

  If (if) we're looking at a particular context in the real world, _then_:- What are the particular complications found in that particular context we're looking at? That must also be considered?

  Hope this is useful.

  Published: April 12, 2007 1:47 AM

• Sasha Radeta

  Dr. Shenoy,

  Thank you for your interesting response,

  1. "Patterns" may have a clear significance in natural sciences. However, when we talk about social sciences we must consider the deeper meaning of a pattern. For example, a long tradition of healthy investments in the United States may have lured foreigners into malinvestments and what we see as a pattern does not have to be so positive.

  2. You were absolutely correct when you cited Hayek, restating that real world complexities must be taken into account when discussing the real world. However, all basic economic axioms are derived from imaginary construsts, with the ceteris paribus assumption.

  For example, there is no other way of isolating the law of demand in the real world, but to assume that demand and supply are not shifting due to numerous factors. These shifts made some "economists" think that law of demand is something relative or false. However, the law of demand always holds true and any price tamperings can be devastating for an economy.

  The same goes for the effects of artificial credit on interest rates across the economy. When we take all the uncertainty factors into account, there is still a fundamental reason behind every interest rate -- and these rates of time preference tend to equilibriate in a market competition, based on the simple logic that higher returns (after risk factors are accounted for) will always attract investors from sectors with lower returns. Therefore, credit inflation gets dispersed throughout the economy and cause higher prices of inputs (lower interest rates), just like any inflation disperses and affects general price level, ceteris paribus.

  I hope I explained my ideas somewhat better.

  PS
  Your replies are always useful. We need you more on this blog!

  Published: April 12, 2007 2:55 PM

• Paul Edwards

  Sasha Radeta,

  It appears to me you are merely restating the ABCT. I fail to see what is controversial about what you are arguing. Is the argument between people who subscribe to ABCT and those who don't?

  Fiat money, central bank inflation and bank credit inflation cause booms and busts, malinvestments and liquidations. All of this can be analyzed based purely on the effects of monetary banking mis-deeds.

  Do you or does anyone think that consideration of international payment deficits or current account deficits adds anything to the analysis?

  Published: April 12, 2007 7:48 PM

• Sasha Radeta

  Paul,

  Of course you fail to see what is controversial about what I am arguing. I never claimed any controversy, nor I aimed at it. My approach to ABCT is slightly different than Rothbard's and Hayek's but that could be due to my unforeseen error... But that's not important.

  Anyway, I decided to take Rothbard one step further and I explained why capital account deficits can be the result of a typical business cycle -- and why capital account surplus does not have to be something to cheer about. Actually, I tried to clarify that point to you in oversimplified terms (using those two farmers in my example... both have current account deficit and capital surplus -- however, they have a completely different outlooks and one is destined to fail)...

  Anyway, if you decide to read this thread more carefully, you will see what Dr. Shenoy was getting at and why she disagrees with Stefan Karlsson's pessimism, as well as my skepticism, regarding the U.S. capital surplus and account deficit.

  Regards.

  Published: April 12, 2007 9:27 PM

• Paul Edwards

  Oh, thanks. I might not delve into it any further. I was just hoping for the bird's eye view of the discussion. I, myself also see little to be pessimistic about in observing international account deficits, that i am not already pessimistic about based on watching federal reserve money creation and bank credit expansion.

  Thanks a million.

  Published: April 12, 2007 9:50 PM

• Sudha Shenoy

  Sasha:

  So far as private foreign investment goes:
  (1) FDI (Foreign Direct Investment):- the _kinds_ of investments have remained the same for 125 years (chemicals, tyres, etc.) (2) Secondly, foreigners have been investing in American stocks & shares. (3) Then, they have invested privately in various companies, held bank deposits, etc.

  See the original post, where I give the proportions of various types of foreign investment for the 22 years 1983-2004.

  Published: April 13, 2007 12:03 AM

• Sasha Radeta

  Dr. Shenoy,

  My point was: we don't need massive foreign holding of debt and cash to feel negative consequences. Even direct investments in an economy that is pumped by an artificial booms and fraudulent credit can cause great harm in malinvestments.

  Was the point of your original posting to deny Mr. Anderson's claim about “….ominous growth in dollar denominated debt instruments held by foreign central banks?" He was probably referring to the fact that the percentage of rising public debt held by foreign investors went up from 35.9% in 2000 -- to 51.6% in 2004, which is the highest portion in at least 40 years. But that's just another historical pattern, so it must be good, right: http://www.urban.org/PublicationImages/1000618/1000618_Image.gif

  ==========================================

  As far as private foreign investment goes:

  (1) FDI = 18% -- fell sharply after the year of 2000. In 2004, direct investments fell to the lowest levels since 1994. The "kinds" of investments remained "the same" for 125 years, largely due to the fact that the basic clasifying nomenclature has not changed (in spie of new invention, we still clasify things under manufacturing, wholesale-trade, retail, etc). Only about a third of FDI in the U.S. is held in the manufacturing sector. Some 20.5% of FDI is invested in the banking and financial services sectors (fiat, bubble-making machine). Graphically, the effects of artificial booms on FDI looks like this (they got really burnt in 2000): http://www.bea.gov/bea/newsrel/fdinewsrelease.htm

  (2)Private portfolio investment (i.e., purchase of stocks & shares by foreigners) = 31.4% -- subject to bubbles and crashes, due to our fiat currency and artificial credit pumping.

  Private bank deposits & holdings = 14.6% -- Our fiat coming home :) Monetary holdings that are tomorrow's claims on goods and services, leading to a potential for higher inflation, especially if we decide to bail-out the victims of the housing bubble and keep policing the world (now situation in Kosovo threatens to escalate, as if Iran was not enough).

  US govt. debt = 22.5% -- I covered that in the introductory part. It keeps going up http://preview.xignite.com/xstatistics.asmx?op=xDemo&demo=xStatistics.aspx&list=y&topic=M3 ...To contrast it: The 1982 Special Analyses of the Budget (page 117) notes that "The federal debt during most of American history was held almost entirely by individuals and institutions within the US. In 1946, the debt held in foreign official balances was about $2 billion, less than 1 percent of the debt held by the public. In the following years the debt held abroad tended to grow gradually and rose to $10 billion in the late 1960s."

  ----------------

  How should all this mitigate my scepticism?

  Published: April 13, 2007 2:14 AM

• Sudha Shenoy

  Sasha:

  1. Have a look at: The Skeptical Optimist, updated pie chart. It contains further links to the US Treasury data. (Sorry - I don't know how to put the link into the comments here.) 3/4 of Federal debt is held in the US, as of Jan 2007. Of the rest, the bulk is held by foreign central banks. These figures include changes in the last few years.

  2. FDI has always fluctuated: see the balance-of-payments figures in the annual Statistical Abstracts. And obviously any investments _in_ the US will experience whatever is happening to _all_ investments there. But foreign investments in the US are not a recent development -- they have been coming in since the 1880s. So they have gone through whatever has been happening in the US, economically, over that length of time.

  3. Foreign FDI in the US is broken down further by type & country in every Statistical Abstract. There are investments in chemicals, petroleum, wholesale trade,& more recently, 'information'. German investments in chemicals; Dutch investments in 'petroleum' (Shell), & in 'manufacturing' (Philips); UK investments in 'petroleum' (BP); Swiss investments in 'manufacturing' (Nestle's)& finance & insurance have been there from the start.

  Foreign investments in finance are specified as non-banking. There have been such investments & in insurance from the start, eg Canadian investments in insurance.

  4. Foreign private portfolio investment has also been there from early days; it has grown significantly since 1990 or so, ie, for some 17 years. _In_ the US it is subject to whatever the US is going through, economically; but its origins are abroad.

  5. Foreigners have also held bank deposits in the US from the start: to help payments from & to US residents & for other business purposes. These deposits have of course fluctuated very considerably; they have risen since the mid-1970s -- i.e., as trade grew.

  Published: April 13, 2007 6:14 AM

• Sasha Radeta

  Dr. Shenoy, I completely agree with everything you said, yet I can't derive a positive conclusion.

  You can see from the fluctuations in FDI that they are carried up and down by our business cycles.

  In other words, any capital surplus attributable to FDIs or foreign holdings can mean very different things for different economies... In a healthy economy, they have positive effects, while in an inflationary environment they can aggravate artificial booms and busts and we can't a priori cheer about it, until these investment's start producing goods that will bring more money into this country than it's coming out. Even in the manufacturing sector (which accounts for about 1/3 of FDIs), we see the consequences of artificial booms -- and I tried to explain the pure theory behind this dispersion of credit inflation. The same goes for banking -- we can't equate investments during the gold standard with bubble driven financial sectors today.

  As far as debt goes, let's take a look at Skeptical Optimist pie chart. http://www.optimist123.com/optimist/images/2007/04/09/piechart200701.gif

  It is showing a "intergovernmental debt" of governments (what the members of gang "owe" to each other with our money)... Let's focus on public debt portion. The chart shows that public debt held by foreign debt was $2,240 billion in Jan. 2007. Compare this to Nov. 2005, when the estimated combined total of all foreign holdings was $2,065.5 billion. http://www.house.gov/berry/crs/RS22331.pdf

  So the fact remains that in past fiscal years, the government's foreign debt increased by almost $200 billions. And that should make us feel good, because our own internal debt went up by a higher rate, as the government's nondiscretionary spending explodes???

  I am trying hard, but I can't make a positive spin, neither on our debt and bubble driven capital account surplus -- or on our malinvestment driven current account deficit. I'm trying, but alas...

  Published: April 13, 2007 1:30 PM

• Sasha Radeta

  Correction: "intergovernmental" should read "intragovernmental," obviously, since it refers to government's internal "debt" (pseudo-debt, since none of the money actually belongs to the "lender," but to the American people).

  Published: April 13, 2007 1:51 PM

• Sudha Shenoy

  Sasha:

  It's a question of (a) perspective (b) hitting the right target(s).

  1. Federal debt: Intragovtal or not, the bulk of the debt is held in the US. The totals held, mainly by central banks, outside the US are the _minor_ part -- & this includes recent changes. So IF (if) our target is the growth of US Federal debt, then this target is _domestic_. Attacking the wicked foreigner is a standard diversionary tactic of politicians. And in this case, it focusses attention on the _minority_ of the debt.

  2. FDI, as I've mentioned, has been going on for at least 125 years; & the areas of investment have remained largely the same. FDI(or other foreign investment) is only a tiny fraction of total US investment -- again, the overwhelming bulk is domestic. So again, going after the wicked foreigner is a diversionary tactic. US monetary policy is made in the US -- & IF the target is lax US monetary policy, then this too is a domestic target.

  Foreign investment has always been around. To focus attention on something which, in the US case, has been coming in for some 125 years, is to divert our attention away from the _real_ issue. That is, if the target is US monetary policy.

  I hope this helps to put things into perspective.

  Published: April 14, 2007 1:08 AM

• Sasha Radeta

  Dr. Shenoy,

  Thanks for your perspective. However, I almost have nothing to add to or subtract from my last posting.

  1. Foreign ownership of the U.S. debt continues to rise and in 2006 it went up by almost $200 billions. In other words, Mr. Anderson was correct -- foreign ownership of our debt increase dramatically and if there is a high potential for inflation from their currency holdings. The fact that most of the recorded "debt" consists of intragovernmental exchange and increasing domestic debt does not make the enormous size of foreign debt any smaller.

  2. As you can see from the historical data, FDIs dramatically go up during the artificial booms, and then dramatically go down. This means that they can drop dramatically, just like in 2000.

  When you discount these bubble effects and debt -- that’s my perspective on our capital surplus and account deficits…

  Regards.
  

  Published: April 14, 2007 1:59 AM

• Sudha Shenoy

  Sasha,

  1. US Federal debt is the other side of Federal spending. That is: the debt finances spending. That is why the debt is significant (whoever holds it.)

  Between Jan 2006 & Jan 2007, US Federal debt:
  +$US 511.5 thousand million.
  US holdings +$US 462 thousand million.
  Foreign holdings +$US 49.5 thousand million (US Treasury data.)
  Thus foreign holdings (mainly central banks) are becoming a smaller _proportion_ of the US Federal debt.

  2. Yes, US economic activity fluctuates. So does foreign economic activity. So foreign investment into the US _also_ fluctuates.

  The fluctuations in US economic activity are caused by Federal monetary policy. Foreigners cannot control this.

  Published: April 14, 2007 5:20 AM

• KY Leong

  Having learnt much from the participants in this stimulating thread, I now feel the courage to dive in to add an Asian perspective. Hopefully I won’t contribute to more confusion.

