In recent posts I have written about how international capital mobility has expanded since the 1960s to the point where one cannot imagine the world without freely flowing capital. Sebastian Mallaby has presented a confirming essay on this in the Financial Times, “The Genie of Global Finance is Out of the Bottle,” (http://www.ft.com/cms/s/0/9084f8c8-d527-11df-ad3a-00144feabdc0.html).
“The truth is that, however cogent the case for reining in financial globalization, sheer momentum will carry it forward…the bottom line is that, once a country has a sophisticated capital market, it is tough to keep foreigners out.
It is even tougher to exclude a particular class of foreigner, which is why the understandable urge to impose portfolio sanctions on China will prove impractical. The US has sold around $3,000 billion worth of Treasury bonds to foreigners, and perhaps only a third of those are held by China—if Beijing wants to bulk up its holdings tomorrow, it can buy plenty from Middle Eastern sovereign funds. Once finance is globalized, it just is not possible to deglobalize it cleanly. The genie is out of the bottle. We must find ways to live with it safely.”
Take de-globalization off the table.
What is one way to live with this freely flowing capital mobility? Certainly not inflation.
Yet the United States government has acted over the past 50 years on an economic philosophy that has created an almost constant credit inflation. This has left the United States is a weakened bargaining position relative to other nations in the world. (See one of several posts I have recently written on this subject: http://seekingalpha.com/article/227990-monetary-warfare-can-nations-have-independent-economic-policies.)
The United States has justified the need for this “independent” economic policy to ensure high levels of employment within the country. However, international financial markets have not given the United States high marks for such a policy as the value of the United States dollar has declined by about 40% throughout the period this policy has been in effect.
The justification for allowing the dollar to decline in value has been that this will help to stimulate American exports and help correct the American balance of payments.
Well, the Chinese (and other emerging countries) are buying goods from the rest of the world. However, they are not consumer goods…they are capital goods.
A headline opinion piece in the New York Times by Andrew Ross Sorkin trumpets “Worrying over China and Food” (http://www.nytimes.com/2010/10/12/business/12sorkin.html?ref=business). The concern is over the fact that a “consortium of state-backed Chinese companies and financiers may make a takeover offer for Potash that rivals a $38.6 billion hostile bid from BHP Billiton.”
Sorkin states that “The politically charged subtext is this: Do we really want the Chinese to control the company that has the largest capacity (in the world) to produce fertilizer?”
But this is not all from the morning papers as other headlines read “China Takes New Bite at U. S. Energy” (http://professional.wsj.com/article/SB10001424052748703794104575545992992771182.html?mod=ITP_moneyandinvesting_7&mg=reno-wsj) and “China Turns to Texas for Drilling Know-How” (http://professional.wsj.com/article/SB10001424052748703358504575545183782651388.html?mod=ITP_marketplace_0&mg=reno-wsj). It seems as if the China National Offshore Oil Company (Cnooc) is investing money in Chesapeake Energy, an investment “in onshore U. S. energy assets.”
Contrary to an earlier effort by Cnooc to acquire Unocal, a bid that caused grave concern in the United States Congress, this bid seems to be gaining favor because the Chinese will only have a minority ownership (one-third of the company) which means that this position will not be a “credible threat to national security.” The reason for this is that “Chesapeake will retain operational control of its…shale assets.”
What is the old saying about someone who gets their foot in the door?
But, this pattern is occurring all over the world as China intentionally expands its global reach in owning or influencing physical capital…owning all or part of companies.
And, who is underwriting this expansion? The United States government!
The United States government has outsourced to China and others the savings it needs to finance its massive deficits. The Federal Reserve System continues to keep interest rates excessively low exacerbating the credit inflation that that was begun at an earlier time.
And the response of the United States government? It is China’s fault that they are taking advantage of the excessive amounts of credit that have been created in the United States. And China will not change its behavior even as the United States government signals it will continue to follow the same policy it has followed for most of the last fifty years. No matter that this economic policy has brought the United States to the position it now finds itself in.
Bottom line: as Mallaby has argued, finance has been globalized and this trend cannot be cleanly reversed. Given that this is the case, continued efforts to inflate credit in the United States will only worsen the trade position of the United States and make the value of its currency sink even further. In such a situation, who cares about US firms outsourcing jobs to other countries. Instead, let’s just sell US companies to foreign interests and keep those jobs right here in the United States. That is, the jobs will not have to be outsourced to another country…they will just be outsourced to foreign-owned American firms located here in the United States.
Showing posts with label capital mobility. Show all posts
Showing posts with label capital mobility. Show all posts
Tuesday, October 12, 2010
Friday, October 1, 2010
Monetary Warfare: Is An Independent Economic Policy Possible for a Nation?
John Maynard Keynes, after 1917, wanted to achieve full employment for England, but also for other major countries in Europe and the western world. The reason for this goal was that he was afraid of the Bolshevik menace threatening his civilized world.
