Much to the surprise of many, the U.S. dollar has shown resilience despite the growing problems with the U.S.economy. But how long can we count on the kindness of foreign strangers to keep our heads above water? Dr. Hans Sennholz explores...
- From: periodistalibre@xxxxxxx
- Date: 15 Feb 2006 12:29:06 -0800
UNFAVORABLE BALANCES
by Dr. Hans Sennholz
To the surprise and wonder of many economists, the U.S. dollar
continues
to be rather strong in international money markets despite ever growing
American trade deficits. Last year, these deficits amounted to more
than
seven hundred billion dollars, or six percent of gross national
product,
increasing the indebtedness of the United States to the rest of the
world
to nearly one-fourth of GNP. At this rate, American indebtedness is
likely
to reach one-half of GNP in just five years. Despite the soaring debt,
the
U.S. dollar rose some 14 percent relative to the euro and even more,
relative to the Japanese yen. It lost a fraction toward the Chinese
renminbi after the Chinese central bank raised its dollar rate by 0.4
percent. Yet, the dollar seems to be the rock on which most countries
rest
their currencies.
The financial world, apparently, is ignoring the trade deficits and the
rapidly rising American indebtedness. Being accustomed to deficit
financing, American officials seem to handle them with ease. Even
long-term interest rates are remaining exceptionally low. But many
politicians and media spokesmen like to complain about China,
especially
about its refusal to allow its currency to find a free market rate and
thus allow the money market to function freely. They like to look
abroad
and find fault with foreign demeanor rather than reflect on their own
conduct.
Former Federal Reserve Chairman Alan Greenspan evidently does not agree
with these critics. He has a ready explanation for American
balance-of-payment deficits, which constitute by far the biggest
maladjustment of the global economy. He believes that such deficits are
merely the byproduct of a long-term development facilitating the
deficits,
and that they are the side effect of the ever-increasing importance of
the
financial industry and its great flexibility. We do agree with the
former
chairman that the world economy, and especially world finance, has
expanded significantly ever since the disintegration of the Soviet
Union
and the dissolution of the Soviet bloc of countries. Many trade
barriers
have come down and capital markets have widened to include all but a
few
recalcitrants. But such an explanation of the size of the trade
imbalance
does not explain its very cause. In fact, central bankers rarely render
accurate accounts of the consequences of the policies they conduct.
Ever since the world discarded gold as the standard medium of exchange,
the U.S. dollar has served in its stead. And just like gold or any
other
commodity, the dollar has been moving from places where its market
value
is low, to places where it is higher. It is sent to all corners of the
world, always guided by its purchasing power. And just as the gold-
producing countries usually experienced "unfavorable" balance of
payment -
that is, the exports of gold exceeded the imports - so does the United
States suffer "unfavorable balances," or exports of dollars exceed
their
return. But while the quantity of gold mined and offered on the market
was
always rather small, the volume of Federal Reserve notes and deposits,
as
well as the fiduciary credits resting thereon usually is much larger.
It
affects not only international money relations, but also tends to give
rise to worldwide business cycles. The Fed has generated numerous
boom-and-bust cycles ever since it opened its doors in 1914. The booms
are
periods of easy money and abundant credit that lead to malinvestments,
squandering, scarce factors of production, and encourage
over-consumption.
In the recessions that are bound to follow, the maladjustments are
corrected and the factors of production are employed again for the best
possible satisfaction of consumer needs and wants.
Economists like to distinguish among several phases of a business
cycle. A
central bank launches the first phase by embarking upon money and
credit
expansion in order to stimulate the economy or finance government
budgetary deficits. It may purchase government obligations with money
it
creates or lower its interest rates, which encourages member banks to
borrow money it creates. In the second phase, businessmen tend to
borrow
these funds and embark upon production that hitherto had not been
economical. Business is very rewarding and profitable. In the third
phase,
feverish activity may cause factor prices as well as goods prices to
rise.