  First, I think there is no dispute over the existence of long distance trade and int’l division of labor since ancient times. The Chinese e.g. were trading with the Arabs at least from the Han period (some 100+BC) onwards; the Romans had garments made from silk produced by the Chinese. Han and Tang dynasty junks sailed the South China Sea and brought tea and fine ceramics to SE Asia in exchange for gold, ivory and spices. During the Shang period (16th -11th Cent BC), luscious jade stones were arduously transported from the Kunlun mountains (Xinjiang) across the Taklamakan desert by Afghans and brought to the Chinese central plains, to be fashioned into exquisite jewellery and fine ornaments for the nobilities. Recent archaeological finds strongly suggest the presence of cultural exchanges between the Liangzhu Culture (4500 BC) of the Shanghai region (coastal eastern China) and the late Neolithic peoples of the Szechuan highlands (S W China).

  Question is – what did they use for money? Of course, they simply bartered in the beginning. Then came the unification of the Middle Kingdom by the Qin (Shi Huangdi) around 200+ BC, and int’l trade subsequently expanded during the stable and prosperous Western Han period, west through the Silk Road, south via the South China Sea, east to Japan, Korea and so on…Today, one can still find Chinese copper coins dating to the Han, Tang and Song periods in many curio/antique shops all over SE Asia. So, we could say the Chinese specie money was the internationally accepted medium of exchange for a long time. But did the Chinese have fiat paper notes then? Or was fiat money a unique invention of Western Civilization?

  Like the West, the Chinese also had depository banking businesses very early on (issuing warehouse receipts against deposits of silver ingots and other specie monies), at least as far back as the Tang dynasty (6th – 9th Cent AD), maybe even earlier. Did they practice fractional reserve loan banking then? Did they experience bouts of fantastic inflation? And did they suffer bank runs every now and then? The answer is a definite yes, on all counts, through the many dynasties and right up to the modern period, with especially severe boom/bust cycles during the late Qing and Civil War years of the early 20th Century.

  However, my research so far cannot confirm whether the non-Chinese traders were ever duped into accepting Chinese (Imperial) promissory notes for their hard goods way back then. (I don’t suppose they had the equivalent of institutions like the ECB or the US-led IMF like we do today?) More recently, the British colonial masters came and brought their Straits Settlement Notes, supposedly backed by sterling silver stored in London. Then there was WW2 and the Japanese invaders forced their ‘banana’ money on the local SEA economies as the way to finance the Imperial Army. When they surrendered to the Allied Forces in 1945, my grandparents were left with (literally) sacks of worthless Japanese papers under the mattress.

  But if I have followed this thread correctly, the contentious question remains – do trade deficits financed by fiat Fed Notes and wanton credit creation by the fractional reserve system matter? Of course, they do. Otherwise the ABCT should go out the window. In the days back when money was solid there were no issues with current account deficits or balance-of-payment problems deriving from trade deficits. One simply had to give up something valued by one’s exchange opposite in return for something one values more. But not so with the presence of fiat papers (what David White refers to as non-asset-based or work-free currencies) backed only by an (potentially) unlimited supply of promissory notes, which is after all a not-so-modern social construct, alluded to above. All sorts of economic distortions come into the picture to confuse market participants, not only within national borders, but also in the highly complex modern production structure spread all over the globe. Economic systems built on such a shady foundation WILL give, sooner or later, bringing with them social and political turmoil as well as destruction of real wealth. As a businessman who operates in the high-tech industry, I have witnessed the horrors of the 97/98 Asian Financial Crisis and the economic wreckage (particularly in the IT industries) brought on by the dotcom bust of 2000. Both have their roots in the Fed’s fiat money regime.

  I could go on further and talk about the great complexity of the fast-changing and highly competitive Telecom Industry (by way of discussing the new realities of the ‘globalized’ Hayekian Production Structure), or how the mercantilist Asians synchronize the counterfeiting of their national currencies with that of the Fed via their “managed” exchange floats, and how, ultimately, there will be no escape from the logic of the ABCT. But I should stop here. Suffice to add that I do apologize for having just used the ‘g’ word, which I think should be strictly reserved to show up the ignorance of modern day “Globalization” gurus, for what were the Han Chinese traders doing more than two millenniums ago?
  

  Published: April 14, 2007 5:41 AM

• Sudha Shenoy

  KY Leong;

  1. "..trade deficits financed by fiat Fed Notes & wanton credit creation by the fractional reserve system..."

  The US has been experiencing a _current a/c deficit_ & net capital inflow since 1983, ie for about a quarter of a century. How has this been covered? That is the question I answered in the blog posted. It has a list of the components of the (net) capital inflow. These same components are _also_ found before 1983, & for decades before then. (See the balance-of-payments figures in the Statistical Abstract.)

  2. The US 'economy' is huge. Eg, the domestic US economy is about 4 times larger than total foreign trade (exports + imports.) US monetary mismanagement has a vast field to act on. So the trade cycle can & does occur. Trade cycles are found in the US economy right from the mid-19th century onwards.

  I'm glad the discussions have helped.

  Published: April 14, 2007 7:40 AM

• David White

  Sudhy Shenoy,

  I welcome your response to the following article, beginning with this excerpt:

  "If it is not handled properly, the housing collapse could result in another Great Depression. America no longer has the (manufacturing) capacity to work its way out of a deep recession. While the Fed was sluicing $11 trillion into the real estate market via low interest loans; America’s manufacturing sector was being carted off to China and India in the name of globalization. Without capital investment and increased factory production, economic recovery will be difficult if not impossible. The so-called 'rebound' from the 2001 recession was due to artificially low interest rates and easy credit which inflated the housing market. It had nothing to do with increases in productivity, exports, or paying off old debts. In other words, the 'recovery' was not real wealth creation but simply credit expansion. There’s a vast chasm between 'productivity' and 'consumption' although Greenspan never seemed to grasp the difference. ... Greenspan’s attitude was aptly summarized by The Daily Reckoning’s Addison Wiggin who said, “GDP measures debt-fueled consumption; it really only measures the rate at which America is going broke'."

  http://www.atlanticfreepress.com/content/view/1350/81

  Published: April 14, 2007 9:41 AM

• RogerM

  "America’s manufacturing sector was being carted off to China and India in the name of globalization."

  Simply not true. The opposite is closer to the truth. Visit the BEA web site and look at the data for manufacturing. You'll find that the real dollar volume of manufacturing in the US is at an all time high. US manufacturing only retreated small amounts during recessions but then soon recovered. Visit the OECD web site and you'll find that the US manufacturing sector by itself is almost as large as China's entire economy. The US has the largest manufacturing sector in the entire world and it is growing.

  If the Atlantic Free Press can't get something so simple and obvious right, why would you trust anything else they write?

  Published: April 14, 2007 2:31 PM

• David White

  RogerM,

  See my reply to TGGP on the "Recession 2007" thread.

  Published: April 14, 2007 3:50 PM

• RogerM

  David: "Services? I don't think so, at least not on a wage scale comensurate with manufacturing, especially with US workers having to contend with rampant illegal immigration, to say nothing of the collapsing dollar..."

  Check out the BLS data. The average new service job pays more than the average manufacturing job. We're naturally moving to a service dominated economy where we all we be much richer in the future.

  Published: April 14, 2007 10:52 PM

• quincunx

  RogerM, a lot of these 'services' are just paper-shuffling and private expenditures resulting from government regulation. Not to mention the amount of debt 'servicing' these days. I very much doubt the necessity of about 15% of our service jobs, and I doubt the survivability of another 10%.

  The nation is too politicized and bureaucratized (there is too much mutual plunder) and not enough real production for the people to be able to continue to live in the manner they are accustomed to.

  The BLS data is illustrating ABCT in action. As to our services to the rest of the world, it seems to consist of nothing but bad policy proposals and intellectual property protectionism.

  While manufacturing and agriculture obviously produce goods, the same can not be said of services. In fact, I may even suggest that the main growing services in our economy: healthcare and education, is about spreading disease and then offering the cure, and spreading propaganda. Sickness and stupidity are hardly good services by which we will be enriched.

  Published: April 14, 2007 11:19 PM

• KY Leong

  Dr Shenoy,

  Yes, I had wanted to comment on those numbers you put up at/near the top of this discussion, but left that out in my last post, for fear of clogging up this blog. But since you brought it up, and it’s a Sunday, I’ll take a shot.

  What is really interesting (and arguable) about those numbers is their qualitative details that had been “aggregated” out, when they were being sorted, grouped, categorized and finally published under broad headings. To obtain better understanding of what they actually mean, we should try to discern the facts behind those numbers. Let me explain.

  I once worked for a high-tech company owned by the Singapore government (in the 1980s). They had a venture capital investment arm that regularly invested part of their retained earnings (out of normal operations) in promising tech startups in Silicon Valley and the Boston Route 128 area. Although I am not at liberty to disclose the size of the venture fund and how much returns it’d been making, I can assure you they were/are not peanuts. In the heydays of venture capital investing (before the dotcom bust), returns of between 1000% - 10,000% over a 3-5 years vesting period is not unusual. The profits from the hugely successful IPOs were typically kept in the US (for tax reasons) and re-invested into further new ventures. As the initial capital snowballs (becoming domestic capital), at some point, those fat profits were “diversified” into prime real-estate, hedge funds, USG securities etc…

  That’s just one case. While all this was happening, more venture funds from other (S’pore) government-linked companies and agencies followed suit. Attracted by the huge potential returns, the local private sector also jumped onto the bandwagon with their own (US directed) funds. [Is it any coincidence that such ‘net’ capital inflows into the US started around the early 1980s and has continued ever since?]

  Now, the question is – where do all these US dollars that are continuously flowing into the US originate from? No prizes for answering with the ‘f’ words. Yes, Fed and Fiat. How so?

  Well, some 20% or so of Singapore’s GDP is derived from manufacturing exports, mostly to the US and much of it consists of PCs, peripherals, semiconductor components, as well as all sorts of consumer electronics. Pretty much the same story can be told about our neighbor, Malaysia, except that the figure for manufacturing exports there is even higher at 25%, at last count. Similar stories goes for the other ‘Asian Tigers’, i.e. Hong Kong, Taiwan and S. Korea. What do these “miracle” economies do with their export earnings accumulated in US greenbacks? Well, they plow them back into the US economy, buying up USG securities, corporate bonds, mortgage-back securities etc…amongst other things. (I am sure you know this already).

  So, in short, Fed Notes and fractional reserve credits continually fuel US consumption, flood the Asian mercantilist economies, which then promptly “recycle” the fiat papers back into the US, gradually owning a bigger and bigger chunk of prime Americana, e.g. high-tech companies operating at the very early stages of the modern production structure. (I don’t see many Asian investors pouring money into the US farm sector.) Thus, we must realize, it is not merely the size of the capital inflows that we should look at, it is also the quality of the American assets that the incessant foreign investments are locking into, over the long haul (since 1983, at least?) that matters most. Put another way, IMHO, the Fed has been, unwittingly, conducting a fire sale of prime Americana through its gross mismanagement of the nation’s money, grave risks of ABCT reckoning someday notwithstanding.

  So, I suggest that the broad aggregates which you brought into this discussion, superficially, do not provide such a qualitative perspective.

  p/s: BTW, let’s not forget the Japanese. On many occasions, when I was asked to vet investment proposals originating from Silicon Valley (as part of the tech-transfer due diligence process), I often noticed the list of investors, those really big ones, they read like the Who’s Who of Corporate Japonica (industrial giants, banks, major trading houses). FYI.
  

  Published: April 14, 2007 11:19 PM

• Björn Lundahl

  From the book, “Dollars and Deficits, Inflation, Monetary Policy and the Balance of Payments”, by Dr. Milton Friedman published in 1968, chapter nine “Free Exchange Rates”, pages 230-231:

  “What objections have been raised against floating rates?

  One is the allegation that we cannot move to floating rates on our own, that just as two governments are now involved in pegging each rate, so it will take two to unpeg. This is in one sense correct, yet it is irrelevant. The United States can announce that it will no longer try to keep the dollar from depreciating- i.e., in the case of the pound, no longer try to prevent the price of the pound from rising above $2.82. If Britain wants to take on the task of keeping the price of the pound from rising, fine. It can do so only by either being willing to accumulate dollars indefinitely-which is to say, by extending us an unlimited line of credit-or by adapting its internal policy to ours, so that the free market rate stays below $2.82. In either case, we can only gain, not lose.”

  Naturally the same principle is at work in regard to that the Chinese central bank (People's Bank of China) keeps pegging the Chinese Yuan from appreciating against the dollar.

  Björn Lundahl
  

  Published: April 15, 2007 1:37 AM

• Sudha Shenoy

  KY Leong:

  1. In 2004, some 79% of FDI in the US came from Western Europe & Canada. These areas have been investing in the US for some 125 years. They contd to invest in the same types of products they had always invested in (chemicals, petroleum (BP, Shell), milk products (Nestle), electrical goods (Philips), insurance, etc.) (See one of my replies above.)

  In 2004, Hong Kong, Singapore, Taiwan together supplied some 0.44% of total FDI.

  3. SEAsia has grown dramatically in the last 35 years or so, & exports all sorts of electronic & other goods all round the world. In 2005, some 77% of Taiwan's exports went to countries _other than_ the US; for HK, this was 72%; Malaysia, 80.3%; Singapore, 88.5%.

