US Dollar history since 1980 - and how it affects GDP

The USDX is the indice that measures the relative worth of the US Dollar to the rest of the world. Here is a graph showing how the US Dollar has performed since 1980:

As you can see, there was a huge increase in the mid 1980s. The Plaza Accord wiped out the value in the second half of the 80s, while the late 90s saw a resurgence in the US dollar, partly as a result of panic induced by the Asian Economic Crisis, and partly by the Dot-Com Bubble. The large swing upwards in 2008 was due to panic induced by the 2008 Credit Crisis, when investors dumped shares and fled to the safety of treasuries, which naturally drove the US dollar up.

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Now if we add Real GDP to the mix, we can see just how well the United States as an economy has performed against the rest of the world. The idea here is that we look at Q1 1980 as the baseline (100), and then adjust each quarter's GDP performance by the 12 month USDX average. I chose to average out the USDX over twelve months rather than three months because otherwise the graph would look a bit too shaky. Here it is:

What is notable here is that the US economy grew rapidly in the early 80s and then busted as a result of the Plaza Accord. this meant the US GDP relative to the rest of the world did not recover until the 90s. The indicie on my spreadsheet shows that GDP per capita peaked at 193.86 in Q3 1985, reached a trough of 133.49 in Q1 1991, and then reached 195.29 in Q2 1998. In other words, it took 13 years for the 1985 peak to be reached again.

GDP then peaked at 259.93 in Q1 2002, which is interesting since this was after the early 2000s recession had peaked. Obviously the drop in GDP was more than made up for in the rise of the US Dollar. Since 2002, the US has been in a protracted fall in real GDP measured against the value of the US Dollar, the trough being 192.54 in Q3 2008 (just when the credit crisis was hitting the most). Since then there has been a small rise, but not by much. The Q3 2010 indice was 207.38 (awaiting GDP revisions), which means that the US economy has barely doubled in size since 1980.

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Now we look at Real GDP per capita. This is an important measurement because it examines economic performance per head of population rather than just output. Measuring Real GDP per capita is probably the broadest way to measure whether an economy is growing or is in recession. If we adjust it according to the USDX, we get this:

This, of course, looks worse than Real GDP. In fact the latest indice on my spreadsheet for Q3 2010 is 151.48, which means that economic growth per person is only 50% better than what it was in 1980. Peaks and troughs are pretty much the same as Real GDP.

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The last thing I want to look at is the performance of public companies in the US. The Russell 3000 Index measures market capitalisation and has been running as an indice since September 1987. If we adjust the indice by the USDX (monthly values for both) we get the following graph:

Again you can see here the massive impact of the Dot-Com bubble in the late 1990s. The index peaked at 532.12 in August 2000, with a trough of 266.82 in February 2003, a smaller peak of 417.43 in May 2007, a deep trough of 209.98 in February 2009 (a few months after the credit crisis started), and a recent peak of 326.03 in April 2010. The October 2010 indice is 309.75.

In many ways you can see just how damaging the Dot-Com bubble was - each successive peak appears to be lower than the previous one. And remember that this takes into account the relative value of the US Dollar, which means that while Market Caps (and the Russell 3000) might be increasing, the US Dollar might be lowering in value - so what we're seeing is US Market Capitalisation in the context of the entire global economy.

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NOTE: The use of Real GDP figures as opposed to current dollar GDP figures here may be problematic. When I measure public debt I only ever use current dollar GDP. If there are any problems with this then let me know, since re-doing these graphs according to current dollar GDP will be fairly easy (the numbers are already in my spreadsheet).

If anyone wants the raw data on my spreadsheet, contact me and I'll send a copy to you. Having my data and conclusions verified by others is a pleasure (even if it means that I have been proved wrong).

World trade needs to be rebalanced - here's my suggestion

International trade has been around for centuries and has been the creator of both good and bad world economic conditions. What has evolved now, though, is a trade and capital imbalance that is one of the causes of the current economic crisis. If a new economic order is to be created out of this mess, world trade and capital flows need to change.

In the bad old days, mercantilism ruled the waves and nations would compete against each other to gain the best export advantages. This was a self destructive process, since it resulted in trade tariffs and quotas. Mercantilism was part of a broader scheme called "economic nationalism" which saw international trade as a win/lose battle against other nations. Instead of fighting against another nation with armies, countries would fight each other economically. Fortunately economists appeared whose arguments proved beyond reasonable doubt that international trade was actually a win/win - though with a number of caveats.

Sadly, mercantilism is still around. It is practised most notably by China and Japan, with a number of smaller nations (eg Singapore) jumping in. When one nation has a mercantilist trade policy in world trade, the result is a large trade surplus. This trade surplus generates large amounts of foreign currency, which the countries then use to reinvest back into their trade partners. So in Japan and China's case, their trade surplus with the United States leads to large US dollar profits which, rather than being converted into Yen, are reinvested back into the United States. It is a circular process which creates a "virtuous cycle" - US demand for Japanese & Chinese goods leads to US Dollar profits for Japan & China, which leads to reinvestment of these profits back into the United States, which results increased domestic US demand, which results in increased demand for Japanese & Chinese goods. The problem is that this "virtuous cycle" has been exposed as just another bubble that is in the process of bursting.

Theoretically, mercantilism has been abolished. The Word Trade Organisation and its members take a very dim view of member countries setting up trade barriers or quotas. Japan and China get around it however, thanks to the actions of their Central banks. Instead of creating trade barriers, the Central banks of Japan and China sell their own currency and purchase US government bonds (treasuries). This keeps the Yen and the Yuan/Renmimbi cheaper while simultaneously making the US dollar more expensive. With cheap domestic currencies and a customer country with an expensive currency, Japan and China naturally end up having a trade surplus with the United States. Having a cheap currency allows the development of cheap labour thus undercutting any competition from US based companies.

This situation is reflected in a fairly basic economic indicator called the Current account. Nations which have a Current account surplus are nations who receive large amounts of foreign currency for goods and services they sell, as well as from investments that they have in foreign nations. Nations which have a current account deficit are nations who borrow lots of money from nations with current account surpluses.

It is best to look at the current account as an accounting measurement. If our world economy consists of two countries, and country one has a $1 billion current account surplus, then the other country will have a $1 billion current account deficit. You can't have these two nations in this model both running current account deficits or both running current account surpluses. When we take this model to the wider world we realise that one nation's current account deficit is another nation's current account surplus.

So which is better? It might sound better to have a current account surplus, but this is actually mercantilist thinking. In reality they are just as good or just as bad as each other. If we think that the US current account deficit is bad, then we must conclude that the Japanese current account surplus is bad too.

The problem with running large, long term current account imbalances is that, over time, the economy becomes "geared". In the case of the United States, the economy has been "geared" towards the importation of goods and services, it has become "geared" towards borrowing money from overseas - in short, it is an economy that is geared towards consumption and borrowing. By contrast, China and Japan have been "geared" to complement the United States - they are geared towards producing goods and services, and they are geared towards saving. In short, Japan and China are geared towards production and saving.

The figures for these three countries are stark. The United States is running a current account deficit of 3.3% of GDP; Japan is running a current account surplus of 3.3% of GDP; China is running a current account surplus of 4.9% of GDP. Smaller economies have even more notable imbalances (eg Singapore with a current account surplus of 18.4% of GDP, Turkey with a current account deficit of 5.4% of GDP)

Now of course China and Japan DO purchase goods and services from the United States, and people in China and Japan DO borrow money from the United States, and the United States DOES manufacture goods that it exports to China and Japan, and the United States DOES save money. But what we're talking about here is the net result. Just because the United States gets most of its manufactured goods from China and Japan doesn't mean that the United States doesn't manufacture anything. What I'm trying to point out here is that in the back and forth of buying and selling and borrowing and investing that makes up international trade, that current accounts reflect an overall, net position. This means that various industries within these countries stand to gain from any changes in the exchange rate, whichever way it goes.