Thus, beginning with the time that he returned to England from the Paris Peace Conference following World War I, Keynes sought ways that would allow a country to follow an independent economic policy that would primarily focus on full employment for the nation. Before the First World War, Keynes was, like most of his liberal counterparts, a free-trader who believed in capital mobility and flexible exchange rates
Keynes, in essence, developed a policy prescription that is consistent with what is now called the “Trilemma” problem as it is applied to economics. The “Trilemma” problem is that a nation can only achieve two out of the following three policies: fixed exchange rate, independent economic policy, and capital mobility.
Keynes opted for an independent economic policy for a government in order to achieve high levels of employment. He also believed, in his later years, that exchange rates should be fixed. This was ultimately achieved in the Bretton Woods agreement in 1944. This agreement set up the current system of international financial organizations and created a foreign exchange system that stayed in place until August 15, 1971.
The third component of this, international capital mobility, was severely restricted at the time.
What occurred in the 1960s was that inflation increased in the United States due to the fiscal and monetary policies of the government and capital began flowing throughout the world. Thus, the value of the dollar had to float in world markets. Thus, President Richard Nixon set free the dollar on August 15, 1971 and we entered a new age.
Full employment remained a policy goal of the United States government written into law by the Congress. So, the monetary and fiscal policy of the government had to remain independent of what other nations did.
Capital mobility increased as the world became more and more globalized in the latter part of
the 20th century.
And, the consequence of this combination of events left the value of the dollar on its own. And, since the early 1970s, the value of the dollar has declined by about 40% against other major currencies.
The fundamental reason for the decline in the value of the dollar was the credit inflation created by the United States government. The gross federal debt of the United States has risen at an annual compound rate of about 9.5% in the fifty years from 1961. Financial innovation on the part of the United States government has been huge.
The private sector has emulated this governmental behavior as incentives all pointed to increasing amounts of leverage on family and company balance sheets. Again, following the government, financial innovation was everywhere, especially in the area of housing finance.
World financial markets reacted by sinking the value of the dollar…except in a crisis when there was a so-called “flight to quality”. The dollar continues to remain weak and will continue to be weak as long as the United States government follows its policy of underwriting the credit inflation which is undermining the strength of the economy.
But, given conditions of the Trilemma, the dollar must continue to sink as long as international capital mobility continues and the deficit of the United States government is expected to add $15 trillion or more to federal debt over the next ten years. The United States can inflate credit all it wants, but it will have to pay in terms of a falling dollar. The two parts of the Trilemma, flexible exchange rates and the independent economic policy of the government are not really compatible at this time.
For one, this seems to play right into the hands of the Chinese. They are building up enormous international reserves. These reserves are being used to buy productive resources around the world, acquire commodities which they badly need, and increase their political power and influence throughout the nations. (See my post “Monetary Warfare: U. S. vs. China?”: http://seekingalpha.com/article/227632-monetary-warfare-u-s-vs-china.) Yes, we have a major case of mercantilism, here.
And, how does the United States respond? In terms of the policy of the government, it continues to pump things up, just what the Chinese want. And, then the United States government points its finger at China as if it is the bad guy. Well, China is the “bad guy” because it is growing stronger as the United States weakens itself.
The other piece of the picture has to do with what the economic policy of the United States government is doing to its own economy. Well, the results are not good: one in four workers of employment age are under-employed; in industry, capital utilization is between 75% and 80%; and income inequality has increased dramatically over the past 50 years as the wealthy have taken advantage of the credit inflation and the less-wealthy have suffered dramatically from the massive increase in debt leverage. (See my post “Does Fiscal Policy Really Work?”: http://seekingalpha.com/article/227210-does-fiscal-policy-really-work.)
The United States must either get its monetary and fiscal policy in order or it must seek to reduce or prohibit capital mobility. The United States cannot continue to pursue a policy of credit inflation in this era of almost totally free capital mobility without serious ramifications to the strength of its economy. The evidence of this is the current status of the American economy.
The weakness in the economy is what is driving the decline in the value of the dollar. The first conclusion one draws from a declining currency is that the decline is related just to monetary factors, to inflation. However, what we are seeing in the case of the United States is that the U. S. has exported inflation to the emerging nations through the freely flowing capital in the world. The inflation has not shown up explicitly in U. S. prices. But, the inflation has shown up implicitly in terms of the dislocation of economic resources within the United States economy.
That is why I argue that either the United States must change its philosophy about what governmental policy can do or it must seek to reduce or prohibit capital mobility. It cannot continue to support both.
In this mobile global world we live in, we cannot achieve the Keynesian requirement that the monetary and fiscal policies of a country can conducted independently of the rest of the world. Economists have to move on from the Keynesian prescription. The funny thing is, I believe that Keynes would have changed his mind many years ago.