The specter of inflation makes its appearance, which may induce
monetary
authorities to raise their interest rates. But these usually trail
actual
market rates that are rising - and may even accelerate. During this
phase,
legislators and regulators like to impose price and wage controls and
threaten violators with heavy fines and imprisonment. In the fourth and
final phase, a new central banker facing runaway inflation may have the
courage to raise his discount rate to the market rate, which finally
balances the demand for funds with the supply of actual savings. At
this
time, the economic readjustment and correction - that is, the recession
-
begins. But before it has run its course and properly corrected all
maladjustments, the monetary authorities usually launch another cycle.
And where in the cycle are we today? Most symptoms seem to point to the
third phase, when goods prices begin to rise and the inflators become
inflation fighters. Surely, consumer goods prices have been rising at
modest rates because massive imports from China and other Asian
countries
have diminished the price pressure. But these countries compete for raw
materials and energy products, such as petroleum, which has raised
those
prices significantly. Moreover, American real estate prices have been
soaring, which enabled many homeowners to consume the rising equity and
go
deeper into debt. Yet, foreign central bankers and commercial bankers
continue to trust the financial structure and invest some of their
dollar
surpluses in U.S. Treasury obligations. They recently rushed to acquire
a
large bloc of new 30-year bonds, which obviously helped to support the
dollar and hold interest rates at present levels. They simply ignore
the
massive level of dollar debt and the large maladjustment of the global
economy.
The fourth and final phase of the cycle is not yet in sight. However,
we
must face and get ready for the ordeal that is bound to come at home
and
abroad. The Federal Reserve may continue to raise its discount rate
until
it finally reaches the market rate, at which time the readjustments
begin.
But even if it should not dare to raise its rate to a level at which
the
demand for funds is covered solely by genuine savings, the
readjustments
may commence whenever the distortions come in sight. The readjustment
in
real estate may already have begun in the form of stagnation and
decline
in some communities. It may continue to spread as more and more
consumers
become reluctant to live beyond their means and increase their debt.
The coming readjustments may commence abroad. Some foreign creditors
may
tire of amassing ever more dollars and supporting the standards of
living
of a rich and powerful country. They may question the creditability of
a
debtor who makes no preparation for reducing his debt, but actually
continues to enlarge it. Even if no important creditor should unload
his
dollar claims and seek refuge in some other currency, such as the
European
euro, the Japanese yen, or Chinese renminbi, the clouds of
international
conflict seem to be gathering, casting a shadow on all international
debtors, especially the biggest and brightest. In Palestine, which
Jordan
ceded to Israel after the 1967 war and is inhabited by some 2.5 million
Arabs and 250,000 Jews, the most militant Muslim party, called Hamas,
recently came to power. It is unlikely that it will call a halt to the
bloody Intifadah uprising and suicide bombings in Israel. Encouraged
and
supported by Muslim fanatics from its kindred neighbors, it may unleash
a
bloody clash of arms, which soon may trigger a grave crisis of world
finance. It surely would bruise and mar the U.S. dollar.
In Iran, the issue of weapons of mass destruction has led to acute
tension
and confrontation with the European Union and the United States. They
still are trying to persuade Iranian authorities to abandon the
development of nuclear power and arms, which would constitute a deadly
peril to some of its neighbors and especially to tiny Israel. If they
should fail, and Iran edges ever closer to the possession of nuclear
arms,
there is serious speculation that either the United States or Israel
may
strike at the country's nuclear bases. Such an assault undoubtedly
would
enrage the world of 1.3 billion Muslims in 206 countries, and topple
the
international debt structure that is resting on the U.S. dollar.
There are times when precaution is wise and profitable. It keeps a
watchful eye on present dangers and on things to come.
Regards,
Dr. Hans Sennholz
Editor's note: The Fed has remained irrationally confident in the U.S
economy - because they can't afford from American consumers to see the
truth - that the basis for this confidence is a shamelessly fraudulent
farce of trumped-up statistics.
Dr. Hans Sennholz is president emeritus of The Foundation for Economic
Education (FEE) in Irvington, NY. His essays and articles have appeared
in
over thirty- six major German journals and newspapers, and 500 more
that
reach American audiences. Dr. Sennholz is also the author of 17 books
covering the Great Depression, Gold, Central Banking and Monetary
Policy.
You can write to him at this address: hans@xxxxxxxxxxxxx
.
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