But the problem with gearing is that any changes in the exchange rate will impact both consumer-friendly nations and producer-friendly nations. Just as investment bubbles will inflate, burst and destroy wealth in the form of stock market busts or property busts, so too can it happen on an international scale. The US, for example, has been running as a consumer-friendly nation for a long time and, as a result, the bubble is about to burst. The United States is naturally the world's financial capital, yet debt has ballooned out of control over the years. The GFC is the beginning of the end of the consumer-friendly United States. Steps need to be taken to gear the United States into a more producer-friendly economy. This doesn't mean becoming mercantilist and running a current account surplus, but it does mean policies to ensure a balanced current account.

The current accounts of Japan and China should therefore no longer be running at a surplus, but should become balanced (ie neither surplus nor deficit) over the long term. This means that the current account of the United States should no longer be running at a deficit, but should become balanced as well. Put simply, the United States needs to produce more and consume less, and save more and borrow less. On the other side of the coin, this means that China and Japan needs to consume more and produce less, and borrow more and save less.

Retooling the United States to become a more producer friendly economy will be painful and it will take time (ie years) to bear fruit. Similarly, retooling Japan and China to become more consumer friendly will be painful too, and will take a similar amount of time to bear fruit.

One solution to the problem of international trade and current account imbalances is to have a common currency. That is what Europe has done with the creation of the Euro. Within the Eurozone, current account differences do occur: Germany has a current account surplus, Spain has a current account deficit. But that doesn't really matter since comparative advantages are very real in international trade, while internal current account issues within the Eurozone will be dealt with by the market without having problems caused by differing currencies. What does matter is the Eurozone's current account overall (presently a current account deficit of 0.4%, which is close to being balanced)

But since the chances of Japan, China or the United States joining the Eurozone (and all that such a joining would entail) is virtually none, another solution must be found.

The solution I have is for the creation of a new international trading agreement that ensures all member nations have balanced current accounts. This would involve the creation of national currency boards in each member nation whose role will be the maintenance of a balanced current account (as opposed to the traditional role of a currency board to maintain a fixed exchange rate). If a nation has a current account deficit, as the United States does, then the currency board (acting with various government bodies like the central bank and/or treasury) will sell off its local currency and purchase foreign currencies on the foreign exchange market, most obviously the currencies of nations who run current account surpluses. Of course these currency boards will have a reciprocal arrangement with the currency boards of the nations they are dealing with. So in the case of the United States and Japan, the US currency board would sell off US dollars and purchase Yen, while the Japanese currency board would sell off US dollar and purchase Yen as well - with the eventual aim of ensuring a balanced current account between the US and Japan.

This system still allows floating currencies but the forex market will be initially dominated by the actions of national currency boards buying and selling currencies in order to create balanced current accounts throughout. This would be better than instituting fixed exchange rates or returning to a gold standard. Since the currency boards will be operating with their respective central banks, money creation by fiat followed by the selling of this currency will be one way to devalue a currency. These currency boards would then only act to ensure a balanced current account. So long as a balanced current account is maintained for their nation or currency zone, they will stay out of the forex markets. Long term current account maintenance will, however, result in regular forays into the forex market - but each foray being only as large as it needs to be to maintain a balanced current account.

Moreover, the more nations which join this agreement, the more natural comparative advantages between nations can be maintained. Rather than ensuring that each nation has a balanced current account with every other nation, the agreement will simply ensure that member nations have a balanced current account overall. For example, in an international economy of three nations, nation A might have a $500 billion current account deficit with country B, country B might have a $500 billion current account deficit with country C, while country C has a $500 billion current account deficit with country A. In this situation, each nation has an unbalanced current account with individual nations, but the overall result is a balanced current account for each of the three nations.

Once this situation is imposed, international trade and capital flows will be easier for the market to handle, since the market will act in the knowledge that currency values will only move within a certain band - and that band will be determined by the currency board and only acted upon according to the status of the current account. There will be less market speculation and more real trade being achieved. This should also result in more predictable, more sustainable economic growth for all nations involved. The win/lose attitude of mercantilism should be replaced by the win/win of balanced international trade.


Addendum

Of course the theory I am working with here is that balance ensures better economic conditions for all. Ensuring that nations (or more correctly, currency zones) run balanced current accounts is one "pillar" of the new economic order that I see should emerge over the next few decades. These three pillars are:

• Each currency zone has a balanced current account - neither current account surplus nor current account deficit over the long term.
• Each currency zone has governments that run balanced budgets over the long term - neither budget surplus nor budget deficit over the long term
• Each currency zone maintains absolute price stability - neither inflation nor deflation over the long term.
  

I believe that if these three pillars are set up and maintained, the chances of devastating economic downturns (eg great depression / GFC) will be minimised.

Collateral Stupidity

I'm one of the millions of people on the internet who downloaded and watched the "Collateral Murder" video, showing an airstrike on a group of Iraqi men in Baghdad on July 12th 2007. From the point of view of the pilots, we see a group of suspicious men seemingly armed with assaults rifles and at least one rocket propelled grenade (RPG) take up position on a corner from which they could ambush a potential American convoy. The group, is watched by a number of AH-64 Apache Gunship helicopters, and the video was taken through the gun camera of these helicopters. Not only do you hear (and also read, thanks to the subtitles) the alarmed chatter between the pilots, but communications with ground forces and the sound of the 30mm cannons firing at the group.

Unfortunately it appears as though the group were not insurgents at all. Two members of the group were Reuters news reporters, one of whom was using a telephoto lens which made it look like he was carrying an RPG. As the video continues and the group is killed by the cannon fire, one of the Reuters reporters manages to escape up the road before collapsing on the sidewalk. A van then pulls up and moves the injured man inside it. Fearful that the insurgents were rescuing their own, the helicopters fire also upon the van, destroying it and killing the reporter and the two men who placed him into the van. Unfortunately it appears as though the men in the van were trying to help the injured man and were not insurgents at all. Moreover, the video shows images of two children inside the van who were seriously injured by the attack - the children were rushed to hospital by the US troops who eventually arrived at the scene.

Naturally anti-war proponents have used this video as an example of the heartless killers in the US armed forces who supposedly enjoy mowing down civilians and children (when informed that a child was injured one of the pilots openly placed the blame on the van drivers for taking children into a war zone). So how do I, as an opponent of America's invasion and conquest and occupation of Iraq, think?

The first thing I want to say is that the pilots are not to blame in any way. Given the stresses involved in making snap decisions inside a cockpit thousands of metres away from targets, the pilots acted in the only way they knew how. That the men were not insurgents could not be determined, and that two men were reporters could not be determined either. In hindsight it was easy to spot the telephoto lens of one of the reporters but you could quite easily mistake it for an RPG in the heat of the moment. The children were not clearly visible in the van either. In short, the pilots believed that they were engaging the enemy. This was a terrible mistake, of course, but there was no way of them knowing that it was a mistake. Moreover, the comment by one of the pilots criticising the men in the van for taking children into a warzone should be taken at face value only and not as an example of American callousness - after all, if the men in the van were the enemy, then why would they bring children along? No, the pilots did nothing wrong that I could see. Their deed was terrible but they only did what they were trained and ordered to do. Without any clear indication that the people involved were civilians (which the video does not show) the pilots needed to treat the people as insurgents.

The second thing I want to say is that this incident shows the limits of using military force in an urban environment. The war machines of the US military are designed for conventional warfare. The AH-64 Apache gunship helicopter is designed to knock out armoured vehicles on a battlefield - its 30mm cannon can reduce tanks to wrecks so you can imagine what effect this cannon would have upon the human targets shown in the video (which is thankfully black and white). The US military is NOT designed, however, to effectively police a foreign city full of insurgents engaging in a guerilla war against the Americans and the American backed Iraqi forces. While there is no doubt that the sheer volume of firepower directed by American forces can completely destroy any group of enemy (as proven by this video), there will always be the danger of collateral damage - namely the deaths of civilians (as proven, again, by this video). What we see in this tragic video is an example of the sheer stupidity of American battlefield doctrine when applied to an urban environment full of civilians. In such an environment the margin for error is just non-existent. The pilots had to weigh up the chance that they were firing on civilians against the chance that they were firing on insurgents - had they chosen not to act then there would be the real possibility of American troops being killed by these people. Faced with the prospect of either possibly killing civilians or taking a course of action that would result in the deaths of American troops, the pilots made the only choice that made sense. So while I do not blame the pilots in any way for their action, I do blame the system and the generals who placed them into this intolerable situation.

