International Capital Mobility: the United States Dilemma

In this globalized world, international capital mobility must be taken as a given.

According to modern international economic theory, if international capital mobility is a given, then there are only two other policy choices left a nation, but that nation can only choose one of the two. The first is a fixed exchange rate and the second is the ability to run an independent government economic policy. By independent is meant that a nation’s economic policy can be run according to the internal goals and objectives of that nation without regard to the economic policy of any other nation in the world.

The assumption has been that a nation can follow an independent path internally so as to achieve high levels of employment as well as other social goals like attempting to put every family in the country in its own home.

The United States began following a fully independent economic path in the 1960s and with the growing mobility of capital globally following World War II, the Nixon administration found it could not continue keeping the value of the dollar tied to a gold standard. In August 1971, President Nixon released the dollar and allowed its value to float.

The basic assumption of this move was that the value of the dollar would adjust in international markets so that the United States government could inflate the economy so as to achieve full employment of its labor force. As credit inflation took place within the country, the value of the dollar would decline causing exports to increase which would keep the labor market fully engaged.

One problem: this assumed that the United States economy would stay competitive with other nations. Unfortunately, this assumption did not hold as the credit inflation within the United States resulted in a deterioration of the competitive base of American industry.

A consequence of this deterioration is that American exports could not keep up with the competition in world markets. As the value of the dollar declined, exports did not expand as the economic model predicted. Charles Kadlec reported in the Wall Street Journal that as the value of the dollar declined dramatically over the 42 years following 1967 “net exports have fallen from a modest surplus in 1967 to a $390 billion deficit equivalent to 2.7% of GDP today.” (http://professional.wsj.com/article/SB10001424052748703440004575548451304697496.html?mod=WSJ_Opinion_LEFTTopOpinion&mg=reno-wsj)

Hello?

Is the market trying to tell us something?

In my post yesterday, I presented information cited by Tom Freidman in the New York Times who focused on a report from the National Academies listing how the United States has declined from being a leader in innovation and technology. The conclusion from this report is that the United States just is not as competitive in the world as it was fifty years ago.

Bloomberg adds further evidence that the world is shifting in terms of competitive action. How do you like this headline? “IPOs in Asia Grab Record Share of Funds as U. S. Offers Dry Up.” (http://www.bloomberg.com/news/2010-10-27/ipos-in-asia-grab-record-share-of-global-funds-as-u-s-offerings-dry-up.html)

“‘What the market needs and wants is a lot more IPOs coming out of China,’ said Jeff Urbina, who oversees emerging-market strategy at Chicago-based William Blair, which manages more than $41 billion. ‘That’s where the growth is.’”

The article states that “Record demand for initial public offerings in Asia is reducing the share of U. S. IPOs to an all-time low as companies from China to Malaysia and India flood the market with more equity than ever.”

Who says the world is not shifting?

And, then, in another blow to American pride, we learn that the Chinese have built a supercomputer that has 1.4 times the horsepower of the fastest computer that exists in the United States. (http://www.nytimes.com/2010/10/28/technology/28compute.html?hp)

Maybe, just maybe, the United States needs to take a hard look at the economic philosophy it has based economic policy on over the past fifty years. Maybe an economic policy based upon credit inflation is not productive in the longer run after all.

There is substantial information being produced by the market place to indicate that maybe the predominant economic model in the United States, the “Keynesian” model, does not produce the results that we want. In fact, the information is pointing to the fact that, in the long run, the results that are produced by this model are exactly the opposite of what people were trying to achieve.

However, the real Keynes argued that when the facts seemed to point away from the models currently in use, one should change the models that are being used.

Maybe, just maybe, we should listen to this Keynes and not to the “Keynesian” true-believers that preach the fundamentalist gospel that has dominated economic policy making over the past fifty years.