  Was this a _world consumption boom_ fuelled by the FRS? Hardly. Sales of goods fromm SEAsia to _all_ countries are the result of the growth in SEAsia. So sales to the US too represent SEAsian growth & change (nothing stands still). SEAsian companies chose to reinvest their earnings in US assets, rather than repatriate them.

  4. Real changes are going on all the time. What the FRS does is additional to these changes.

  Published: April 15, 2007 1:44 AM

• Sudha Shenoy

  D White,

  The shortest & most constructive suggestion I can make is: The author should study carefully:

  (1) D Salvatore, Schaum's Outline of International Economics (1996), beginning with p.168, item 8.5: Exports & Imports, 'explain what is meant by the merchandise trade balance'. 'This is...the first item in the balance of payments'. Ch 8 then goes through _the rest_ of the American BoP step by step.

  Thereafter; p.146, items 7.2 & 7.3 how the foreign exchange market works -- how importers receive payment & what foreign exchange rates mean.

  (2) Barbara Ingham, International Economics, A European Focus (2003) should also be read. Ch 7 deals (inter alia) with European capital movements; ch 11 with capital flows & financial crises.

  Ch 12 shows that the European Central Bank (the Euro) & the Bank of England (the £ sterling) constitute two distinct monetary systems. They are, in fact, separate from the FRS. The £ is a very old currency; the Euro replaced a number of much older currencies. All of these existed centuries before the FRS. Thus there are at least two currencies in nonamerica that the FRS does _not_ control.

  Published: April 15, 2007 2:54 AM

• Björn Lundahl

  “A truly wealthy people sells its products not its productive capacity. The US is trending rapidly toward the latter.”

  “America’s manufacturing sector was being carted off to China and India in the name of globalization.”

  These are truly mercantilist positions. A free market position would be that anything people would voluntarily trade is a good thing and indeed it is, as it optimally increases prosperity and wealth.

  “And when the dollar is finally so devalued as to be not worth holding, expect China to ease out of the US bond market and let the yuan appreciate in hopes of going on a "Buy America" shopping spree targeting the tech sector.”

  If they really wanted to buy cheaply from the USA, they shouldn’t have kept the Chinese Yuan from appreciating against the dollar in the first place.

  Anyway, an American mercantilist who worries about what will happen if the Chinese starts selling their large assets of U.S. dollars and that the dollar would plummet if they did is indeed a very puzzling position. Mercantilism is of course a destructive and lousy “theory” and apart from that, mentioned worry is also contradictory with regard to the “theory” itself, as a situation like that would dramatically increase U.S. exports to China and at the same time enormously decrease U.S. imports from China. This should be something that an American mercantilist should applaud and welcome as a good thing.

  
  Björn Lundahl

  
  

  Published: April 15, 2007 3:49 AM

• KY Leong

  Dr Shenoy,

  “Was this a _world consumption boom_ fuelled by the FRS?”

  No, you are right, hardly so. What I am suggesting really is - a _US consumption boom_ fuelled by the FRS. And that major trading partners of the US are deeply into this game of “recycling” the Fed’s fiat papers and easy credit back into the US economy, via various forms of foreign FDI. The three small economies of HK, Spore & Taiwan making up only a miniscule % of this is beside the point.

  I am also suggesting that we examine the qualitative aspects of some of these FDIs – relatively small quantums focused on early stages of the modern production structure, with subsequent capital leveraging effects (later manifesting as US domestic FDIs).

  I can’t and would not dare to dispute the numbers you have put up so far. In fact, I believe they are really quite useful starting points for our forum here. For that I am thankful.

  
  

  Published: April 15, 2007 4:42 AM

• KY Leong

  ...capital leveraging effects (later manifesting as US domestic FDIs).

  Sorry, I meant "US domesticated FDIs", or more correctly, US domestic investments, as opposed to fresh foreign investments.

  Hope that's clear.

  Published: April 15, 2007 5:30 AM

• Björn Lundahl

  Free trade have nothing to do with the instability that central banks and fractional reserve banking causes.

  The fiat monetary fractional reserve system causes the business cycle but international trade does not.

  It is true that, to a certain degree, foreign investments in the U.S. are really malinvestments but so are also, to a certain degree, American investments done abroad. An isolationistic U.S. trade policy would cause less foreign malinvestments in the U.S. but also more malinvestments in the U.S. done by American businesses.

  If anything is bad which is bought by American fiat dollars, worries should be cried out at any purchase and exchange done with them, which includes purchases done by Americans on American and foreign products.

  Björn Lundahl
  

  Published: April 15, 2007 5:46 AM

• David White

  I am not a mercantilist. I am merely trying to make the case that the root cause of the "globalization" fiasco -- and it IS a fiasco -- is the absolute corruption of money by governments, first and foremost the US government.

  I say again, you can't have truly free trade -- either within or between countries -- without sound (i.e., commodity-based) money. And the refusal to accept this fact by those who otherwise consider themselves to be Austrians only confirms to me how hopeless the situation is.

  Published: April 15, 2007 8:03 AM

• David White

  RogerM,

  The BLS? You've got to be kidding me. Next you're going to tell me that the CPI is a correct assessment of inflation.

  http://www.shadowstats.com/cgi-bin/sgs?

  Published: April 15, 2007 8:08 AM

• Björn Lundahl

  David White,

  “I say again, you can't have truly free trade -- either within or between countries -- without sound (i.e., commodity-based) money. And the refusal to accept this fact by those who otherwise consider themselves to be Austrians only confirms to me how hopeless the situation is.”

  Yes, it is true that pure free trade is only based on sound money such as gold, silver etc. That is also the truly libertarian position which I support.

  Fiat money and fractional reserve banking causes business cycles and makes the world economy instable compared to a commodity based standard. Different currencies are also much more inefficient, as such monetary systems are nearer a state of barter than an international commodity based one.

  But by saying all those things I have just said, does not mean that I believe that if we do not implement a pure commodity based monetary system and put an end to fractional reserve banking, we are doomed and headed to a world economic collapse which will lead us back towards the Stone Age.

  As the implementation of a pure gold, silver etc standard is not, at the moment, on the political agenda and is also much further away the political agenda than removing many other government restrictions, it is logical to propagate that those other government restrictions, within and between nations, are bad too and it would be a good thing if those restrictions were eliminated and this even if the monetary system is still a fiat money standard one.

  Björn Lundahl

  
  

  Published: April 15, 2007 12:16 PM

• David White

  Bjorn,

  The one thing that is not restricted is the issuance of non-asset-based credit, this being the essence of the global fiat system. And while the powers that be do not appear to have any plans to revert to a sound money system, the growing instability of the present system assures that a time will come when it breaks down -- i.e., when the credit ponzi collapses for the simple reason that that people and institutions can no longer take on the additional debt.

  What will unfold in the aftermath? I don't know. All I can do is contemplate, yet again, what Nobel Laureate Robert Mundell said in his 2000 acceptance speech:

  “The main thing we miss today is universal money, a standard of value, the link between the past and the future and the cement linking remote parts of the human race to one another. ... The absence of gold as an intrinsic part of our monetary system today makes our century, the one that has just passed, unique in several thousand years.”

  Published: April 15, 2007 12:42 PM

• Sudha Shenoy

  KY Leong,

  "..major trading partners of the US are deeply into...'recycling' the Fed's fiat papers & easy credit back into the US...via various forms of foreign FDI."

  1. As mentioned earlier, in 2004 _79%_ of FDI in the US came from Western Europe & Canada -- who have been investing in the US for _125 years_. They have contd with the same types of investments throughout; insurance (Canada); nonbank financial services (UK -- remember the City of London); petroleum sales (BP, Shell); milk products (Nestle); electrical goods (Philips); chemicals (Germany); etc. In other words they began operating several decades _before_ the FRS came into existence, & they've been continuing since. The FRS was founded in 1913.

  2. In 1992, manufacturing FDI equalled 60% of all FDI; in 2004, it was 46%. That is, manufacturing FDI has declined, relative to wholesale & retail trade, insurance, nonbank finance, etc.

  In 1992, chemicals, petroleum, electrical equipment, iron & steel & bars, ingots, etc., all together equalled 62% of manufacturing FDI. In 2004, chemicals, cars, petroleum, machinery, computers, together came to 62% of the manufacturing total.

  The 'mix' is different, of course, but I'm not sure which together are further away from final consumption:- cars, machinery, computers; _or_ electrical equipment, iron & steel, bars, ingots, etc.

  (The other manufactures: stone, glass, ceramic, plastic, rubber products; food, drink, tobaccco; & 'all others'.)

  Incidentally, the stats come from the Statistical Abstracts. Details of FDI are from the Dept of Commerce, Survey of Current Business articles.

  Published: April 15, 2007 2:02 PM

• quincunx

  David White,

  I get the feeling that there is two camps on the global trade issue. Both favor free trade, but one seems to accept any trade occurring now as fully justified. You and I seem to be on the side that sees our current trade situation as bad policy, whereas the others, like Murphy & Shenoy sees it as nothing but mutually advantageous.

  I wish that other libertarians would realize that there is no need to have a lot of our international trade unless our local politicians make our own climate less competitive. There would be no shipment of manufacturing jobs oversees if our taxes and regulations were not prohibiting production here at home.

  Realizing that the problem lies in bad domestic policy does not make us protectionists or mercantalists. I would think that blindly accepting FORCED international trade on unsound money is worse.

  Dr Shenoy,

  The Skeptical Optimist is a supply-sider, why are you basically repeating him?

  Published: April 15, 2007 2:25 PM

• RogerM

  David: "The BLS? You've got to be kidding me."

  If you know of better statistics, please enlighten me.

  Published: April 15, 2007 3:10 PM

• RogerM

  quincunx: "There would be no shipment of manufacturing jobs oversees if our taxes and regulations were not prohibiting production here at home."

  The manufacturing jobs going overseas are primarily in the consumer products sector, especially clothing manufacturing. These have been the most heavily protected industries. The state has always tried to promote them, not prohibit them. But they left anyway.

  Published: April 15, 2007 3:13 PM

• David White

  quincunx,

  There is no doubt in my mind that were Mises and Rothbard alive today, they would roundly condemn the rampant credit expansion that has global "liquidity" running in double digits, creating massive trade imbalances that are in no way sustainable.

  That's why those who believe that deficits don't matter are either supply-siders or Keynesians, regardless of how they label themselves.

  Thus does the Mises Institute end up in bed with Beltway libertarians like the Cato institute -- http://www.cato-at-liberty.org/2007/03/14/the-good-news-behind-todays-trade-deficit-report -- sanctioning the status quo rather than standing foursquare against the gross injustice of fiat-driven "globalization."

  Frankly, I'm at a loss to understand it. While it obviously wouldn't be true in Dr. Shenoy's case, perhaps the mental disorder known as American exceptionalism -- http://en.wikipedia.org/wiki/American_exceptionalism -- has something to do with it, preventing otherwise clear-thinking people from confronting the consequences of what the government has done to our money.

  Hey, sounds like a great book title!

  Published: April 15, 2007 3:15 PM

• Björn Lundahl

  “There is no doubt in my mind that were Mises and Rothbard alive today, they would roundly condemn the rampant credit expansion that has global "liquidity" running in double digits, creating massive trade imbalances that are in no way sustainable.”

  Naturally they would condemn credit expansion as this is the very cause of business cycles. I also condemn all credit expansion. All true Austrian economists do that.

  But that doesn’t mean that we all believe that we are now heading towards a worldwide disaster.

  Rothbard, for instance, wrote in his book “America’s Great Depression”:

  “Since it clearly takes very little time for the new money to filter down from business to factors of production, why don't all booms come quickly to an end? The reason is that the banks come to the rescue. Seeing factors bid away from them by consumer goods industries, finding their costs rising and themselves short of funds, the borrowing firms turn once again to the banks. If the banks expand credit further, they can again keep the borrowers afloat. The new money again pours into business, and they can again bid factors away from the consumer goods industries. In short, continually expanded bank credit can keep the borrowers one step ahead of consumer retribution.”

  http://mises.org/rothbard/agd/chapter1.asp#boom_and_depression

  Björn Lundahl

  
  

  Published: April 15, 2007 4:33 PM

• Björn Lundahl

  I would, though, support a scenario where inflation (decreases of the purchasing power of money) sooner or later arrives and where central banks around the globe will be forced, because of this, to increase the rate of interest, whereby a worldwide recession together with stock market crashes will dominate the performance of the world economy.

  Central banks around the world have, because of increased demand for money, been “lucky” so far as the huge increases of the money supplies have not yet been realized by similar decreases of the purchasing power of money. Central banks have around the globe pledged to keep the inflation rates, on a yearly basis, around two percent and will, probably, respond quite quickly when inflation rates start to increase above their targets.

  The worldwide recession can be quite deep indeed. The unemployment rates can be quite high as well as the inflation rates.