The last thing I want to say is that this incident proves beyond doubt that a different strategy is required. It is fortunate that levels of violence have dissipated considerably since the 2003 invasion (and 2007, when this incident occurred), but there are lessons to be learned. The amount of Iraqis who have died since "Mission Accomplished" is criminal, and reflects very poorly upon the morality and upon the competence of those responsible for planning the war and its aftermath. Rebuilding Iraq and improving the social conditions of Iraqis should be far more important than setting up a puppet democracy or simply maintaining the status quo. I have never had faith in America's ability for nation building and I think that the only real solution is for US forces to withdraw and be replaced by the forces of neutral nations under the aegis of the United Nations. The UN has successfully created peace in the Balkans to the point where most Balkan nations are now seriously contemplating joining the European Union (Croatia, Macedonia, Montenegro, Serbia, Bosnia and Herzegovina, Albania and Kosovo). I say let the UN take over Iraq - and Afghanistan as well - and move US troops back to America.

Who opposes Health Care Reform?

It's the South:

The WSJ Real Time Economics blog has posted the letters for and against the health care reform bill winding through Congress. The most interesting thing about the lists of signatories is the geographical divide. It was so interesting, I did a fast tabulation (so, don't quote me on it), and what one finds is that of the list in favor, only 2 of 41 economists are affiliated with institutions in the South (defined using the most restrictive definition in this Wikipedia page -- so to be completely accurate, I haven't used the actual Mason-Dixon line). Of the 131 signatories to the against letter, 40 are affiliated with institutions in the South, i.e., essentially 30% of the total.

Dirty Deeds

From the BBC:

Haiti has charged 10 US missionaries with child abduction and criminal conspiracy for allegedly trying to smuggle 33 children out of the country.

Haitian officials said their cases would now be sent to an investigating judge who would decide how to proceed.

If convicted they face lengthy jail terms, says the BBC's Paul Adams, in Haiti's quake-hit capital city.

When stopped on the border last Friday, they said they were taking the children to a Dominican Republic orphanage.

But it has emerged some of the youngsters had parents who were alive.

Hanlon's Razor says Never attribute to malice that which can be adequately explained by stupidity and I think that is what is going on here. I'm not saying that it's impossible that these missionaries were deliberately stealing children out of Haiti - of course it is - it's just that in this case I don't think their actions were malicious. Misguided? Yes. Stupid? Yes. Embarrassing? Yes. Deliberately evil? No.

When faced with a disaster of the scale of the recent Haiti earthquake, and also faced with advertisements pleading for charity, many people (including Christians) can feel somewhat disempowered. Although their concerns can be assuaged somewhat by giving away money, some have decided on more direct action - especially when there are reports of charity money never actually reaching those who need it most.

So I think this is what happened: A bunch of US Christians from a missionary agency decided on direct action to save and help the lives of a small amount of Haitian children. They flew to the Dominican Republic (the nation which occupies the Eastern half of Hispaniola, while Haiti occupies the Western half), organised some slapdash accommodation, then set off in a bus across the border where, upon reaching Port-au-Prince, they picked up 33 kids who they deemed to be orphans, and then headed east to bring these children to freedom and a better life.

Of course what happened then was that Haitian authorities stopped the bus before it crossed the border, took away the children - some of whom were then reunited with family, including parents, in Port-au-Prince - and arrested the missionaries.

Obviously time well tell whether these missionaries were child trafficking, but I think it is safer to assume that these were well meaning people who committed a seriously stupid act.

What if?

One of my great fears is that this current economic crisis will lead to a crash in the value of the US Dollar. This is something I have been predicting since at least 2005 and now seems more certain than ever.

Of course, what prompts me to write this is the recent drop in the US Dollar. Is this the beginning of the end? I honestly don't know. The thing about predicting economic trends the way I do is that the event occurring is more certain than when it occurs. The US Dollar may jump back up to last week's levels in the next 24 hours, but the downward trend is more likely to occur at some point than any time before. It's like geologists making predictions about earthquakes or volcanic eruptions - the signs are all there that it will happen, but the actual time and date is unknown. When it comes to the US Dollar crashing, the same principle is in effect.

So, assuming I am correct, what will happen to America after the Dollar crash?

1. Economic decline - even more.

It's hard to imagine, but the most obvious effect of a currency crash is economic decline. In normal circumstances this would be bad enough, but, if judicious economic and financial analysts are to be believed, America is already facing the worst economic conditions since the Great Depression. The subprime bubble has spread financial contagion all throughout the US. Big companies are going bankrupt, the sharemarket is volatile and unemployment is rising. And that is all happening before a dollar crash.

If and when the dollar crashes, the effects of the crash will reverberate throughout the economy. While the current credit crisis is hitting mainly financial firms while manufacturing and services take some serious collateral damage, a crash in the dollar will heighten these effects. Banks and financial firms that could have been saved from bankruptcy won't be saved. Firms that could've survived battered and bruised will go under. People who would've been able to keep their jobs throughout the original crisis will lose them. A dollar crash will take the damage already done and make it worse.

In terms of official statistics, you can already see GDP reclining. 2008 Q3 will most likely see economic decline when the stats get released in October. Unemployment, already at 6.1%, is likely to increase. But a dollar crash will make these worse. GDP will continue to decline for 2 or more quarters after the dollar crash, and unemployment will continue to rise.

As I have pointed out above, economists and financial analysts see this crisis as being the worst since the Great Depression. This means that unemployment is likely to reach, at the very least, the levels of the early 80s recession - 10.8% in November and December 1982. Now add to this the dollar crash and you can add a few more points to that level. Unemployment of 12% or more is likely.

2. Inflation and the policy problems that follow it.

The most obvious effect of a dollar crash will be a substantial increase in inflation. The United States is a consumer-based economy rather than a producer-based economy. This means that much of America's economic life depends upon the consumption of imported goods. If and when the dollar crashes, the price of all goods and services will increase.

A dollar crash will make imported goods more expensive to import. Americans will therefore find that everything from gasoline to teddy bears will begin to cost more.

Debate still rages over whether this crisis will lead to increased inflation or deflation. The "Deflationistas" - those who believe that prices will drop - argue that a credit crunch of the sort we are experiencing has historically led to deflation, that is, falling price levels. These people are actually correct in a sense, as any economic contraction leads to lower levels of demand for goods and services, which will inevitably lead to downward pressure on prices. Unfortunately, these deflationistas don't take into account something as serious as a crash in the dollar. If the value of the US dollar is ignored in calculations, then deflation is a natural conclusion for those who are studying the current credit crisis. The problem is, though, that recent history - namely the 1997 Asian Economic Crisis and the 1998 Russian economic crisis - shows that any credit crisis in economies with floating currencies (ie, currencies that are traded in the marketplace and change in value accordingly) eventually leads to capital flight - a situation in which people take assets and money out of an economy in order to invest it in another. What happened in 1997 and 1998 was that investors ran from Asia and Russia and invested in the US Dollar.

So, in the midst of the worst financial crisis in over seventy years, a dollar crash would inevitably lead to upward pressure on prices- namely, inflation. What these inflationary levels might become depends upon how far the currency crashes - the more the currency crashes, the higher inflation will get.

In the midst of this situation, what can the government do? Very little I'm afraid. The only government institution charged with the task of controlling inflation is the Federal Reserve Bank. Faced with a dollar crash and spiralling inflation, what would the Fed do? Standard monetary policy is for central banks to raise interest rates to control inflation. In the past, the Federal Reserve has indeed lifted rates whenever inflation began to worry them.

The problem with raising interest rates is that, while it ends up controlling inflation, it also acts to dampen economic activity. If the Federal Reserve should raise rates in response to inflation brought about by the dollar crash, the effect upon an already deteriorating economy would be devastating. Yet to keep rates low and to endure inflation in the hope that the economy might be given a chance to recover is a process which has historically never worked - the 1970s, for example, saw central banks all over the world ignore inflation and focus on employment and economic growth. Despite this, neither the economy nor levels of employment nor inflation were ever fixed. It was only until Paul Volcker bit the bullet and killed off inflation with high interest rates in the early 1980s that inflation, economic growth and employment ended up getting fixed. In other words, the only way for central banks to improve economic conditions and levels of employment is to focus solely upon inflation. In our particular situation, with a potential dollar crash looming, the only thing the Federal Reserve Bank could do in response is to raise rates.

