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://www.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