  This scenario, I am afraid, is very plausible.

  Björn Lundahl
  

  Published: April 15, 2007 6:05 PM

• Björn Lundahl

  This one is better:

  I would, though, support a scenario where inflation (decreases of the purchasing power of money) sooner or later increases and where central banks around the globe will be forced, because of this, to increase the rate of interest, whereby a worldwide recession together with stock market crashes will dominate the performance of the world economy.

  Central banks around the world have, because of increased demand for money, been “lucky” so far as the huge increases of the money supplies have not yet been realized by similar decreases of the purchasing power of money. Central banks have around the globe pledged to keep the inflation rates, on a yearly basis, around two percent and will, probably, respond quite quickly when inflation rates start to increase above their targets.

  The worldwide recession can be quite deep indeed. The unemployment rates can be quite high as well as the inflation rates.

  This scenario, I am afraid, is very plausible.

  Björn Lundahl
  

  Published: April 15, 2007 6:13 PM

• RogerM

  David: "There is no doubt in my mind that were Mises and Rothbard alive today, they would roundly condemn the rampant credit expansion that has global "liquidity" running in double digits, creating massive trade imbalances that are in no way sustainable."

  You're half right. Mises and Rothbard always condemned credit expansion. But they would wonder at your sanity for claming that trade deficits are imbalances, and that credit expansion has caused them.

  Published: April 15, 2007 6:55 PM

• Sasha Radeta

  Roger M:
  But they would wonder at your sanity for claming that trade deficits are imbalances, and that credit expansion has caused them.

  They would wonder at his sanity????

  Have even read the explanation of business cycle, by either Rothabrd, or Mises?

  During the artificial boom, credit expansion creates overinvestment (actually malinvestments) in higher stages of production -- which we would record as increases in domestic capital. Such artificial increase in prices of capital naturally attract foreign investors -- since that's the basic role of market prices.

  At the same time, investments are incorrectly shifted away from consumption goods, although the consumer spending has not go down (as in the case of increase in genuine spending). In other words, domestic production of consumer goods goes down due to miscalculation, and naturally, more competitive foreign goods must replace them. And I'm not talking about goods only, while neglecting services (I never mentioned irrelevant trade deficits) -- there is a negative flow of money from all combined transactions (current account deficit)

  If you still don't see how business cycle affects imbalances in trade (and what else do they do, for heaven's sake), then you're just refusing to think. I paused with replies, since I don't see anything but misinterpretation of statistics (dramatic increases in foreign debt are considered to be "good" only on this thread, based on the notion that we owe more to "ourselves"), and I also see some completely misplaced quotes. Bjorn, how does Rothbard's quote about the role of banking prove anything about today's situation? Or you're just trying to fill-up the space in any way you can?

  Anyway, I hope you all enjoyed the weekend as much as I did :)

  Published: April 15, 2007 11:06 PM

• Sasha Radeta

  Oh, and I forgot to mention that lower stages of production (capital goods) also suffer from underinvestments during the artificial (credit) boom.

  Published: April 15, 2007 11:13 PM

• Sudha Shenoy

  quincunx:

  The Skeptical Optimist provides quick access to _US treasury data_. That's the reason to mention him -- to save trouble in finding the statistics.

  More generally:

  1. SEAsia has now developed enormously & produces a vast range of particular kinds of good-quality industrial goods. That is why Hong Kong, Taiwan, Malaysia, Singapore, etc now export so much to the world. A _minority_ of these exports also come to the US. See the figures I gave earlier.

  The world does not stand still. Everywhere people have changed what they produce; everywhere SEAsian goods are bought happily. Why should the US alone be different? Why must the world stand still for the US alone?

  2. Before 1983, the US had a trade surplus, & exported capital on net. This means the Rest of the World was importing capital from the US. And the Rest of the World had a trade deficit with the US. No one complained about this, least of all nonamericans.

  Now,for a quarter of a century, it is the US with the trade deficit, & the net capital imports. Suddenly this situation -- which has lasted for 25 years -- is a huge problem.

  It's OK for foreigners to import capital from the US but _not_ OK for the US to do so? It's OK for foreigners to have a trade deficit with the US but _not_ OK for the US to do so?

  Published: April 16, 2007 1:04 AM

• Sasha Radeta

  Once again: trade balance is irrelevant, since it only measures exchanges of goods (service oriented economies such as Luxemburg or Monaco will always have a trade deficit, but that doesn't mean that they should forsake their banking and tourism -- and switch to steel production)...

  Anyway, my concern with the current account deficits is not motivated by xenophobia (I'm a recent immigrant) or non-existing American nationalism. I just point out, from a strict Austrian perspective, that current account deficits mean something completely different in an inflationary economy from the same occurrence in a perfectly market.

  In the free market economy, it is quite normal for any economic entity (on micro or macro level) to have periods in which more is imported than exported, due to a shift in the structure of production (resources can be correctly shifted toward higher stages and future consumption). It's like the first farmer in my example, who spends more money on goods than he sells, simply because it is cheaper for him, considering the opportunity cost of his wonderful new investments, which will bring him much more in return. However, in an inflationary economy, these movements are likely to be malinvestments, because they are not directed by higher saving (higher future and lower present consumption).

  Problem with 27 year old deficits are not political, but economic in nature. We see that service component of current account is bringing money to the United States, but it is offset by larger deficits in the trade of merchandise. http://www.hwwa.de/Publikationen/Intereconomics/2002/ie_docs2002/ie0204-brueck.pdf In other words, all these wonderful investments and capital build-up, including that crazy boom of the late 1990s (when current account deficits peaked -- followed by a bust) did not result in a great success in the American production.

  If a farmer lost money in overall trade for 27 years, but still persistently raised credit and kept investing in capital and means of production, we would conclude that he is not much of an entrepreneur and that something is clouding his judgment (something like falsified market signals). On the other hand, when the U.S. does that, the majority a priori tries to find excuses.

  Published: April 16, 2007 2:11 AM

• quincunx

  Dr Shenoy,

  The Skeptical Optimist does indeed provide good access to data, and I have been to his site in the past. However, you seem to agree with him too much (in the bad sense). Although, you are just not as persistant as he is in condemning those who find the debt growth troublesome as essentially idiots in need of being educated by him.

  '1. SEAsia has now developed enormously & produces a vast range of particular kinds of good-quality industrial goods. That is why Hong Kong, Taiwan, Malaysia, Singapore, etc now export so much to the world. A _minority_ of these exports also come to the US. See the figures I gave earlier.'

  Yes, but none of those exports would need to be stacking up in our ports (not a chauvinist), if our local idiots in charge were not busy making us less competitive. That's my problem. International trade = good, domestic restraint artificially necessitating huge international trade = bad.

  "The world does not stand still. Everywhere people have changed what they produce; everywhere SEAsian goods are bought happily. Why should the US alone be different? Why must the world stand still for the US alone?"

  I think that those SEAsian regimes are just as nuts as we are, but they have masses of labor to exploit, in order to ship us stuff we don't deserve, and some of us do not want. Let's make no mistake about it, there is plenty of mutual UNNECESSARY plunder.

  And the big question is did they change for purely economic reasons or political ones? Well I say it almost entirely the latter, as it usually is.

  Change is good, unless ofcourse the change was a malinvestment, and then resources will have to shift back to undo the change.

  "2. Before 1983, the US had a trade surplus, & exported capital on net. This means the Rest of the World was importing capital from the US. And the Rest of the World had a trade deficit with the US. No one complained about this, least of all nonamericans."

  Most of US's history was spent in deficit. I have no problem with that, and neither does David White. What we have a problem is deficits on unsound money. We are again heading towards repeating the 70s because we have imbibed too much soma. See chart:

  http://www.nowandfutures.com/images/dow_gold_oil_crb1900-current_rev.png

  (I am not positing that this chart is a crystal ball all by itself)

  "Now,for a quarter of a century, it is the US with the trade deficit, & the net capital imports. Suddenly this situation -- which has lasted for 25 years -- is a huge problem."

  Yes, we have monetized too much debt (Treasury obligations are indeed like money to most firms). The piper must and will be paid.

  I wish I had more time to answer this question now, because I've spent quite some time studying precisely this period. Some interesting events:

  - Monetary Act of 1980
  - Reserve Requirement Lowered in 1990 & 92
  - Sweep Accounts
  - Introduction of 1m T-Bills (2001) [Hey, the UK did that after the recession of 1990]
  - The almost total irrelevance of the 20 & 30 y T-bonds.
  - Fascinating changes in CPI methodologies

  "It's OK for foreigners to import capital from the US but _not_ OK for the US to do so? It's OK for foreigners to have a trade deficit with the US but _not_ OK for the US to do so?"

  Come on now, you know comments like that are unnecessary. It's OK to let the international market work, it's not OK to praise bad policies that relatively cripple domestic markets. That is what the debate is about.

  Published: April 16, 2007 2:22 AM

• Sudha Shenoy

  A couple of points:

  1. The SEAsian countries export industrial items like computers, air conditioners, heaters, intermediate goods, etc. They do so with savings from their own businessmen & Japanese capital. They have recently-built, modern factories & have rapidly rising real incomes, with rising purchases of industrial consumer goods, rising life expectancy, vastly-improved housing, etc. This has occurred over the last 35 years & more & the info is readily available. Singapore, Hong Kong, Malaysia, Taiwan, So Korea, are all areas with a very high standard of living. They are not Asian slums.

  These areas have increased their exports enormously to the world because of the quality of their goods (inter alia.) In the case of the US alone, their goods suddenly become too shoddy to buy. It's OK for foreigners to buy their own goods but not the US?

  2. Over 25 years, the world has changed. Yes, there have been monetary changes in the US. But everything else has _not_ stopped dead. These other changes -- such as the spectacular industrial development of SEAsia -- have also been going on. They too are part of the changing world. They too determine what happens.

  3. To repeat: the kinds of 'fixed' investments that foreigners make in the US have very largely remained the same for 125 years. That is, the types were broadly the same from the 1880s to the present day: during the period when the US exported capital _&_ afterwards. This cannot be ignored. The FRS didn't even exist in the 1880s.

  Since the mid-1970s, foreigners have also invested in the US stock market. That is, they have brought in more of their own savings for these additional kinds of investments. These savings are in their own currencies. The FRS produces only US$, not foreign currencies.

  4. The world imported capital from the US in the interwar period & then from the 1950s to 1983. Then the world exported capital to the US. The world did _not_ stand still. Real incomes & output increased, capital markets expanded & grew even more interlinked. Therefore foreigners also increased their investments in the US -- as they did across the world.

  Published: April 16, 2007 3:12 AM

• KY Leong

  Dr Shenoy,

  With all due respect, you just keep bringing up the same old bunch of statistics without really addressing the real concerns raised by other participants in this blog.

  Your “fortified” stance seems to me like this – the world is chugging along just fine, has been doing so for last 125 years, things are changing all the time, yes, US fiat money and FRS may not be great, but hey they’re not going to kill us anytime soon, so, no worries mate.

  Well I am sorry to say that such a complacent attitude is not something that the thinking businessman can afford to adopt. Unlike the professional academic who can always throw up all sorts of statistics and cleverly “duck” away from harsh realities, the entrepreneur has to live by his wits. We have to constantly ask ourselves one question, by the day, the hour, even minute – “What is real?”

  From this perspective, the numbers you’ve thrown up thus far are only of academic interest, not terribly helpful, in fact I find them rather misleading in the way presented, even dangerous when interpreted the way you do.

  Published: April 16, 2007 6:12 AM

• Björn Lundahl

  Sasha

  “Bjorn, how does Rothbard's quote about the role of banking prove anything about today's situation?”

  In the way that I have just answered, which is that the worldwide economic boom is sustained by mastered increases of money supplies done by central banks and that this situation can be going on for some time (and already has). Sooner or later, though, the increases of the money supplies will, at least, have to decelerate and to a certain degree; liquidations will take place. Increases of the money supplies I believe are bad and a relevant thing and what we should therefore focus on. Trade imbalances I do not consider, at all, as relevant.

  On this I agree with Robert P. Murphy:

  http://mises.org/daily/2478

  Björn Lundahl
  

  Published: April 16, 2007 6:13 AM

• quincunx

  Dr Shenoy,

  We seem to be talking right past each other. So let's have another round.

  "They do so with savings from their own businessmen & Japanese capital."

  I do not think that Japan has much capital to loan. It has a huge carry trade - but that is not capital - that is straight fiat nothingness.

  Perhaps you should look into the growing Japanese poverty situation. People are essentially being looted to provide 'capital' elsewhere. This has been the trend for the last 15 years. And that will be precisely where the US will head as well (barring the next new world order).

  "Singapore, Hong Kong, Malaysia, Taiwan, So Korea, are all areas with a very high standard of living. They are not Asian slums."

  Oh please, every place has slums. You should check out Google Earth, it gives great visuals as to where these places are - and every place that practices fraudulent banking will have people who have been looted. The money injection effects bring people to the source, and when they are not accommodated (as in many places in China) you get serious strife.