I need to reiterate: There is nothing that the President, Congress or the Federal Reserve Bank can do to solve this problem. The only thing they can do is to limit the damage and remove the policies that caused the problem in the first place. As I have mentioned before, the only thing that the Government can do is:

• Cut military spending
• Raise taxes on the rich
• Run a budget surplus and pay off public debt
• Use interest rates to keep inflation low
• Regulate the financial industry with more common sense laws
• Fire Ben Bernanke
  

As I said, none of these things will solve the crisis, but they will give a better grounding for the eventual economic recovery.

I would also add to this list the following:

• Institute a Universal Health Care system, and raise taxes to pay for it.
  

I don't put this here just because I'm a pinko commie subversive, but because it also makes economic sense. The United States of America could cut its total health care costs by one third if it instituted a Universal Health Care system similar to those already in operation in other Western nations. The US spends around 15% of GDP on health care while comparable Western nations spend around 10% of GDP and have the same - if not better - health outcomes. Cutting health care costs by deprivatising and regulating the health industry will have enormous social and economic benefits.

3. A Current Account Surplus as America recovers.

Although I often joke that a dollar crash will be "financial armageddon", I know that things will eventually turn around. Even the great depression ended, although those who suffered through it thought it might never end. The same is true in this case. The current crisis added to a dollar crash will cause some very serious economic damage, but a recovery will naturally follow (although the speed of this recovery might not be as fast as people hope).

One thing that will happen as America - and the world - recovers from an economic disaster and dollar crash is that the US will eventually become a net exporter. Moreover, the United States will eventually end up running a current account surplus. This will be the natural effect of a dollar crash.

If and when the US Dollar crashes, one result will be that American goods and services - even manufactured goods - will become more competitive on the world market. While the dollar crash will naturally hurt every part of the economy, international demand from US manufacturing will increase. America's economic recovery will be in many ways due to an increase in demand for American goods. Instead of being a consumer nation, the US will become a producer nation after the dollar crash.

Moreover, it is also likely that the world's producer nations - especially those who have run massive trade surpluses like Japan and China - will end up becoming consumer nations. This will be because the dollar crash will end up overturning current trade balances. It may seem strange to believe that Japanese consumers might end up buying US manufactured goods, but, if a dollar crash occurs then the natural corollary will be a rise in the value of the Yen and other world currencies. When a currency rises, imported goods become cheaper to buy and exported goods become more expensive to sell.

4. A New International Economic Order.

One eventual result of this crisis will be a new economic world order. I'm not talking conspiracy theories or a one world government here, I'm talking about a more integrated world economy in which trading nations agree to abide by treaties that will determine what sort of policies are implemented in national economies.

Such treaties already exist. Supranational entities like the United Nations, the World Bank, the International Monetary Fund and the World Trade Organisation all exist as a way of creating and developing international co-operation in economic areas. An even more advanced supranational entity - the European Union - has even greater power over how member countries may run their affairs.

For anyone who insists upon national sovereignty, such entities are despicable and evil. For those of us who know just how important common rules and policies are for international economic well-being, such entities are exceptionally important (although certainly not perfect).

The importance of any future economic agreement rests upon the damage done at present. Although the US is a sovereign nation and its economic downturn is entirely its own fault, the damage that it will create will spread around the globe. No nation linked in with the world economy will escape damage, although it is clear that the US will be the nation most badly affected. Given that this is the case - that one nation's economic stupidity can lead to economic pain for all nations - economic treaties and agreements will be put in place to ensure that all nations who participate in the world economy follow "the rules" to prevent their own contagion from affecting everyone else. One aspect of this agreement may be common monetary policy, whereby central banks will pursue the same goals, such as having common inflation targets. Another agreement may be universal rules applied to financial sectors, which would not only prevent economic problems in one nation, but in all nations who are part of the treaty. In America's case, accounting principles would be better suited following international rules rather than the homegrown American ones.

Conclusion

For some, a dollar crash will lead to financial armageddon. But, just like in the Great Depression, the United States and the rest of the world will recover and learn from the mistakes that were made. Unemployment may sky-rocket and the economy may decline, but they will both recover eventually.

Unfortunately I'm not as confident as I could be at this point. Peak Oil will make it very difficult for economies to recover over the next 10-20 years, while Global Warming won't stop just because humans have had some economic problems. Both of these issues will require much thought and changes in economic and social behaviour - changes which will cost but which are necessary if people's lives are to be saved. Moreover, the economic and social challenges posed by both Peak Oil and Global Warming need a workable economy to be faced.

Negative real interest rates, credit crunches and capital flight

Here's some quick research I've done on real interest rates around the world:

The source for this information are two charts published weekly in The Economist (dated 19 September 2008), under the section "Economic and Financial Indicators" (click here, scroll down on the right hand side, and click on Output, prices and jobs for inflation figures. Then click on Trade, exchange rates, budget balances and interest rates for 10 year bond rates).

As you can see from this quick bit of table-creation from Openoffice.org, there are quite a number of countries around the world who are running negative real interest rates.

Negative Real Interest rates occur when the inflation rate exceeds interest rates. In this situation, money loses its value - not just when it is in people's wallets but also in their savings accounts. Anyone who has money stashed away in a savings account is essentially losing wealth, since inflation exceeds the interest paid on these accounts. As a result, money is quickly used either to purchase goods and services or invested in anything that will exceed the inflation rate. This may be shares, or it may be property, or it may be flowers - whatever the market sees as potentially exceeding the inflation rate.

In this scenario, of course, a self-fulfilling cycle begins. Since inflation punishes liquidity, money is used in such a way as to devalue it. Thus inflation begets inflation. Moreover, since investments that exceed inflation become more and more valuable, a "bubble" begins to form. Thus inflation-beating investments beget inflation-beating investments. The end result is an eventual popping of the inflation-beating investment, an increase in liquidity and a drop in inflation - until the cycle begins anew.

This is pretty much what has happened to the US since 2003. As I mentioned before, real interest rates in the US were negative between late 2002 and the end of 2005. This situation has been repeated since 2007 Q3 and continues today. It was during that 2002-2005 period that the housing bubble began to grow. The growth in housing prices exceeded the inflation rate, causing the market to invest in it and inflate it - an inflation-beating investment begetting inflation-beating investments. Now that this bubble has collapsed there has been a rush back to liquidity.

The danger that now exists for the US - and in all places where negative real interest rates are being experienced - is that an economic recovery is now highly dependent upon the creation of new investment bubbles. Since US interest rates have been driven down so low, even those who have rushed to liquefy their investments have placed their money in loss-making accounts - inflation is still eating away at people's bank accounts. The difference, of course, is that bank accounts (and treasury bonds and other "safe" investments) are not declining nearly as fast as shares and property prices.

One of the end results of negative real interest rates - when they have been going on too long - is capital flight. Capital flight is pretty much what I have already described above (people liquefying their investments and putting money into bonds) but is felt in the value of national currency. In other words, capital flight is when investors not only liquefy shares and other assets, but also end up selling the currency and buying another currency that is more attractive.

This process is what hit Asia in 1997 and also created the Russian financial crisis in 1998. In both of these cases, investors not only liquefied their investments but also sold off the currency to invest in something safer (which turned out to be the US Dollar, mainly). In both cases, these nations did not just suffer credit crunches, but also quickly depreciating currencies. In the end they were left with ruined financial sectors and substantial levels of inflation caused by increased import costs. The current accounts of these nations also flipped from deficits to surpluses, since imported goods became expensive and exported goods became more attractive to overseas buyers.

It is important to note that bubbles and busts and credit crunches can still occur when real interest rates are positive. However, since bonds and bank accounts compete more effectively with inflation-beating investments, the bubbles and busts are reduced to "peaks and troughs" - what is know today as the business cycle. The higher real interest rates are, the safer an economy is from internal imbalances like the formation of investment bubbles. But since the world economy is so powerfully linked, "contagion" can still spread from one economy to the next, even if that economy has been running positive real interest rates.

