The Missing Link
Dr. Kurt Richebächer
The
Daily Reckoning
January 10, 2005
The Daily Reckoning PRESENTS
: Most Americans refuse to acknowledge
the absurd amount of damage the trade deficit has inflicted on
the U.S. economy... luckily, the Good Doctor is here to illustrate
the risks the trade deficit puts on the entire U.S. financial
system. Read on...
The badly flawed
consensus thinking about the implications of sustained large
U.S. capital inflow starts with the error that U.S. assets are
uniquely attractive to foreign investors. The reality is that
U.S. investors are earning far higher returns on their assets
in Europe and Asia than foreign investors do on their U.S. assets.
European firms and investors who invested heavily in the United
States during the "new paradigm" years in the late
1990s are still smarting from horrendous losses. The DaimlerChrysler
disaster is by no means an isolated case.
As to U.S.
bond yields, they are just marginally above euro yields, but
considerably below the yields obtainable in emerging countries.
What is more, after inflation, they are the lowest in the world.
A falling dollar is, of course, a virtually prohibitive deterrent
to foreign bond purchases. In fact, it might induce selling.
This leaves
the central banks of Asian surplus countries as the potential
buyers of last resort for the dollar, unwanted by private investors.
They did heavy dollar buying in 2003 and in early 2004, but never
forget, the dollar purchases by the central banks have a heavy
price in turning healthy economies into sickly bubble economies.
The sustainability
of the U.S. capital inflows is, actually, the totally wrong question
to ask from the American point-of-view. Far more important is
another question, concerning the effects of the trade deficit
on the U.S. economy, in particular on employment and income creation.
We find that the dogmatic belief in the mutual benefit of foreign
trade has stifled any reasonable discussion in this respect.
The benefits
for the surplus countries are obvious. Exports in excess of imports
create higher employment, higher profits and higher incomes.
But what are the benefits to the United States? Frankly speaking,
we do not see any true benefit of a trade deficit. What the American
"mutual-benefit" apostles fail to see is that a balance
in benefits essentially presupposes a balance in the underlying
trade.
Yet there is
a widespread view that the flood of cheap imports, by keeping
a lid on U.S. inflation and wage pressures, fosters lower interest
rates, which tend to spur economic growth.
For us, both
effects are not beneficial at all, because the imports implicitly
distort both inflation rates and interest rates to the downside.
In essence, the lower inflation rates allow a looser monetary
policy than domestic conditions justify. For Greenspan and many
others wanting the loosest possible monetary policy, this was
certainly a highly esteemed effect of the trade deficit. For
us, it is insane.
Nobody seems
to realize the enormous damages that the egregious trade deficit
has inflicted on the U.S. economy. Indisputably, it diverts U.S.
demand from domestic producers to foreign producers, and this
implies an equivalent diversion of employment and associated
income creation from the United States to these countries. That
is the manifest direct damage of the trade deficit to the U.S.
economy, the obvious main victim being the manufacturing sector,
with horrendous job and income losses.
Blinded by
the dogma of compelling mutual benefits; policymakers, economists,
investors and the American public flatly refuse to see this disastrous
causal connection. The alternative explanation is that America's
extremely poor job performance has its main cause in the highly
desirable high rate of productivity growth.
It is a convenient,
but foolish explanation, reminding us of the early days of industrialization,
when people destroyed machinery for fear of unemployment. For
us, productivity growth that destroys millions of jobs is definitely
suspect as a mirage. Historically, strong productivity growth
has always coincided with strong capital investment involving,
in turn, strong employment growth in the capital goods industries.
That is presently,
of course, precisely the missing link in the U.S. economic recovery.
(As an aside, in a healthy economy with adequate savings, cutting
labor costs generally takes place through investment, not through
firing.)
The job losses
from the soaring trade deficit have always been there. But they
did not show up in the aggregate for many years because the booming
economy - driven by extremely loose monetary policy - created
sufficient alternative jobs. But this alternative job creation
has drastically abated since 2000, and the soaring trade deficit's
damage to manufacturing is now surfacing in full force.