  The US has plenty of slums too, and thy are created by the same method: legal plunder.

  "It's OK for foreigners to buy their own goods but not the US?"

  The politicos have decided for us that we shouldn't buy our own goods, rather we should compete for goods with the poor people in those Asian nations, and we should do it through vendor financing. To me, it is not about foreigners versus the U.S., it is about foreigners vs. their government and us versus our own.

  "The FRS didn't even exist in the 1880s."

  NO, but we still had serious malinvestments and recessions with even the gold-backed fractional reserve banking. We still had a treasury, and oligopolistic underwriters to distort our chain of production.

  "The FRS produces only US$, not foreign currencies."

  The FED doesn't produce anything, it simply swaps US Treasury Debt for FED Debt.

  If foreign central banks make the US$ the reserve asset and then issues their own currency pyramided on top of that, then you get essentially the same effect (possibly amplified in the cases of pegged currency).

  US Treasury Debt is swapped with Debt. Which is then converted back into dollars and then loaned right back to us, but now through the 'money multiplier'.

  Published: April 16, 2007 7:07 AM

• RogerM

  Sasha: "Such artificial increase in prices of capital naturally attract foreign investors..."

  So the only time foreigners are interested in investing in the US is when the Fed inflates the money supply? I doubt it. As many have pointed out, foreigners have been investing in the US since its founding. Does the Fed increase the amount of foreign investment with its monetary inflation? Probably, but not much. Investors always want to invest as close to home as possible because it's easier to keep watch over the investment. That foreigners would rather invest in the US than at home suggests that the home market suffers from severe problems. In most cases, the major problem is high taxes, monetary inflation much greater than that in the US, and outright theft by people in government positions.

  Sasha:"At the same time, investments are incorrectly shifted away from consumption goods, although the consumer spending has not go down.."

  Actually, I think the issue in the ABCT is that the upstream (higher order) industries attempt to bid resources away from the downstream (consumers) sectors and can't do it. That's why business failures typically happen in the upstream industries when the money stops. But you're right that an increase in incomes causes Americans to buy more imports, but again, monetary pumping is only one of many causes of increased imports and far from the most important. People would still buy most imports whether or not the Fed pumped up the money supply. Besides, monetary inflation may not cause prices to rise; prices didn't rise during the boom of the 1920's and they didn't rise much during the 1990's boom, in which case imports wouldn't be more attractive.

  Sasha:"If you still don't see how business cycle affects imbalances in trade (and what else do they do, for heaven's sake), then you're just refusing to think."

  I've never said that monetary inflation or the business cylce has no effect at all on trade. Obviously they do. However, the mercantilists posting on this site insist that 100% of the current trade deficit in the US is caused by nothing but monetary inflation. They insist that without the monetary inflation, the US would balance its merchandise trade deficit. That's complete nonsense.

  Sasha:"I just point out, from a strict Austrian perspective, that current account deficits mean something completely different in an inflationary economy from the same occurrence in a perfectly market."

  No they don't! Monetary inflation has very little to do with the trade deficit. The Fed gov's budget deficit does play a significant role. Here's something to ponder: if monetary inflation has caused the current trade deficit, why didn't the US have a much bigger trade deficit in the 1960's and 1970's when the rate of monetary inflation was far greater?
  

  Published: April 16, 2007 9:56 AM

• billwald

  How does Gresham's Law fit in? If foreign countries hold dollars and spend euros . . . ?

  Published: April 16, 2007 11:03 AM

• Sasha Radeta

  Bjorn,

  Of course that "saving-investment" booms are cause by central banks, but to claim that they don't cause trade imbalances is just ludicrous to any Austrian. Austrian business cycle theory is all about trade imbalances caused by false market signals (underinvestment in lower stages, and overinvestments in higher stages of production structure).

  ========================

  Roger M,

  I never said that "the only time foreigners are interested in investing in the US is when the Fed inflates the money supply." So please quit with misinterpretations. I explained that foreigners have a long tradition of successful investments in the U.S.A. and that's partly the reason why they are less cautious with the artificial booms (as evidenced by booms and busts in FDIs). On the other hand, claiming that raising prices in higher stages of production (lower interest rate) is not attracting investors is economically illiterate. The basic role of prices is to guide production in such way.

  You also said: "I've never said that monetary inflation or the business cycle has no effect at all on trade. Obviously they do."

  Then, why in the world would you say something like this:
  "they would wonder at your sanity for claming that trade deficits are imbalances, and that credit expansion has caused them."

  The heart and soul of the Austrian business cycle theory is the fact that credit expansion causes misallocation of resources, which leads to trade imbalances. If you have overinvestment in higher stages and underinvestment in lower stages of production (including consumer goods). To say that foreign goods will become more competitive as our own supply goes down is a plain tautology.

  By the way, the fact that you're asking why didn't the US have a much bigger trade deficit in the 1960's and 1970's, simply shows your misunderstanding of inflation (now you are the one confusing raising prices with inflation). http://www.federalreserve.gov/releases/h6/hist/h6hista.txt Also, you have to remember that credit inflation acts completely differently from a primary emission (printing press). Plus you forget that we're talking in relative terms: even if we have surplus from trade nowadays, it would be theoretically correct to say that this surplus would have been greater if it wasn't for artificial credit pumped at higher stages of production.

  Published: April 16, 2007 1:52 PM

• RogerM

  Sasha:"The heart and soul of the Austrian business cycle theory is the fact that credit expansion causes misallocation of resources, which leads to trade imbalances."

  Not even close to the truth. Please re-read Mises and Hayek. Malinvestment does not cause trade imbalances. Just the fact that you call trade deficits "imbalances" demonstrates that you don't understand Austrian economics. Trade can never be unbalanced as long as agreements are freely entered into. Monetary inflation contributes a very small amount to imports.

  Sasha: "By the way, the fact that you're asking why didn't the US have a much bigger trade deficit in the 1960's and 1970's, simply shows your misunderstanding of inflation (now you are the one confusing raising prices with inflation)."

  I don't understand what you're trying to say. You wrote that price inflation (caused by monetary inflation) increases imports. I responded that monetary inflatin doesn't always produce price inflation (because of productivity increases). What's wrong with that?

  Sasha:"Also, you have to remember that credit inflation acts completely differently from a primary emission (printing press)."

  No it doesn't!

  Your'e dodgning my question, so I'll ask again: If price inflation increases imports as you clame, then why didn't we have huge trade deficits in the 1960's and 1970's?
  

  Published: April 16, 2007 2:08 PM

• RogerM

  Sasha: "I never said that "the only time foreigners are interested in investing in the US is when the Fed inflates the money supply."

  Yes you did. You wrote:
  "During the artificial boom, credit expansion creates overinvestment (actually malinvestments) in higher stages of production -- which we would record as increases in domestic capital. Such artificial increase in prices of capital naturally attract foreign investors -- since that's the basic role of market prices."

  Since you offered no other reasons why foreigners might invest in the US, it's reasonable to assume that you think monetary inflation is the only cause.

  Published: April 16, 2007 2:12 PM

• Björn Lundahl

  Sasha

  “Of course that "saving-investment" booms are cause by central banks, but to claim that they don't cause trade imbalances is just ludicrous to any Austrian.”

  Have I said that?

  Björn Lundahl
  

  Published: April 16, 2007 2:26 PM

• Sasha Radeta

  Roger M,

  Now you're simply dishonest, or just totally confused. The basic economic fact that credit expansion artificially reduces the production of consumer goods and good in lower stages of production - DOES NOT IMPLY in any way that foreigners do not have any other reason to invest in the U.S. What did you think -- that I'll list every single reason why someone would invest. Please get serious: we're now only focusing on the effects of credit expansion.

  It's not my fault that you can't apply ABCT beyond restating the obvious. Malinvestments are nothing but artificially produced trade imbalances (you can't sell what you produced, simple because you did not listen to consumers' preference, which someone else must satisfy). What else can result from overinvestment in higher stages and underinvestment in lower stages of production?

  Once again: if you say that credit expansion artificially decreases production in lower stages of production, including consumer goods -- while their consumption stays the same or even goes up -- the logical consequence is the account deficit (caused by lower competitiveness) and capital surplus (from malinvestments and debt).

  "Your'e dodgning my question, so I'll ask again: If price inflation increases imports as you clame, then why didn't we have huge trade deficits in the 1960's and 1970's?"

  I answered your question. You are incorrect. Who said that:
  - credit inflation (reflected by sharp drops in interest rates, which cause the shift of resources away from production for present and near future consumption) was higher back than????
  - who said that our surplus wouldn't have been much higher if it wasn't for inflation

  Dude, first you have to prove your claims before I answer them.

  "I don't understand what you're trying to say. You wrote that price inflation (caused by monetary inflation) increases imports. I responded that monetary inflating doesn't always produce price inflation (because of productivity increases). What's wrong with that?"

  What's wrong with that is your lack of understanding of basic economics. I said that CREDIT inflation causes increase in prices in higher stages of production (NOT IN GENERAL PRICE LEVEL), which in turn attracts saving-investments from abroad, as well as from the lower stages of domestic production. Since less expensive foreign goods naturally replace domestic one, we don't have to see any sharp increases in prices of consumer goods. However, large malinvestements in higher stages will even cause drops in prices, but not before we hit the recession. Than government with its banking cartel steps in with new credit expansion and cycle continues.

  Published: April 16, 2007 2:38 PM

• Sasha Radeta

  Bjorn - I said that.

  Published: April 16, 2007 2:39 PM

• Björn Lundahl

  Sasha

  Well, let me be a little more precise. Have I claimed that central banks do not cause trade imbalances?

  Björn
  

  Published: April 16, 2007 3:01 PM

• Sasha Radeta

  Bjorn,

  Actually, I needed such statement as a confirmation, since you said you agree with Dr. Murphy (who seem to a priori think that account deficits and capital surpluses are great).

  People like Roger M even deny refuse the possibility that malinvestment can cause shift away from present production of goods (making foreign goods more competitive) and toward higher stages of production.

  Just like, I don't claim that the U.S.A. will reach a disaster that will take it back to the Stone Age -- HOWEVER, there are many troubling indicators that I pointed out (debt and inflationary potential). These problems cannot be discounted by stating that we owe more to ourselves (two evils are not like two minuses in arithmetic -- they do not amount to a positive outcome), and the repetition about our great capital surplus also does not prove anything, since it also fits into theory of malinvestemnts.

  In other words, pessimists at least have some economic justification for their arguments... Optimists just keep misinterpreting statistics and basing their views on lazy thinking (applying Austrian theory only a half way)... And I am just a skeptic :)

  Published: April 16, 2007 3:14 PM

• Sasha Radeta

  If this does not answer Roger M's 1960s/1970s question, I don't think anything will:

  http://bigpicture.typepad.com/comments/images/m3_money_stock_1105.jpg

  http://home.comcast.net/~markthoma/Graphics/m3.11.02.05.jpg

  As of March 23, 2006, information regarding M3 will no longer be published by the Federal Reserve. Go figure... (On March 7th, 2006, Congressman Ron Paul introduced H.R. 4892 in an effort to reverse this change.)

  Published: April 16, 2007 3:31 PM

• RogerM

  Sasha:"Now you're simply dishonest, or just totally confused."

  Forgive me for encouraging it, but you're hysteria is amusing.

  Sasha: "Malinvestments are nothing but artificially produced trade imbalances (you can't sell what you produced, simple because you did not listen to consumers' preference, which someone else must satisfy)."

  Now you're playing games with words. We're talking about trade balances between nations, not between businesses. There is no reason that malinvestment in the US would cause a trade deficit.

  Sasha: "What did you think -- that I'll list every single reason why someone would invest."

  Why don't you list a few so I'll know that you understand. And you might indicate which ones are the most important and where credit expansion fits in.

  
  Sasha:"Once again: if you say that credit expansion artificially decreases production in lower stages of production, including consumer goods -- while their consumption stays the same or even goes up -- the logical consequence is the account deficit (caused by lower competitiveness) and capital surplus (from malinvestments and debt)."

  In the first place, ABCT does not say that the production of consumer goods will decrease with credit expansion. Generally, consumer prices rise because of greater demand for them. Rising incomes and greater demand contribute to imports, but they are not the major causes of imports or a significant contributer to the trade deficit.

  Sasha:"Who said that:
  - credit inflation (reflected by sharp drops in interest rates, which cause the shift of resources away from production for present and near future consumption) was higher back than????"

  Federal statistics. It's also common knowledge. Those decades are famous because the monetary inflation of those two decades caused huge increases in price inflation, leading to "stagflation", and the decline of Keynesian econ.

  "who said that our surplus wouldn't have been much higher if it wasn't for inflation.."