I have spoken before about the potential of a damaging fall in the value of the US Dollar. At the present moment, the credit crunch in the US has led to a liquefying of investments and zero bond yields. Yet America's negative real interest rates, if they remain, will eventually lead overseas investors to ditch the dollar in favour of other currencies (such as the Euro and the Yen). At that point the credit crunch would develop into capital flight and lead not only to a financial crash comparable to the great depression but also damaging levels of inflation (caused by dollar devaluation) that would outstrip any deflationary effects caused by the credit crunch.

If the United States of America were any other nation, the IMF would probably be advising them to make policy changes based upon the Washington Consensus. I see little choice in doing anything else. Central Banks (like the European Central Bank and the Bank of Japan) could use their vast financial power to rebalance any runs on the US Dollar, but I seriously wonder whether such a process would be workable over the long term. Financial austerity is the key to rebalancing the US economy, and I would think that any intervention on behalf of non-American central banks to prop up the Dollar would have to come at a price - that being austerity measures (policy changes based upon the Washington Consensus) forced upon the US by foreigners. Thus foreign central banks would be able to provide the US with financial help in the same way as the IMF and the World Bank would be.

There is a question, however, as to just how much foreign central banks could possibly prop up the dollar without harming themselves. The US is too big an economy to fail, yet it may be too big to help if and when any capital flight takes place. Moreover, with the international community also suffering financially from America's economic meltdown, it may end up being a case of nations looking after themselves first and foremost.

The onus is therefore upon the US to solve its own problems. The Washington Consensus is a good place to start. From this policy should come positive real interest rates, fiscal responsibility and better regulations for the financial market. Moreover, in the face of capital flight, the Federal Reserve has no choice but to raise interest rates to control any resulting inflation.

The alternative to this would be a continuation of negative real interest rates and either the creation of another damaging investment bubble and/or eventual capital flight. This process would ruin the US economy for years to come and bring untold harm upon the international financial system.

It's time to follow The Washington Consensus

I've just finished scanning my way through The Washington Consensus. Until now I didn't realise how much neoliberal economic theory I had imbibed over the years, which is supremely ironic considering my support for big government ideas like universal health care, free public education and industry regulation - essential components of Democratic Socialism.

The Washington Consensus was, according to Wikipedia:

initially coined in 1989 by John Williamson to describe a set of ten specific economic policy prescriptions that he considered to constitute a "standard" reform package promoted for crisis-wracked developing countries by Washington, D.C-based institutions such as the International Monetary Fund (IMF), World Bank and the U.S. Treasury Department.

And here were the ten policy prescriptions (again, copied and pasted from Wikipedia):

• Fiscal policy discipline.
• Redirection of public spending from subsidies ("especially indiscriminate subsidies") toward broad-based provision of key pro-growth, pro-poor services like primary education, primary health care and infrastructure investment;
• Tax reform – broadening the tax base and adopting moderate marginal tax rates;
• Interest rates that are market determined and positive (but moderate) in real terms;
• Competitive exchange rates;
• Trade liberalization – liberalization of imports, with particular emphasis on elimination of quantitative restrictions (licensing, etc.); any trade protection to be provided by low and relatively uniform tariffs;
• Liberalization of inward foreign direct investment;
• Privatization of state enterprises;
• Deregulation – abolition of regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudent oversight of financial institutions;
• Legal security for property rights.

Now compare that list to the list of policy decisions I have been proposing as a way of mitigating America's current economic plight:

• Cut military spending
• Raise taxes on the rich
• Run a fiscal surplus to pay back public debt
• Use monetary policy to keep inflation low
• Create and enforce stricter financial regulation so this doesn't happen again
• Fire Ben Bernanke
  

Who would've thought about prescribing for America what America prescribed for developing economies under financial stress?

If you check out the points of The Washington Consensus, there are many points which apply.

Fiscal Policy Discipline.
This pretty much fits in with my "cut military spending, raise taxes on the rich and run a surplus to pay back debt". The important thing here is that fiscal policy - how a government spends its money - should be disciplined. In other words, there should never be any large amounts of public debt. As I have pointed out multiple times before, America's public debt is too high as it is and will go even higher in the aftermath of this current financial crisis. Had the US government under Bush been fiscally disciplined, the level of public debt would have been a lot smaller, and the cost of bailouts and fiscal stimuli been more sustainable. Moreover, neither the US government nor the market can spend its way out of the current financial crisis. Spending more will make it worse. Austerity is needed.

Redirection of public spending from subsidies toward broad-based provision of key pro-growth, pro-poor services.

I haven't really touched on this because the US doesn't have much in the way of subsidies except for the mind-blowingly stupid agricultural subsidies and protection in place. What has occurred, however, is a "subsidy" in the form of tax cuts for the rich. In other words, the cutting of taxes for the rich since 2001 might as well be the same as government subsidies for certain industries. These tax cuts were certainly not enjoyed by the poor, whose plight is shown up by median wage data which shows wages in 2008 to be below that of 2001. Moreover, according to The Washington Consensus, "pro-growth, pro-poor services" are things like increased spending on health care and basic education - two areas which have suffered in America's recent history.

Tax reform – broadening the tax base and adopting moderate marginal tax rates.

Tax should be simple and should be broad. Taxing one industry more than another leads to an economic imbalance. Again, this part of the Consensus can be applied to the Bush tax cuts because such tax cuts ended up narrowing the tax base. Moreover, by decreasing taxes for the rich, more money than normal would have been pumped into investments. The current financial crisis has seen this money disappear.

Interest rates that are market determined and positive (but moderate) in real terms.

As I have argued elsewhere on this blog, the Federal Reserve ran negative real interest rates from 2003-2005, and from mid-2007 onwards. This has occurred under the chairmanships of both Alan Greenspan and Ben Bernanke.

John Williamson, one of the main proponents of The Washington Consensus, writes that positive real interest rates "discourage capital flight" and "increase savings". Capital flight is now a real danger to the US economy, a process which would lead to a severe devaluation of the US dollar.

Privatization of state enterprises.

Fannie and Freddie - need I say more?

Deregulation.

This is obviously and interesting one. Some people think that this would involve cutting away government rules and letting the market go haywire - in other words, what has been occurring recently. Yet such deregulation in The Washington Consensus is qualified - only regulation which will result in better economic performance should be set up. This naturally includes instances where unregulated markets end up destroying themselves and the wealth of others. In the case of America's financial market, better rules and regulations should be set up to prevent this crisis from occurring again.

...

In summary, I submit again that the only policy direction the US should go in now is to follow the points of The Washington Consensus that they themselves helped to create. Moreover, I submit again that there is no other choice. The crisis has hit, the seeds that were sown are now being reaped. Watching the Treasury and the Fed act like incompetent third-world officials making panic-stricken, knee-jerk decisions is more than enough evidence for anyone who looks at this issue judiciously.

A new financial order needed?

Reuters:

Threatened by a "financial tsunami," the world must consider building a financial order no longer dependent on the United States, a leading Chinese state newspaper said on Wednesday.

The commentary in the overseas edition of the People's Daily said the collapse of Lehman Brothers Holdings Inc (LEH.P: Quote, Profile, Research, Stock Buzz) "may augur an even larger impending global 'financial tsunami'."

The People's Daily is the official newspaper of China's ruling Communist Party, and the overseas edition is a smaller circulation offshoot of the main paper.

Its pronouncements do not necessarily directly reflect leadership views, but this commentary by a professor at Shanghai's Tongji University suggested considerable official alarm at the strains buckling world financial markets.

China's central bank earlier this week cut its lending rate for the first time in six years, a move analysts said was aimed at bolstering the economy and the battered stock market.

"The eruption of the U.S. sub-prime crisis has exposed massive loopholes in the United States' financial oversight and supervision," writes the commentator, Shi Jianxun.

"The world urgently needs to create a diversified currency and financial system and fair and just financial order that is not dependent on the United States."

Kenneth Rogoff:

One of the most extraordinary features of the past month is the extent to which the dollar has remained immune to a once-in-a-lifetime financial crisis. If the US were an emerging market country, its exchange rate would be plummeting and interest rates on government debt would be soaring. Instead, the dollar has actually strengthened modestly, while interest rates on three- month US Treasury Bills have now reached 54-year lows. It is almost as if the more the US messes up, the more the world loves it.