Thus, beginning with the time that he returned to England from the Paris Peace Conference following World War I, Keynes sought ways that would allow a country to follow an independent economic policy that would primarily focus on full employment for the nation. Before the First World War, Keynes was, like most of his liberal counterparts, a free-trader who believed in capital mobility and flexible exchange rates
Keynes, in essence, developed a policy prescription that is consistent with what is now called the “Trilemma” problem as it is applied to economics. The “Trilemma” problem is that a nation can only achieve two out of the following three policies: fixed exchange rate, independent economic policy, and capital mobility.
Keynes opted for an independent economic policy for a government in order to achieve high levels of employment. He also believed, in his later years, that exchange rates should be fixed. This was ultimately achieved in the Bretton Woods agreement in 1944. This agreement set up the current system of international financial organizations and created a foreign exchange system that stayed in place until August 15, 1971.
The third component of this, international capital mobility, was severely restricted at the time.
What occurred in the 1960s was that inflation increased in the United States due to the fiscal and monetary policies of the government and capital began flowing throughout the world. Thus, the value of the dollar had to float in world markets. Thus, President Richard Nixon set free the dollar on August 15, 1971 and we entered a new age.
Full employment remained a policy goal of the United States government written into law by the Congress. So, the monetary and fiscal policy of the government had to remain independent of what other nations did.
Capital mobility increased as the world became more and more globalized in the latter part of
the 20th century.
And, the consequence of this combination of events left the value of the dollar on its own. And, since the early 1970s, the value of the dollar has declined by about 40% against other major currencies.
The fundamental reason for the decline in the value of the dollar was the credit inflation created by the United States government. The gross federal debt of the United States has risen at an annual compound rate of about 9.5% in the fifty years from 1961. Financial innovation on the part of the United States government has been huge.
The private sector has emulated this governmental behavior as incentives all pointed to increasing amounts of leverage on family and company balance sheets. Again, following the government, financial innovation was everywhere, especially in the area of housing finance.
World financial markets reacted by sinking the value of the dollar…except in a crisis when there was a so-called “flight to quality”. The dollar continues to remain weak and will continue to be weak as long as the United States government follows its policy of underwriting the credit inflation which is undermining the strength of the economy.
But, given conditions of the Trilemma, the dollar must continue to sink as long as international capital mobility continues and the deficit of the United States government is expected to add $15 trillion or more to federal debt over the next ten years. The United States can inflate credit all it wants, but it will have to pay in terms of a falling dollar. The two parts of the Trilemma, flexible exchange rates and the independent economic policy of the government are not really compatible at this time.
For one, this seems to play right into the hands of the Chinese. They are building up enormous international reserves. These reserves are being used to buy productive resources around the world, acquire commodities which they badly need, and increase their political power and influence throughout the nations. (See my post “Monetary Warfare: U. S. vs. China?”: http://seekingalpha.com/article/227632-monetary-warfare-u-s-vs-china.) Yes, we have a major case of mercantilism, here.
And, how does the United States respond? In terms of the policy of the government, it continues to pump things up, just what the Chinese want. And, then the United States government points its finger at China as if it is the bad guy. Well, China is the “bad guy” because it is growing stronger as the United States weakens itself.
The other piece of the picture has to do with what the economic policy of the United States government is doing to its own economy. Well, the results are not good: one in four workers of employment age are under-employed; in industry, capital utilization is between 75% and 80%; and income inequality has increased dramatically over the past 50 years as the wealthy have taken advantage of the credit inflation and the less-wealthy have suffered dramatically from the massive increase in debt leverage. (See my post “Does Fiscal Policy Really Work?”: http://seekingalpha.com/article/227210-does-fiscal-policy-really-work.)
The United States must either get its monetary and fiscal policy in order or it must seek to reduce or prohibit capital mobility. The United States cannot continue to pursue a policy of credit inflation in this era of almost totally free capital mobility without serious ramifications to the strength of its economy. The evidence of this is the current status of the American economy.
The weakness in the economy is what is driving the decline in the value of the dollar. The first conclusion one draws from a declining currency is that the decline is related just to monetary factors, to inflation. However, what we are seeing in the case of the United States is that the U. S. has exported inflation to the emerging nations through the freely flowing capital in the world. The inflation has not shown up explicitly in U. S. prices. But, the inflation has shown up implicitly in terms of the dislocation of economic resources within the United States economy.
That is why I argue that either the United States must change its philosophy about what governmental policy can do or it must seek to reduce or prohibit capital mobility. It cannot continue to support both.
In this mobile global world we live in, we cannot achieve the Keynesian requirement that the monetary and fiscal policies of a country can conducted independently of the rest of the world. Economists have to move on from the Keynesian prescription. The funny thing is, I believe that Keynes would have changed his mind many years ago.
Subscribe to:
Posts (Atom)