  Well, since monetary and price inflation in the 60's-70's were about 4 to 5 times what they have been in the past 20 years, I would expect our trade deficit to have been much worse back then. You're arguing that the inflation of those decades kept the trade surplus (was there a surplus?) from being larger. So inflation 5 times higher than we've experienced recently wasn't powerful enough to overcome some force in the economy that increased exports, or reduced imports. Please enlighten me on what that amazing force was, a force so powerful it could stop the effect of enormous inflation in its tracks?

  
  

  Published: April 16, 2007 3:43 PM

• RogerM

  Sasha:"If this does not answer Roger M's 1960s/1970s question, I don't think anything will:"

  Which question are those graphs answering?

  Published: April 16, 2007 3:46 PM

• Björn Lundahl

  Sasha

  What I meant to say is that I do not believe that trade deficits matters and nothing more and nothing less.

  Naturally there are a lot of malinvestments (over investments in the higher order) done in the U.S. by foreign investors and through foreign loans as it is a lot of malinvestments done abroad by American investors and through American loans. There are a lot of sound investments made in both directions as well. Central banks and fractional reserve systems are a dominant part of every nation’s monetary system and they all have, in different degrees, an influence on the economic structure in other nations which they are not situated, as well.

  If the U.S. was, hypothetically, a economically isolated nation, there would be proportionally more malinvestments made in the U.S. by American companies and no malinvestments done in the U.S. by foreign companies.

  My points is that we should focus on the increases of the money supplies and that we should reject central banking and fractional reserve banking in every nation, instead of trying to make a twisted case against free trade.

  Björn Lundahl

  Published: April 16, 2007 4:33 PM

• Sasha Radeta

  RogerM,

  Of course that Austrian business cycle explains trade imbalances that occur between businesses - and these imbalances are the greatest between countries (especially if one is experiencing the artificial boom and the other one is not).

  Ask Bjorn and he'll explain it to you:
  - The basic premise of Austrian theory of business cycle is following: lower interest rates (higher prices in higher stages of production, i.e. increase in production of future goods) must lead to overinvestment in higher stages of production and underinvestment in lower stages (less remote in time of finalization). That's based on simple economic axiom that rising prices attract the supply (the prices in higher stages, in this case) Since consumers' spending has not go down - foreign goods naturally replace it (they are now more competitive) and people don't have enough savings (future consumption) to support this large build-up of future goods.

  Even RogerM recognizes that he can't say anything against the logic of this simple analysis... Instead, he claims that my analysis is not Austrian. He says:

  "In the first place, ABCT does not say that the production of consumer goods will decrease with credit expansion."

  Oh, really? That's what happens when you pick-up your information from the internet blogs, instead of real literature. Check out what Austrians have to say:
  Rothbard:
  "Let us assume that the time-preference schedules of the people remain unchanged. This is a proper assumption, since there is no reason to assume that they have changed because of the inflation. Production now no longer reflects voluntary time preferences. Business has been led by credit expansion to invest in higher stages, as if more savings were available. Since they are not, business has overinvested in the higher stages and underinvested in the lower... As soon as the consumers are able, i.e., as soon as the increased money enters their hands, they take the opportunity to re-estab­lish their time preferences and therefore the old differentials and investment-consumption ratios. Overinvestment in the highest stages, and underinvestment in the lower stages are now revealed in all their starkness...

  If some readers are tempted to ask why credit contraction will not lead to the opposite type of malinvestment to that of the boom—overinvest­ment in lower-order capital goods and underinvestment in higher-order goods—the answer is that there is no arbitrary choice open of investing in higher-order or lower-order goods. Increased investment must be made in the higher-order goods—in lengthening the structure of production. A decreased amount of investment simply cuts down on higher-order in­vestment. There will thus be no excess of investment in the lower or­ders, but simply a shorter structure than would otherwise be the case."

  Also, check Garrison's interpretation of Hayek's theory, since Friedrich s probably too complicated for your level.

  Good luck in your further research!

  ---------------------------------------------

  
  PS

  If you don't know which question about inflation during 1960s/1970s these graphs are answering, then you have issues that are far more serious then your obvious ignorance of Austrian economic theory.

  Perhaps you don't know, but those graphs depict different levels of money supply:

  http://bigpicture.typepad.com/comments/images/m3_money_stock_1105.jpg

  http://home.comcast.net/~markthoma/Graphics/m3.11.02.05.jpg

  I mean dude, you claim that monetary inflation was higher back then??? are you out of your mind. You probably heard somewhere about the so-called "stagflation" and you incorrectly assumed that the level of monetary pumping was the highest back then (when the FED's numbers show something completely different. That's what happens when your knowledge of economics is anecdotal.

  Also, had inflation during 1960s and 1970s were any lower, who says that American account surplus would not have been higher back then?

  Published: April 16, 2007 4:45 PM

• Sasha Radeta

  Plus, I forgot to repeat (since RogerM did not register this :) - I talked about the effects of credit inflation - not just any general inflation.

  ================================================

  Bjorn,

  We agree on everything, then. Great!

  Trade balance is totally irrelevant (this measure records goods only, while neglecting services and unilateral transfers) and there is really no need to repeat that. However, current account deficits do record loss of money from trade and of course they matter.

  There is a natural limit on how much money an economic entity can continue to loose before people realize that there better investments elsewhere (regardless of our great history and booms that make people think that American future consumption will be higher than depleted savings can actually support). Once these direct investments go down (as they dramatically did in 2000), our ability to finance these deficits through further debt will also eventually go down (the same happens in personal finances).

  Published: April 16, 2007 5:00 PM

• RogerM

  Sasha: "Of course that Austrian business cycle explains trade imbalances that occur between businesses - and these imbalances are the greatest between countries (especially if one is experiencing the artificial boom and the other one is not)."

  Gee, I must be as ignorant as you clame. I've read quite a bit of Mises, Rothbard and Hayek and never once saw that they tied the ABCT to trade deficits between countries. Please cite a reference for me where they do that.

  Sasha:"Check out what Austrians have to say:"

  I hate to point this out to you, but did you notice that the quote from Rothbard never mentioned that consumer goods production will decrease. All it said was that investment would shrink. Producers will continue to produce consumer goods with the capital already invested. If investment shrinks, that means nothing more than that the growth of consumer goods production will slow.

  
  Sasha: "If you don't know which question about inflation during 1960s/1970s these graphs are answering, then you have issues that are far more serious then your obvious ignorance of Austrian economic theory."

  Look at the graphs again. They show levels of money, not changes in the supply of money. We measure monetary inflation as the change in the money supply from year to year. Of course the money supply level grows from year to year and is always larger in later years than earlier ones. But if you look at a chart of money supply inflation, which is the change in the money supply from year to year, you'll find that the rate of growth in the money supply in the decades of the 60's and 70's was about 5 times greater than in the 90's until today. It's that growth rate in the money supply that most economists refer to when talking about monetary inflation.

  Sasha: "Also, had inflation during 1960s and 1970s were any lower, who says that American account surplus would not have been higher back then?"

  I addressed that above and you ignored me again. You have to explain what incredible phenomena broke inflation's ability to generate such huge trade deficits as those we enjoy today.

  This is getting boring. Unless you add a little creativity to your insults, I'm afraid I'll have to quit responding.
  

  
  

  Published: April 16, 2007 7:32 PM

• Sasha Radeta

  Roger M,

  You simply don't have capabilities for any meaningful discussion. Allow me to explain:

  I quoted Rothbard when he mentions that credit expansion must lead to: "overinvestment in the highest stages, and underinvestment in the lower stages..."
  To which you replied: "Rothbard never mentioned that consumer goods production will decrease"

  Again, you have no idea what you're talking about. When investments shift to higher stages of production -- more will be produced at those stages. The prices of future goods go up -- and the market supply (PRODUCTION) at these stages will go up. Consequently, as investments go away from lower stages of production, we produce less than people actually demand. Those are the basics of Austrian business cycle theory. It is the EXCESS PRODUCTION in higher stages of production that result overinvestment in those stages -- and the LACK OF PRODUCTION in lower stages result from underinvestment in lower stages. Otherwise, without mistakes/miscalculations in PRODUCTION wouldn't have any proof of malinvestments.

  PS

  It is not my intention to insult you, but you clearly have issues with hallucinations or an uter ignorance. Check out the graph one more time! Look at the average rate of change (ON Y-AXIS) during the period from 1960 to 1980 -- and compare it to period since then 1980-. You don't need derivatives for this... just look at the increase on Y-axis (change in dollars) for the same number of years.

  But once again, distortion in the production structure are only caused by CREDIT inflation. You did not offer any evidence that credit expansion was higher during Breton Woods and those high interest rate years... I don't have anything to respond to.
  

  Published: April 16, 2007 8:31 PM

• Sasha Radeta

  I hope that RogerM will see that rate of growth was not 5 times greater during 1959-1980, as opposed to 1980-2001.

  What's more important is that inflation (production of new money) does not affect economy in some "rate of change" -- but it affects it with the amount of produced dollars.

  For example, if my stock of currency increases from $1,800 to $3,600 in one year, you can't argue that my spending will have a greater effect than following year when currency increases from $3,600 to $7,000.

  However, I'm still waiting the promised data about CREDIT inflation, since I only talked about that.
  

  Published: April 16, 2007 8:55 PM

• RogerM

  Sasha:"It is not my intention to insult you, but you clearly have issues with hallucinations or an uter ignorance."

  Sorry. But that's a pretty lame insult. You'll have to do better than that to get another response from me.

  Published: April 16, 2007 9:24 PM

• Sasha Radeta

  Correction: "since I only talked about that, when it comes to malinvestments"...

  ========

  I don't know if I explained my position clearly enough for young readers... I hope this will be a better response to poor RogerM:

  Before someone starts claiming that the person who gets a raise from $20,000/year to $40,000/year is better off than a person who gets a raise from $1 million/year to $1.7 million/year... bear this in mind:

  "Rates of inflation" were produced by statist economists, who tried to measure it by rates of changes in general price level -- instead of simply tracking the increase in the amount of currency from year to year, and than seeing how much these increases changed over time (second derivative). From 1959 to 1980, average annual increase in currency was circa $73 billion. From 1980 to 2001 that average annual increase was circa $258 billions!

  That's your real increase in monetary inflation! If you want to observe inflation in terms of rates of change -- changes in inflation will be measured by the second derivative of the monetary stock. If you declare the rate of monetary inflation as a factor in malinvestments, why don't you simply observe how inflation (rate of change) increased over time.

  HOWEVER,

  I'm actually helping out RogerM! I claim that these dramatic changes in rate of inflation did not cause changes in production structure. As Rothbard and Hayek explained -- it is the credit inflation (expansion) that causes these distortions.

  PS
  We really don't need another lame response from you Roger. I think you said enough with your "knowledge" of the ABCT.

  Published: April 16, 2007 9:42 PM

• David White

  Steve Seville gets to the heart of the matter here -- http://www.safehaven.com/article-7373.htm -- or at least a heartbeat away from it, as he correctly places the blame on inflation, without saying that inflation wouldn't exist in a sound-money economy.

  That's what I've been trying to say all along, reiterating that it ultimately doesn't matter whether the trade is foreign or domestic; what matters is that currency-destroying inflation is a product of non-asset-based (i.e., work-free) money.

  And our millennia-defying, 36-year-old experiment in it is soon going to blow up in our face.

  Published: April 17, 2007 7:24 AM

• Spencer Bradley Hall

  A nation has a TRADE DEFICIT when the cost of merchandise imports exceeds the receipts from merchandise exports. The CURRENT ACCOUNT balance encompasses merchandise, service items, commodities, and “current” financial transactions; while the BALANCE OF PAYMENTS includes the entire above plus capital flow items; all transactions involving foreign exchange.

  The foreign exchange value of any currency is determined by the supply of and the demand for that particular currency. In international financial analysis supply and demand take on an unique role; for what is demand form our point of view is supply from the standpoint of foreigners – and vice versa. All transactions that require the conversion of foreign currencies into dollars constitute a demand for dollars. These include exports, payments received for serves rendered to foreigners, interest and dividends collected from foreigners, etc. An increase in the volume of any one of these times will increase the demand for dollars and, ceteris paribus, the foreign exchange value of the dollar. The opposite types of transactions, imports, etc., which involve payments to foreigners increase the supply of dollars and thereby reduce the foreign exchange value of the dollar.

  There is no “flow” of money internationally, only offsetting debits and credits on the books of the financial institutions involved in financing trade or other transactions. A slight modification of this statement is necessary to take account of the movement of paper and coin currencies. Their contribution to surpluses or deficits is extremely minor and short run, when not actually offsetting.

  In foreign exchange supply always equals demand at the current rates of exchange. International debits equal international credits. The balance of payments always balances since there can be no credit transfer of funds.

  When the balance of payments is balanced by foreigners acquiring net holdings of our equities, bonds, and real estate, and capital outflows (interest, dividends, rentals, etc.) exceed inflows, we are either decreasing our net creditor position in the world, or increasing our net debtor position. Beginning 1985 it has been the latter. The trade deficits, plus the unilateral transfers of funds by the Federal Government to foreigners, transformed this country from this world’s largest creditor to the world’s largest debtor – for the first time since 1917. Since 1985 we now have a net debtor position exceeding 5.7 trillion dollars, but the principle villain (since 1973) has been our dependence on foreign oil.