But can this extraordinary vote of confidence in the dollar last? Perhaps, but as investors step back and look at the deep wounds of America’s flagship financial sector, the public and private sector’s massive borrowing needs, and the looming uncertainty of the November presidential elections, it is hard to believe that the dollar will continue to stand its ground as the crisis continues to deepen and unfold.

If this crisis goes any further and deeper, the chances of a run on the dollar intensify. The US Dollar's recent rise in value has been swift, especially when compared to its long term devaluation over the past year: The value of the Dollar dropped around 10% between August 2007 and the middle of March 2008 (source), a process which was accompanied by a rise in the price of oil and increasing levels of inflation.

There are reasons why the US Dollar is likely to fall.

The first is that interest rates in the US are so low that any overseas investors buying government bonds are unlikely to see a decent return. Interest rates are higher in the Eurozone, Australia and other places in the world.

The second is that, with the sharemarkets tanking in the US, overseas investors are unlikely to want to keep up direct investments in US companies. Put simply, the US is a toxic place to invest and international investors are likely to sell their US shares and then retreat from the US entirely.

Thirdly, the US economy, by running a current account deficit for such a long time, is geared towards borrowing and consumption. A recession will cause domestic consumption to drop, resulting in an eventual rebalancing of the current account - a process which will make US dollars less valuable for investors to hold.

I can assure you beyond any doubt whatsoever that any panicked sell-off of the US Dollar would be the last thing the US needs. This credit crunch is packing some serious damage already. Add to that inflationary pressures of a tanking currency and there will be a stagflationary period the likes of which America has never seen before.

The only real way to prevent the dollar from falling - and the only way to save it once a fall begins - is for the Fed to increase interest rates. Raising rates during a recession may seem counter-intuitive, but I can guarantee you that the alternative, hyperstagflation, would be even worse.

Socialism for the rich - continued

NYT:

Fearing a financial crisis worldwide, the Federal Reserve reversed course on Tuesday and agreed to an $85 billion bailout that would give the government control of the troubled insurance giant American International Group.

The decision, only two weeks after the Treasury took over the federally chartered mortgage finance companies Fannie Mae and Freddie Mac, is the most radical intervention in private business in the central bank’s history.

With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman Ben S. Bernanke convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan.

They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers generally expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.

What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but A.I.G.’s role as an enormous provider of financial insurance to investors who bought complex debt securities. That effectively required A.I.G. to cover losses suffered by the buyers in the event the securities defaulted. It meant A.I.G. was potentially on the hook for billions of dollars worth of risky securities that were once considered safe.

If A.I.G. had collapsed — and been unable to pay all of its insurance claims — institutional investors around the world would have been instantly forced to reappraise the value of those securities, which in turn would have reduced their own capital and the value of their own debt.

“It would have been a chain reaction,” said Uwe Reinhardt, a professor of economics at Princeton University. “The spillover effects could have been incredible.”

Okay, now for my "yes but".

I agree. AIG, like Fannie and Freddie, needed to be bailed out. By taking on the financial problems of one organisation, the Federal Reserve can then dilute its negative effects upon the economy. Rather than AIG getting a bullet in the heart, the Fed catches it, breaks it up into little pieces, and then hurls each little piece at taxpayers and businesses - hurting them but not killing them. In a massive financial emergency, such an action will help mitigate the negative effects of one company's distress. It is, in other words, a classic socialist action - the many paying for the pain of one.

Nevertheless, the Fed is playing with fire here. America's entire financial system is based upon free market ideas that sets aside direct government interference in the marketplace and desires less regulation imposed upon them by this government. With the American financial industry partly collapsing, it could be argued that if the government should turn up to mitigate market failure then the government should also be there when things are going well, regulating the industry and profiting from it through tax revenue.

At some point, the money paid by the Fed and the US Treasury for Bear Stearns, Fannie Mae & Freddie Mac and AIG has to be accounted for. Money has to be found to rebalance government coffers.

Of course, both the Fed and the US government share in the blame for the current financial mess. Both Congress and the White House have, since 2001, decided to be fiscally irresponsible and cut taxes during an economic expansion. Moreover, the Fed kept interest rates ridiculously low under Greenspan from 2003-2005 and has created negative real interest rates during that period and also more recently under Bernanke. Negative real interest rates were one of the reasons why an investment bubble formed, and one of the reasons why it has popped so badly.

But let's get real. Were any Wall Street bigwigs warning the Bush government to stop cutting taxes or telling the Fed to raise interest rates? No. It was pressure from the financial markets that dictated America's expansionary fiscal and monetary policy in recent years. While we can certainly find time to blame Bush, Bernanke and Greenspan for kowtowing to the market, we should also find time to blame the financial market itself for promoting such ruinous policies.

Which means that, of course, the financial markets are simply reaping what they sowed. They profited from a bubble, now they are paying for it popping.

Except that they're not - at least not at the moment.

Where is the government going to get the money to pay for their "socialism for the rich"? Will they raise business taxes? Will they increase the top tax rate? It is the rich who created this financial black hole, so why not make them pay for it?

Of course the government could simply increase income taxes on everyone, which will then burden everyone with the problems created by a few. The government could also decide to cut defense expenditure or health expenditure to cope with the increase in debt. They could also just print money if they want to and create a Weimar hyperinflationary event. Or they could just ignore the debt, keep borrowing whatever they need, and then watch the US Dollar eventually crash.

My solution?

• Cut military spending
• Raise taxes on the rich
• Run a fiscal surplus to pay back public debt
• Use monetary policy to keep inflation low
• Create and enforce stricter financial regulation so this doesn't happen again.
• And, of course, fire Bernanke.
  

Ike and Galveston

It's currently 8.50GMT, which translates to 4.50am in New York and earlier in Texas. I've just looked at a BBC video of the hurricane's effects upon Galveston, and, I gotta tell you, it looks bad.

What I saw on that video was Galveston completely inundated with water. Water had covered the entire city streets. Houses and buildings were jutting up out of the water. But that's not the worst part.

You see, the video showed Galveston from the air during the daytime. In other words, what I saw was not the worst of it. Ike passed over Galveston about 4-5 hours ago, so what I saw on the BBC video was small compared to what it would've become when Ike passed over it. But that's not the worst part.

The worst of it is that 23,000 people stayed in Galveston.

Back in 1900, Galveston was levelled by a massive Hurricane. 6-8000 people were killed. It was the biggest natural disaster in US history. As a result of this disaster, a sea wall was built to protect the city from any future hurricane. Ike, however, produced a storm surge that topped the wall. Moreover, it topped the wall hours before the storm surge reached its highest point.

I think there is a massive tragedy happening now in Galveston. I hate to say it, but people are probably dying as I type. Let's hope and pray that there is a minimal loss of life. I'm not optimistic, however.

Something fishy with the US Dollar

This is the NYBOT index, showing the value of the US Dollar against the currencies of its major trading partners. As you can see, the US Dollar has been in decline since around November 2006, reaching the bottom in around April-May this year, and then zooming up suddenly in August 2008.

I gotta say, this is fishy.

It's fishy because much of the decline in the US Dollar occurred during the credit crisis. The crisis, which started in August 2007, has continued now for over twelve months. Nothing has improved. Unemployment has gotten worse, the housing market has continued to tank, GDP is declining - in short, there are no economic indicators that suggest the US economy is getting better.

This is all the more stranger when you realise that interest rates in the US are now as low as they have been in recent history. Whoever it is buying US Dollars at the moment is not going to benefit from interest repayments, which are more attractive in places like Europe. The only way international investors are going to make money out of this recent spike in the value of the US Dollar is if they are betting US interest rates are going to increase, or if they expect the value to keep rising. The latter explanation is, I believe, what is probably going on... and that means speculation and a US Dollar bubble.

Of importance to this scenario is the fact that the world commodities market has finally popped. Gold, iron, silver, coal and oil have all dropped in value. The reason is obvious - people who have been speculating on the commodities market have begun selling their interests there and using the money to buy US bonds.