Having said
this, we hasten to add that the U.S. trade deficit must be seen
as one imbalance among several others, whether zero or even negative
national savings, a soaring budget deficit, record-low net capital
investment or sky-high consumer debt. They all derive from the
same underlying key cause: Unprecedented credit excesses that
have boosted consumption for years at the expense of capital
formation.
What governs
the U.S. trade deficit is not the law of "comparative advantages,"
but the careless depletion of domestic saving and investment
resources though policies that have recklessly bolstered consumption.
Essentially, employment creation through capital investment is
out. Putting it bluntly, the U.S. trade deficit, like all other
imbalances, reflects a grossly skewed resource allocation toward
consumption.
To American
economists, this idea that over time, excessive consumer spending
leads to recession and worse, by crowding out capital investment
may seem preposterous. Widely unknown, it happens to be the central
idea that F.A. von Hayek developed in his famous lectures at
the London School of Economics in 1931.
In essence,
he explained in great detail that an increase in consumer demand
at the expense of saving will inevitably lead to a scarcity of
capital, which forces a "shortening in the process of production,"
and so causes depression. Putting it in simpler parlance: Excessive
consumption inevitably crowds out business investment. As a share
of GDP, consumption in the United States is presently excessive
as never before. And it keeps worsening.
Assessing the
U.S. economy's prospects, it also has to be realized that the
bubble-driven consumer-spending boom represents artificial, unsustainable
demand. Apocalypse will follow when the housing bubble bursts
- which is sure to happen in the near future.
As the Boston
Herald recently reported: "[Stephen] Roach met select groups
of fund managers downtown last week, including a group at Fidelity.
His prediction: America has no better than a 10% chance of avoiding
economic 'Armageddon'... Roach's argument is that America's record
trade deficit means the dollar will keep falling. To keep foreigners
buying T-bills and prevent a resulting rise in inflation, Federal
Reserve Chairman Alan Greenspan will be forced to raise interest
rates further and faster than he wants. The result: U.S. consumers,
in debt up to their eyeballs, will get pounded."
We could not
agree more. Our particular nightmare is that the huge carry trade
bubble in bonds will inevitably burst in this process. A fire
sale of bonds in unimaginable proportions would begin, with bond
prices crashing and yields soaring. With the prices of housing,
stocks and bonds crashing, the entire U.S. financial system would
be at risk.
It is typically
argued that the U.S. economy is importing too much in comparison
to exports. Superficially, that is true. Yet on closer look,
it is a mistaken perception. Compared to other industrialized
countries, U.S. imports are very low as a ratio of GDP. The true
key problem is abysmally low goods exports, accounting lately
for barely 7% of nominal GDP. This compares, by the way, with
a German goods export ratio of 35% of GDP.
The next implicit
question is the cause or causes of this extremely low U.S. export
ratio. The answer is strikingly obvious. It is precisely the
same cause that chokes productive capital investment - the progressive
shift in the allocation of available domestic resources away
from capital formation through saving and investment in plants
and equipment, and toward immediate consumption.
That is the
supply-side problem. Yet there is a demand-side problem, too.
Greenspan and others like to boast that America is creating growing
demand for the rest of the world. The ugly truth, rather, is
that U.S. monetary policy has been excessively loose in relation
to potential domestic output, because Greenspan has wanted maximum
economic growth for years. But lacking domestic output capacity
to meet the soaring domestic demand, an increasing share of the
demand creation from monetary excess exited to foreign producers,
resulting in the huge U.S. trade deficit.
It is a flagrant
policy failure that has created a monstrous, unsustainable imbalance,
both domestically in the United States and globally. However,
for years, American policymakers and economists have glorified
this deficit as America's great contribution to world economic
growth. But the day of reckoning is rapidly approaching.
Regards,
Kurt Richebächer
for The
Daily Reckoning
Editor's note:
Former Fed Chairman Paul Volcker once said: "Sometimes I
think that the job of central bankers is to prove Kurt Richebächer
wrong." A regular contributor to The Wall Street Journal,
Strategic Investment and several other respected financial publications,
Dr. Richebächer's insightful analysis stems from the Austrian
School of economics. France's Le Figaro magazine has done a feature
story on him as "the man who predicted the Asian crisis."
321gold Inc
Miami USA
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