  Trade deficits at any particular time for any given country can be beneficial or harmful; can represent economic strength or weakness. In the period before Worlds War I the U.S. had mostly trade deficits. We were a debtor country – and we thrived. Foreign investments accelerated our economic development and our standard of living rose faster as a consequence.

  By the end of World War I the U.S. was a creditor nation, but we refused to act like one. We opted for tariffs and other restrictions on imports, rather than free trade. Capped by the sky-high Hawley-Smoot tariff of 1931, U.S. trade policy was an important contributor to the world wide depression of the 1930’s. By 1933 there was not a single major nation on the gold standard except the U.S.

  The situation was further exacerbated when Roosevelt and his Treasury Secretary, Morgenthau, exercising the crisis powers delegated to the executive branch by Congress, took the U.S. off the gold standard in April, 1933 by making the dollar inconvertible into gold at a fixed price. And to make matters worse they periodically kept raising the price of gold from $20.67 per ounce to a final price in Dec. 1933 of $35. This had the effect of depreciating the exchange value of the dollar. All of this was done by a creditor nation operating with a chronic surplus in its balance of payments.

  The Bretton Woods Agreement of 1944 established, amoung other things, the International Monetary Fund and confirmed the previous international status of the dollar, that an ounce of gold was equal to $35 and that all dollars were to be freely convertible into gold bullion at that price to foreign and confirmed the previous international status of the dollar, that an ounce of gold was equal to $35 and that all dollars were to be freely convertible into gold bullion at that price to foreigners but not to U.S. nationals.

  In 1949, the U.S. dollar was not only as “good as gold”, but it was also preferred over gold. There were not enough dollars to finance the legitimate needs of the world economy. So, the chronic balance of payments deficits which began in 1950 were for a number of years beneficial to the world economy and to the U.S. Because of our large and chronic balance of payments surpluses after World War II, foreigners were unable to accumulate sufficient dollar balances to efficiently finance world trade. These balances were desperately needed because of the total dominance of the dollar as the reserve custodian, standard of value and transactions currency of the world.

  The Korean Conflict (1950-1953) temporarily solved the problem but, the longer term solution consisted in implementing our “containment policy” against the U.S.S.R. This involved the establishment of approximately 700 military bases, not only around the perimeter of the Soviet Union but throughout the world. We have paid hundreds of billions of dollars to foreigners to acquire the bases and to maintain a garrison of more than 400,000 military personnel abroad. With diminishing merchandise surpluses this policy proved to be financial overkill.

  By the mid 1960’s foreigners found themselves in possession of excessive dollar balances, excessive in terms of the needs of trade. Some of these excess dollars came to be used as “prudential” reserves in the formation and growth of the Euro-dollar banking system. Since 1970, the “western” world has functioned within a system of essentially free exchanges. Before 1973, exchange rates were in terms of a “fixed target”. Now the dollar is a “moving target”.

  The Korean War, which began in June, 1950, initiated the chronic balance of payments deficits that persist to this time and which will probably continue as long as foreigners are willing to increase their net investments in this country.

  The U.S. has had a net liquidity deficit in every year since 1950 (with the exception of 1957), Up to 1976 (when the private sector contributed its first trade deficit ) these deficits were entirely the consequence of excessive U.S. government unilateral transfers to foreigners (re: foreign policy – solely our far flung military bases and personnel). During all this time the private sector was running a surplus in all accounts: merchandise, services and financial. The Vietnam Ten-year War administered the coup d’etat to our gold bullion standard. By 1968, in an effort to keep the dollar at the $35 par, we had exhausted nearly two thirds of our monetary gold stocks, or approximately 700 million ounces to about 260 million ounces.

  Although the dollar ceased to be freely convertible in March, 1968, institutional (central bank practices) and attitudinal lags were sufficient to offset, until late 1970, the excessive expansion in the supply of dollars. In August 1971, all convertibility was ended. This further accelerated the decline in the exchange value of the dollar. All fluctuations in exchange rates prior to this time were the result of other currencies changing in value relative to the dollar.

  During the early seventies of the Nixon administration the dollar was twice devalued, raising the fictional price of gold to c. $41-43. These were non-events. When the dollar was no longer on a gold standard (after March, 1968), the dollar price of gold was determined by the open market. In response to the devaluations, the Federal Reserve Banks marked up the balance sheet values of their holdings of gold certificates. These were also nonevents; since the capacity of the Reserve banks to create credit (acquire Treasury Bills, etc. by creating Interbank Demand Deposits) was unaffected; nor did the devaluations alter the capacity of the fed to pay out Federal Reserve Notes in exchange for these IBDDs.

  From late 1970 to 1978, the dollar depreciated relative to other major currencies. .

  After the “Marshall Plan”, which did not produce a balance-of-payments deficit, most of this aid was in the form of various types of military assistance, or to maintain our numerous foreign stations and bases, and to finance approximately 400,000 military personnel abroad; except for the Korean and Vietnam wars, which more than doubled that figure. The policy that engendered the outlay of trillions of dollars for these purposes was called dollars for these purposes was called “containment”, i.e., containment of the U.S.S.R.

  High interest rates kept international demand for dollars strong and the dollar's foreign exchange value high. In turn, the strong U.S. dollar-which only began to decline in value in the mid-1980s-made U.S. goods expensive abroad and imports relatively cheap at home. As a result, the United States registered an ominously large and growing trade deficit. In 1980 the annual U.S. merchandise trade deficit was $25,500 million; by 1986 it had ballooned to $144,500 million

  By the end of the cold war in 1990, the United States still maintained 395 major military bases and hundreds of smaller installations around the world. Most of the bases are part of military alliances formed to contain communism. By 1990, 435,000 American troops, 168,000 Defense Department civilians and 400,000 family dependents were living on foreign bases. Another 47,000 sailors and Marines were stationed aboard ships in foreign waters. A million Americans abroad were on the Defense Department payroll.

  Even if we eliminated the trade deficit and ran a surplus sufficient to service our foreign debt, the dollar would still decline because of the war/containment/terrorist deficit. Since actions sufficient to eliminate these deficits are highly improbable, the dollar will eventually decline to a level which will eliminate them. At that level our standard of living, for this and other reasons including financing the federal debt, will be much lower than at present, and the capacity of the Pentagon to project conventional military power abroad will be severely circumscribed.

  We have observed, given the situation of this country in the 19th century, (its people government and undeveloped resources) that it was advantageous both to lenders and borrowers for the U.S. to run a trade deficit.

  Conversely it is also economically advantageous for creditor nations, and for the world economy, if creditor nations operate with trade deficits: deficits proportionate to their creditor status. This is, the deficits should be large enough to enable the nationals of debtor nations to acquire a sufficient amount of foreign exchange to enable them to serve their international debts.

  Since the U.S. is no longer an economically undeveloped nation, but is increasingly an international debtor, what evaluation should be places on our huge trade and current account deficits? For the very short run these deficits keep prices and interest rates lower than they otherwise would be and they subsidize our standard of living. But the deficits also are inexorably forcing the dollar down in terms of its foreign exchange value—and no consortium of central bankers, treasury secretaries, et al. can stop the process

  With a chronically depreciating dollar foreigners will be much less inclined to invest in the U.S. on a creditor ship basis, thus pushing up interest rates. The rising cost and diminishing volume of imports will contribute to an increase in inflation, and the expectation of further inflation will also push up interest rates. This spells stagflation.

  Under pressure from this country, the Pacific Rim, Oil Exporting, etc., central bankers try to support the dollar. They do not try to arrest the long-term downtrend of the dollar, but seek to erase some of the unnecessary short-term and destabilizing fluctuations. This is a correct statement of what the function of the central bank should be where the objective is to influence rates of exchange.

  The net accounting effect of the Chinese buying U.S. dollars is 1) the importer pays in his own country’s currency, 2) the exporter receives payment in his country’s currency, 3) for very debit there is a credit, 4) there is no net transfer of funds, and 5) money is not flowing in or out of the respective countries. This is proved by using “T” accounts. The balance of payments always balances even though the statistics on payment balances never do. To correct this deficiency, the commerce Department inserts an item called “Errors and Omissions”. Thus, the triumph of theory over “facts”.

  The Chinese loss of income and probable exchange rate losses, when the reverse of these operations is consummated at a later date, are, of course, compensated by the Federal Reserve. The adverse effects on the Chinese economy receive no such compensation.

  For all of this reason, the policy of the U.S. Treasury and the Federal Reserve is to minimize overt intervention in the foreign exchange markets.

  Although the lags are sometimes unusually long between exchange rate changes and the changes in volume and value of trade, the present situation cannot be explained by these lags.

  Trade restrictions have some effect, but the U.S. is not immune from subsidizing exports and using numerous devious devices by the Customs Service to restrict imports.

  A weak currency is not a cause; rather it is a symptom of a weak, noncompetitive economy. In time, of course, a declining dollar will eliminate the deficit in our balance-of-trade. But the price exacted will be a sharp decline in imports, principally oil, and the purchase of foreign services, reflecting our relative poverty and inability to compete in the international economy. The fact that we are the world’s number one producer of smart bombs will not arrest that trend.

  The real culprit seems to be the cost of our products relative to their quality. Inferior quality is not a good buy at any price. We are even getting a reputation for inferior products.

  For the people of limited foresight, which apparently includes a substantial majority, debt expansion can be very exhilarating. One’s standard of living can take a quantum leap forward. Taxpayers are currently being subsidized, in terms of taxes not paid, more than 248 billion annually. It is called the federal deficit. Consumers are being subsidized by approximately $763.6 billion annually, of which, 494 billion is for oil. It is called the foreign trade deficit. In the longer term the problem of servicing all this debt, consumer, corporate, and federal poses daunting problems. And that is a gross understatement. These circumstances, as we know, are of our own making. The country has not been invaded, and our productive resources have not been destroyed, or even impaired, by national calamities.

  In foreign trade, imports decrease the money supply of the importing country (U.S.) while exports increase the money supply, and the potential money supply, of the exporting country (China). Purchasing the deficit countries currency and then purchasing U.S. treasury bills (1.0663 trillion by year ending 2006), will reduce the dollar's supply, but it is important to know that sooner or later the Chinese central bank will have to reverse their positions and the foreign exchange dealers know this (gold will rise at this juncture).

  The trade-off of reducing the pressure on the global dollar by temporarily decreasing the volume of the dollars requiring conversion into Yaun, is the cost of foisting an inflationary policy on China. Obviously, and for good reason, the Chinese have reason to resist this kind of assistance.

  Wanting to retain a competitive advantage, and keep the Yaun low, and exports high, as China is export dependent for full employment, the Chinese "sterilize" their foreign exchange reserves. That is, the Chinese "mop up" the increase in the Yaun money supply by selling government bonds. This converts surplus Yaun into government debt and delays the inflationary impact of an otherwise increase in the volume of Yuan. But at some future point, as exchange rate reserves grow, the Chinese capital markets will lose their ability to absorb new debt.

  Eventually, China's protectionism (currency peg) will crack, and the volume of Yuan will fuel inflation. Meanwhile the Chinese have been desperately 1) selling lots of government bonds to their domestic credit markets, and 2) raising commercial bank reserve ratios (to monetize the debt). Both 1 & 2 are to "sterilize" their foreign exchange reserves, and postpone the inevitable. If there is a flight from the dollar, it will be because the Chinese waited too long to realign the Yuan. And as a sign post, the U.S. National Association of Manufacturers estimates the Yuan is currently undervalued by as much as 40 percent.

  Note: Analyst claim that the Chinese $1.202 (mar07) U.S. foreign exchange reserves could buy Microsoft, Citibank, and ExxonMobil Corp. as well as General Motors and Ford. And Japan had $915 (apr07) in U.S. foreign exchange reserves, Eurozone $451, Russia $372…

  While the U.S. will have a temporary gain, as will foreign enterprises engaged in foreign trade who are momentarily freed from excessive fluctuations in the exchange rate, the overall financial effects are a loss to the Chinese and to the Chinese economy. The Chinese central bank suffered a balance-sheet loss of 26 billion Yuan ($3.3 billion) because of currency movements.

  No country has become and remained a world power if it is a world debtor and has a weak currency. From these unwanted events we can expect a vicious level of stagflation that will become an enduring feature of our economic landscape. And the United States will be forced into a high degree of economic isolation, and operate under a command economy and perhaps into an increasingly totalitarian mold.
  

  Published: July 16, 2007 8:22 PM

• Spencer Bradley Hall

  This is the HOLY GRAIL.