In many ways the progression here is important. There was a tech boom in the late 1990s so investors created an investment bubble in the US stock markets. Once that popped, they took their money out and invested it in housing. After that popped, they invested in commodities. Now that that has popped they are investing it in US Dollars. The fact that this has resulted in a rising US Dollar has led to a virtuous cycle, making the Dollar more valuable and commodities cheaper.

Another factor here is the role of central banks. I have been reading around econ blogs and many are of the opinion that the recent rise in the value of the US Dollar has a lot to do with behind-the-door negotiations between the Federal Reserve and other central banks (European Central Bank, Bank of Japan, China, etc). A rising US Dollar would help lower inflation and help stimulate an economy geared towards consumption and borrowing. It would also help economic conditions prior to an election.

One thing, however, is certain - the US Dollar cannot sustain its current value. The US has a large and unsustainable current account deficit that must be reversed if the economy is to rebalance itself.

If I may indulge in a bit of sinister conspiracy - I'm wondering if the current rise is also due to a foreign central bank whose actions in buying up US Dollars has attracted the international forex market back to it. Once the value of the US Dollar has reached a certain point, the central bank will sell off and make a profit, resulting in a sudden drop in the US Dollar - a process that will make things even more confused and dangerous than it already is.

After all, the writing is on the wall for international investors: the US economy is in the doldrums and is no longer a safe place to invest.

I predict that within in the next three months there will be a sustained drop in the value of the US Dollar.

McCain, Money and Mondale

Anyone who reads this blog regularly knows my distaste for the US Republican Party. This distaste has been present ever since George W. Bush won the 2000 election. This does not mean that I am a partisan Democratic supporter, but it does mean that, at present, I honestly believe that the best choice America has in November is Obama and Biden.

The fact is that I will support whatever party has the better policies or the better record or a combination of both. Back in 1996 I voted for John Howard and the Liberal Party (which is, ironically, Australia's conservative party) because the Labor Government under Paul Keating was philosophically bankrupt and, despite 13 years of economic reform, had not been fiscally responsible. My support for John Howard evaporated after 2000 when he began to implement racist policies and use the fear generated by 9/11 for political gain. Joining in the 2003 invasion of Iraq was another problem for me.

So my support for the Democratic Party and Obama has nothing really to do with partisanship. I am sure that I would support the Republican Party at other times if their history since 1981 was different. Having said that, I will state now that a McCain/Palin victory in November may possibly end in disaster.

I personally have no beef with John McCain, and the only thing that really worries me about Sarah Palin is whether or not she is capable of being America's president in case McCain goes to meet his maker. The policies of John McCain, though, are problematic - specifically his tax cutting program.

I have seen a comparison of Obama's and McCain's tax plan and McCain gives the biggest tax cuts by far. Obama gives bigger tax cuts to lower income earners than McCain, while increasing the taxes of those on higher incomes, with the end result being a small net tax cut.

For many conservatives, the idea of a tax cut is wonderful news. The problem is that McCain, along with Obama, has yet to explain how such a tax cut will impact government spending. I am of the belief that any tax cut should be met by a corresponding cut in government spending. I am also of the belief that if anyone wants to increase government spending, then taxes must rise as well.

The problem is that, for the last 25 years, the Republican Party has been dominated more or less by Supply-side economics, a form of "voodoo economics" which believes that tax cuts fund themselves by stimulating economic growth and generating more tax revenue. While there is some truth to be found in the more intellectual corners of this economic system, it has resulted in a simplistic and effective myth -  that the government should just keep cutting taxes.

After 25 or more years, popular supply-side economics has resulted in nothing but large federal government deficits. Ronald Reagan's big tax cuts in the 1980s were followed by increased tax revenue but also a corresponding increase in public debt. It was not until George H.W. Bush raised taxes after his "read my lips" promise that Supply side economics began to lose its influence. But by that stage, the damage had been done and the US government was deeply in debt.

Such was the loss of standing of Supply side economics that Republicans during the 1990s returned to a more traditional economic stance. Whatever I may have disliked about the Republican Congress under Newt Gingrich and their government shutdowns and impeachments, the fact was that they worked with the Clinton administration to balance the budget - a process that eventually led to surpluses near the end of Clinton's presidency.

Unfortunately, the Republican congress under Bush enthusiastically returned to the populist appeal of tax cutting. The result has been astounding, with public debt increasing dramatically. The recent Fannie Mae and Freddie Mac bailout will see a substantial increase to this level of debt. The current recession in the United States will also result in lower tax revenues.

So, fiscal irresponsibility + Fannie and Freddie Bailout + recession equals a federal government with a massive debt burden that will most likely exceed any comparative level of net debt in peacetime US history.

Of course, for regular readers, this warning of mine is nothing new. So why am I repeating the fiscal alarm all over again? It is because I believe that a McCain/Palin administration will continue the fiscal irresponsibility started under Bush. Moreover, the inaction of the Democratic-party dominated congress (elected in 2006) has allowed the situation to deteriorate. If the White House continues to be Republican, there is little chance that a Democratic Congress will have the testicular fortitude to stand up to him and pass economically sensible bills.

The only real chance for fiscal responsibility to return to Washington is for a Democratically controlled Congress and White House. Republicans have proven themselves too attached to Supply side economics for the past 25 years (with the notable exception of the Gingrich years) while the Democrats have not.

This is not to say that the Democrats (Obama and congress) won't make a hash of the economy between 2009 and 2012 - I'm just saying that they are less likely to ruin the economy than one in which Republicans control the White House during that period.

Hard decisions must be made in 2009 about the federal budget. Loaded down with increasing amounts of debt, congress and the president must pass spending bills that will ensure that revenue exceeds spending - or at least a bill that will return the budget to surplus over a number of years. In order to do this, taxes must be raised or spending must be cut or some combination of both.

But herein lies the problem. If taxes are to be raised, won't that hurt the economy? And if spending is to be cut, which government departments should suffer the most cuts? Given the massive expansion in military spending since 2003 and the inefficiencies that run through it, and also given the fact that other federal government departments are so small in comparison (completely closing down NASA and the Department of Education won't be enough to stop a big deficit), then whoever sits in the White House next year will have a very unenviable task. What should next year's president do?

Given the nature of the Republican Party, it is unlikely that McCain and Palin will raise taxes or cut military spending. At most, they will probably cut back on other expenses (like NASA or Education), a process that will simply not be enough to return the federal government to a fiscally sound position - to say nothing for the damage that such cuts would make to important government services. The result of a McCain/Palin White House is therefore likely to be one in which the federal debt gets larger and larger - a process that will lead America further into economic decline.

On the other hand, an Obama/Biden White house along with a Democratic Congress is far more likely to make painful but necessary decisions. I'm not saying that this is a given, but I am saying that it is more likely.

Which brings to mind the prophetic words of 1984 Democratic presidential candidate Walter Mondale. When discussing the Reagan tax cuts and the deficits that had resulted from them, Mondale said these fateful words:

By the end of my first term, I will reduce the Reagan budget deficit by two-thirds. Let's tell the truth. It must be done, it must be done. Mr. Reagan will raise taxes, and so will I. He won't tell you. I just did.

Reagan won the election in a landslide, mainly due to the perception that Mondale was a "tax and spend" Democrat. Yet, in hindsight, Mondale's words have come back to haunt the Republican Party and the memory of Reagan. Supply side economics was still in its ascendency during the Reagan years and people had not yet begun to suffer its negative effects. Now that Supply side economics has been proven beyond reasonable doubt to be unworkable and ultimately damaging to an economy, the time has come to pay the price for political expediency and financial stupidity.

It was over ten years ago that The Simpsons episode "Trash of the Titans" was aired. In that episode, Homer becomes Springfield's sanitation commissioner, defeating the incumbent Ray Patterson (voiced by Steve Martin), and promises a lot of crazy things for the people of Springfield. Homer's policies soon end up bankrupting his department and completely ruining the city. When Ray Patterson is unanimously voted back in as sanitation commissioner, he gives this wonderfully short speech:

Oh gosh. You know, I'm not much on speeches, but, it's so gratifying to leave you wallowing in the mess you've made. You're screwed, thank you, bye.

I can't help but think of comparing Walter Mondale to Ray Patterson here. Twenty-four years after his abysmal failure in the 1984 presidential election, Mondale could probably be justified in repeating Ray Patterson's short speech.

Fundy or Trendy?

I've just been reading a rather famous and controversial Christian blog posting that's been floating around the net for the past few weeks. I haven't read it all, but this part of the post stands out:

A recent cover story at World Magazine about "NextGen Worship" inspired a strong desire to smack the pastors depicted in the article and in the photos. The cover photo alone enraged me, with the pastor wearing baggy jeans and untucked button-up shirt with flip flops and an ear microphone. Later, the same guy is shown out front of a church holding a paper Starbucks-like cup of coffee. Could he try any harder to be lame?

I'd have liked to have taken that cup of coffee and dumped it on his head. But it's nothing personal against that guy or his beliefs or sincerity. It's an anger at something else.

I'm not going to be one of those starched-collar Christians who, based on personal preference, say that this is a sign we're going to hell in a handbasket and that all things are wrong unless they are done as they were with the Puritans. What I'm saying is that I can't stand the phoniness, or trendiness, or sameness -- or whatever I'm trying to say here -- that the church seems to catch onto at the tail end, not even aware of how lame it is. The fact that this is not only actually successful in appealing to people, but attracts them, also disgusts me.

It makes me want to throw up.

It's buying into some kind of lie or substitution of cool culture as being relevant when it isn't.

If I see another cool Bible college student or pastoral studies major wearing the hemp choker necklace, flip-flops, open-at-the-collar shirt that's untucked, and baggy jeans, saying words like "dude" and "sweet", I will kick their ass. It's like the Christian version of annoying hipsters, an overly-studied and homogenized "with-it" faux coolness.

Right on sister! I hate it when Christians get all trendy and "with it" to try to attract people. I quite often see "hip young youthworker types" wearing the clothes of young people. It makes me sick. Young people don't respond to adults wearing their clothes or listening to their music - they respond to honesty and genuineness.

Nevertheless, the comments above can also make us wonder about the appropriateness of wearing the standard fundamentalist "suit and tie" to church. Being Fundy is just as bad in my book because it adds a "dress code" to public worship - something that is not legislated in any way in the NT and is, in fact, prohibited.

The church that I go to - Charlestown Presbyterian Church - does not have a dress code. By this I mean that there is no explicit or implied code that people should abide by when it comes to what they wear. People come in wearing baggy pants, and in summer some people wear thongs (which, for shocked Americans reading this, is what Australians call flip flops). A friend of mine is often seen wearing heavy metal or skater T-shirts.

But, remember, there is no "code" that we are abiding by. The reason why people who attend our church with the clothes that they wear (and many older people dress more conservatively while at the same church service) is NOT because we have some far-out hippy trendy get-with-the-times sort of attitude emanating from people. We just wear what we wear because its comfortable.

To me, and for many Australians who attend conservative Reformed churches, we neither enforce a Fundy suit and tie dress code nor have a trendy get-with-the-times dress code. What people wear when they go out shopping is the sort of thing we do - but without any sort of explicit reason. We just do it.

Part of the reason for this is the influence of Sydney Anglicanism. The Anglican diocese of Sydney is the strongest evangelical diocese in the world. Anglicans, or Episcopalians as you call them in the United States, often wear robes and cassocks and dog collars. Back in the early 1970s, some evangelicals began not to ask questions like "how can we be more trendy" but "why should we bother wearing this garbage?". Since then there has been a revulsion towards dressing in ways that communicate self-importance.

But the other reason for this in Australia is that fundamentalism - the American variety - has never really been strong here. In the US, evangelicalism is broken up into three broad groupings: Pentecostals and Charismatics, Arminian Dispensational Baptist Fundamentalists and Calvinists and Reformed. That is a very broad group - many churches and people fit into multiples groupings. But of that group, the Baptists are the strongest while the Calvinists are the smallest. Here in Australia, the Arminian Dispensationalist Baptist Fundamentalists are the smallest group. The Pentecostals and Charismatics are the biggest group, and Calvinists are second in line but are stil substantially large. Here's a summary of that breakup:

America: 50% ADBF, 40% P/C, 10% C/R
Australia: 10% ADBF, 55% P/C, 35% C/R

This means that the whole "suit and tie" culture was never really a central part of Australian evangelicalism.

Of course, this is not to say that Australian churches don't suffer from the trendy hip get-with-the-times problem. Many do. But wearing informal clothes to church is only an issue when it is an integral and explicit part of the church community. If a pastor gets up and says "I wear baggy pants so I can get hip with da yoof!" then I have a problem with it. If a pastor gets up and says nothing about his baggy pants then that's fine. Wearing baggy pants is not the issue - having some stupid, extra-biblical cultural reason for wearing them is. Moreover, it's the same issue with wearing suits and ties.

Fannie, Freddie and an alternative form of socialism

Being politically left of centre, I am obviously for some level of government involvement in the marketplace that can either replace or augment any form of market behaviour that harms society and/or the market itself.

Having said that, let me just ask some really basic questions about the whole Fannie/Freddie mess.

The first question is - why did the US even create these monsters? Yes, yes, their basis was in The New Deal, which, to all pro-market Americans means it was doomed to fail. But, even from a Social Democratic point of view, the creation of a government sponsored enterprise (GSE) that dominates an economy's mortgage sector by guaranteeing loans is rather weird. I might be wrong here, but as far as I know, no Western nation with a more leftist economy that the US (ie all of them) has similar institutions.

Here in Australia, where government spending represents between 30-35% of the economy, there is no direct equivalent to Fannie and Freddie for our mortgage market. There are loan guarantors, and there are some GSEs, but not a combination of both and certainly not any with such a massive influence upon a major marketplace. In this, the US is actually unique - that within the world's most market-friendly economy there lies not one but two massive government sponsored enterprises whose role is to somehow protect the mortgage market from itself. This has not occurred in nations who run social democracies, so why should it be running in the US?

The second question I have concerns the bailout. The result of the subprime meltdown has been a collapse of the housing market and a wider "credit crunch". Banks are beginning to go under, and both Freddie and Fannie's share prices have collapsed to the point where their market capitalisation is less than their liabilities. For all intents and purposes, both Freddie and Fannie have gone bankrupt. In comes the US government and bails them out. Whatever you may want to call it, this was essentially a nationalisation of the two mortgage giants. They are no longer GSEs, they are now government departments.

Of course such a bailout means that the government has taken upon themselves massive amounts of debt, along with having to buy the shareholders out. I don't know exactly how much money this is going to cost the federal government, but it is a substantial amount and will significantly add to the amount of net public debt already in place. But I can't help thinking that there could have been a better solution. Instead of spending all this money to keep shareholders happy, why not divide the money by the amount of money all people owe on their mortgages and then grant them a once off government funded mortgage subsidy, an amount which will be proportional to the amount they owe in their mortgage?

In simple terms, this would mean that all borrowers would receive a voucher from the Federal Government that they would then mail off to their lenders - the effect being a reduction in their total mortgages. That influx of money would not only prevent a whole swathe of ordinary Americans from foreclosure, but, as the money circulates, would also help prevent some banks from closure, prevent some mortgage companies from going bankrupt and, of course, help Fannie and Freddie's bottom line. Rather than throwing money at the shareholders, the Federal government could have helped ordinary homeowners and the entire market that depends upon them.

While the Fannie and Freddie bailout was inevitable, it seems rather illogical to focus upon just shareholders when they could have helped everybody in the entire industry, including the Fannie and Freddie shareholders, by throwing money at the borrowers. You see, the best form of "socialism" is one where benefits are universal, where welfare and pensions are spread broadly rather than being a narrow focus on a particular industry or market. The nationalisation of Fannie and Freddie is not a broad benefit, but a narrow one, and one that entirely benefits investors (ie, not poor people).

To be honest, I'm all for Fannie and Fred's closure. Whatever good they were able to achieve in the mortgage market can be replaced by private enterprises, better rules and regulations and the enforcement of such regulations. The death of Fannie and Freddie will not ruin the mortgage market, but will make it leaner and, hopefully, less subject to overspeculation and investment bubbles. The intention behind the creation of Fannie and Freddie is not to be questioned, but the results must be.