  First, there is no ambiguity in forecasts. Forecasts are mathematically "precise” (1) nominal GDP is measured by monetary flows (MVt); (2) Income velocity is a contrived figure (fabricated); it’s the transactions velocity (bank debits, demand deposit turnover) that matters; (3) money is the measure of liquidity; & (4) the rates-of-change used by the Fed are specious (always at an annualized rate; which never coincides with an economic lag). Economists have learned their catechisms; .

  Friedman became famous using only half the equation, leaving his believers with the labor of Sisyphus.

  The lags for monetary flows (MVt) – real GDP and the deflator are exact, always the same. Rates of change are always measured with the same length of time as the economic lag (as its influence approaches its maximum impact). Not surprisingly, member commercial bank legal reserves rates of change corroborate the lags for monetary flows (MVt) – they are of identical length. The BEA uses quarterly accounting periods for real GDP and deflator. The accounting periods for GDP should correspond to the economic lag, not quarterly. They should represent a rolling moving average.

  Monetary policy objectives should not be in terms of any particular rate or rate of growth of any monetary aggregate. Rather, policy should be formulated in terms of desired rates of change in monetary flows (MVt) relative to rates of change in real GDP. Note: rates of change in nominal GDP can serve as a proxy figure for rates of change in all transactions. Rates of change in real GDP have to be used, of course, as a policy standard.

  Because of monopoly elements and other structural defects which raise costs and prices unnecessarily and inhibit downward price flexibility in our markets (housing being most notable), it is probably advisable to follow a monetary policy which will permit the rate of change in monetary flows to exceed the rate of change in real GDP by 2-3 percentage points. In other words, some inflation is inevitable given our present market structure and the commitment of the federal government to hold unemployment rates at tolerable levels.
  

  Published: July 16, 2007 8:38 PM

• Spencer Bradley Hall

  What's missing from contemporary analyses: This is the dollars fate:

  Russia, formally the epitome of state controlled economies, did not use the ruble in its foreign exchange operations. Since all trade with the Soviets was monolithic, it was to their advantage to establish a single money center bank through which all foreign financing could be channeled. Their London bank was one of the first to become a part of the Euro-dollar system, an unregulated system of money creating banks operating on the principle of prudential reserves, as contrasted to regulated legal reserves. These prudential reserves are liquid balances in the U.S., or any other major currency country.

  If the bank’s balance is inadequate to meet a specific payment it borrows in the London money market at or new the LIBOR rate (the London Interbank Offering Rate), a rate substantially below the prime rates of most banks. U.S. money center banks were often criticized for loaning money “to other countries” at a lower rate than it would offer local customers.

  With respect to the U.S., all transactions were financed through the Amtorg Trading Corporation which transfers all of its receipts to, and draws all of its drafts on the London bank. The only concern of the London bank with fluctuating exchange rates is to have a minimum inventory of a depreciating currency.

  A common misconception is that Euro-dollars (E-Ds) are U.S. dollars that have somehow contrived to leave this country, whereas in fact all E-Ds are created abroad. The foreign commercial banks, and foreign branches of U.S. banks, which create this money, operate on the premise that they will always be able to convert E-Ds into U.S. dollars on demand on a one-to-one basis.

  This exchange equivalence privilege may suggest to the E-D borrower that there is no meaningful difference between E-Ds and U.S. dollars. But in terms of our national and the international economy this is an illusion. In both an economic and legal sense the E-D is no more a part of the lawful money supply of the U.S. than is the Canadian dollar, or any other national currency.

  Two principal factors were responsible for the origin of the E-D banking system; (1) the possession by foreign commercial banks of an excess volume of short-term claims against the U.S. dollar, and (2) the preeminence (at that time) of the U.S. dollar as the reserve, standard-of-value, and transactions currency of the world.

  Beginning in 1950 the U.S. incurred the first of a chronic series of net liquidity deficits in its balance of payments. These deficits have grown in magnitude and continued uninterrupted ever since 1950 with the exception of 1957. By the mid sixties foreign banks had acquired more dollar balances than were required to cover their own international transaction needs – so they started lending their excess U.S. dollar balances: which contribute to Bernanke’s global savings glut; & Greenspan’s conundrum, i.e., artificially low interest rates).

  E-D banking originated in the City of London and London based banks still dominate the E-D banking system. As the number of banks participating in the E-D transactions increased (G7), the E-D bankers discovered that the E-D deposits they created for borrowers often did not result in any diminution of their U.S. dollar balances – the System was merely shifting balances within itself. That is, drafts drawn on E-D banks increasingly were deposited in other E-D banks. Thus was laid the economic basis of an international system of “prudential” reserve banking – the discovery that the amount of actual U.S. dollar reserves required to support the E-D loans made – and E-D deposits (money) created.

  The prudential reserves of the E-D banks consist of various U.S. dollar-denominated liquid assets (U.S. Treasury bills, U.S. commercial bank CDs, Repurchase Agreements, etc.) and interbank demand deposits held in U.S. banks. These are liquid balances in the U.S., or any other major currency country. If a bank’s balance is inadequate to meet a specific payment in the E-D system, it borrows in the London money market at or near the LIBOR rate (the London Interbank Offering Rate), a rate substantially below the prime rates of most banks. By both promulgating excessive money and credit creation and avoiding statutory reserve requirements, E-D banks are able to preserve their competitive advantages with lower interest rate loans.

  The volume of prudential reserves held by each E-D bank presumably is dictated by “prudence” – not by any legal requirement administered by a monetary authority. All prudential reserve banking systems have heretofore “come a cropper”. Money creation by private profit institutions is not self-regulatory- the “unseen hand” simply does not function in this area. Invariably the systems created too much money, speculation became rampant, inflation distorted and destroyed economic relationships, confidence that the banks could meet their convertibility obligations eroded, “runs” on the banks caused mass banking failures, and entire economies were left in ruin.

  With this historical record to draw from the pertinent question is: Why did the various governments and monetary authorities allow E-D banking to grow on an unregulated, prudential reserve basis? The situation obviously required that the E-D banks be constrained in their money creating activities through the standard devices of legal reserves and reserve ratios, the volume and level of which are controllable by the monetary authorities. There is no assurance, of course, that the monetary authorities having such powers will use them to prevent and excessive creation of money.

  Until the early sixties there was a chronic shortage of U.S., dollars available to finance international transactions. But the E-D system came about precisely because the U.S. balance of payments deficits had finally supplied a more than adequate volume of international liquidity (fed continuously by U.S. trade deficits). The E-D has been a superfluous and harmful addition to the world’s monetary stocks and E-D bankers have increased their earnings assets by approximately this addition.. This figure is many times the U.S. means-of-payment money supply.

  China holds the largest foreign exchange reserves, much of which are denominated in US currency. Such deposits are now available in many countries worldwide, but they continue to be referred to as "Eurodollars" regardless of the location, Yaun-dollars, Yen-dollars, Petro-dollars, foreign-dollars (U.S. trading partners), etc., are now contributing to this excess.

  This vast addition to the world’s money supply has substantially contributed to the high rates of inflation that have prevailed since 1965 with U.S. trading partners. Nor can the E-D be defended as being in any way superior to the U.S. dollar as an international reserve and transactions currency since the acceptability of the E-D is totally dependent on the acceptability of the U.S. dollar.

  If the E-D system is not to repeat the tragic record of all previous prudential reserve banking systems two thins are necessary: (1) the U.S. dollar must remain acceptable as the world’s transactions currency (This requires that the chronic deficits in the U.S. balance of payments cease), and (2) the E-D system must be subjected to the restraints of controllable legal reserves and reserve ratios.

  But this is only the beginning. After the legal structure has been put in place we will still need monetary authorities who understand the economics of money creation, the consequences of excessive money creation – and are willing to force on the governments and business communities of their respective countries the discipline of a properly regulated money supply. The latter problem will be with us whether control is vested in the central bankers, or the International Monetary Fund is made a world central bank and control of the E-D is vested in it.

  But the alternative is, at some point in time, a flight from the U.S. dollar and, therefore, the Euro-dollar. This will generate hyperinflation in terms of U.S. and Euro-dollars, and an international financial crisis of unprecedented proportions. If history is a guide it is obvious these requisite conditions will not be achieved.

  Euro-dollars, Yen-dollars, Yuan-dollars, Petro-dollars, foreign-dollars
  cross-border flow
  Our situation requires measures be taken which will reverse the deterioration of the dollar's integrity. Otherwise, the dollar's acceptability as an international reserve currency will further erode. What is required is no less than an end to the chronic liquidity deficits in our balance of payments, and a halt to the excessive creation of U.S. and Euro-credit dollars. This task will prove to be extremely difficult. But the alternative is, at some point in time, a flight from the U.S. dollar and, therefore, the Euro-dollar. This will generate hyperinflation in terms of U.S. and Euro-dollars, and an international financial crisis of unprecendented proportions.

  Russia, formally the epitome of state controlled economies, did not use the ruble in its foreign exchange operations. Since all trade with the Soviets was monolithic, it was to their advantage to establish a single money center bank through which all foreign financing could be channeled. Their London bank was one of the first to become a part of the Euro-dollar system; an unregulated system of money creating banks operating on the principle of prudential reserves, as contrasted to regulated legal reserves.

  These prudential reserves are liquid balances in the London money market at or new the LIBOR rate (the London Interbank Offering Rate), a rate substantially below the prime rates of most banks. U.S. money center banks were often criticized for loaning money “to other countries” at a lower rate than it would offer local customers.

  With respect to the U.S., all transactions were financed through the Amtorg Trading Corporation which transfers all of its receipts to, and draws all of its drafts on the London bank. The only concern of the London bank with fluctuating exchange rates is to have a minimum inventory of a depreciating currency.

  Since the demise of the Bretton Woods System the dollar ceased to be the currency around which all other currencies revolved. Changes in exchange rates were negotiated by governments, usually through the offices of the International Monetary Fund. Rates now are determined in the open market subject to all the vicissitudes of a competitive market. Consequently the market registers many unwarranted speculative fluctuations. These fluctuations unnecessarily increase the costs and risk of doing business.
  All of the tools at the disposal of the central banks have a limited and short term effect. Direct participation of central banks in foreign exchange markets alters, of course, the actual volume of a currency offered in the market. But central bank purchases have an inflationary effect on their domestic economies, since purchases supply added legal reserves to their domestic banks. Obviously these operations may not conform to the optimum monetary policy of these countries, and consequently have to be reversed sooner or later.

  If we wish to stabilize the dollar or increase its value, it will be necessary to eliminate our trade deficits, and reduce drastically the expenses the federal government incurs in the financing of our foreign policy.
  

  Published: July 16, 2007 8:45 PM

• Spencer Bradley Hall

  Previous post should have ended here: If history is a guide it is obvious these requisite conditions will not be achieved

  Published: July 16, 2007 8:49 PM

• Spencer Hall

  In the beginning there was one M, then three, then five; (M4 & M5), then “L”, “Debt”, MZM, & OCD, etc. It would be a burden to enumerate the components of these various concepts of money.

  From the standpoint of monetary authorities, charged with the responsibility of regulating the money supply, none of the definitions make sense. The definitions include numerous items over which the Fed has little or no control, including many the Fed need not and should not control. The definitions also assume there are numerous degrees of “moneyness”, thus confusing liquidity with money (money is the “yardstick” by which the liquidity of all other assets is measured).

  The definitions also ignore the fact that some liquid assets have direct one-to-one relationship to the volume of transaction deposits (TR’s), while others affect only the velocity of TR’s. The former requires direct regulation, the latter simply is important data for the Fed to use in regulating the money supply.

  2) Money should be defined exclusively in terms of its means-of-payment attributes. The present array of interest-bearing checking accounts has confused the distinction between means-of-payment accounts and saving-investment accounts and created a dilemma as to what portion, if any, of these interest-bearing accounts should be considered as savings. This dilemma is resolved if transactions velocity is taken into account; i.e., TR is analyzed in terms of monetary flows (MVt). No money supply figure standing alone is adequate as a guide to monetary policy.

  From the monetary authority’s point of view, money has to be confined to assets that constitute means-of-payment and are controllable. Currency is not such an asset. Fortunately it is an asset the Fed does not, should not, and cannot control. There is no inflationary bias in an expansion of currency, and the deflationary bias resulting from its growth, can, and is, offset through the expansion of Reserve Bank credit.

  The Fed’s original definition of M3 was mud pie (mixed, i.e., double counts the supply of loan funds as money). And M2 was muck before it: because M3 contained M2, M3 was already contaminated.

  The Fed discontinued M3 because there was no correlation or there were better correlations with the other aggregates than between M3 and nominal gdp. This shouldn't be a surprise because M3 includes both money that has been spent (the supply of loan funds) and the supply of money. Thereby M3 significantly overstates the supply of money by double counting the supply of loan funds from the thrifts.

  Published: July 19, 2007 2:24 PM

• Andy

  The recent panic in subprime mortage market will probably force the FED to lower interest rates and cause another sell off of the USD, ultimately causing the creation of the Amero. www.amero.am is a good recource where you can read, vote and discuss about these important matters.

  Published: August 13, 2007 2:54 PM