Tuesday, October 14, 2003

Auerback - Dire Warnings!

Are most people worried about the wrong things? Many worry about corporations taking over the world. Others are extremely concerned about the environment. Still others are most concerned about political corruption. Well, it is true these are all real concerns and by me as well, but I have much more serious concerns than all these put together. I am concerned with what controls all the above. By this I simply mean the money - the dollar as the reserve currency of the entire world - $6trillion external liabilities - U.S. Treasury figures. Now why do I call this the reserve currency of the entire world? Because it is adding to the fractional reserves of all our trading partners' banking systems, thus multiplying not only their reserve capacities, but ours as well - on the quasi-return trip. The problem with this is an increase in world overliquidity at the same time the world is suffering from a true lack of global demand. I simply ask, can we reflate ourselves and the entire world out of its deflationary position with all the overly indebted/bankrupt nations - without contributing errors toward the next crash? Marshall Auerback poses the same question?

The Great Sucking Sound of Imports

.....While this may seem to be a stable situation in the near term, there are a number of reasons to see it as ultimately unsustainable and hugely dangerous over the medium term. For one thing, we believe there is a fundamental flaw in the approach of Dooley, Folkert-Landau, and Garber. Their analysis fails to take account of the enormous differences between the US external financial position today versus the time of the Bretton Woods, where the US had a massive current account surplus and effectively accounted for about half of all global activity. The sheer magnitude of the American debt today is enormous, and thus the asserted ability of the “trade account” nations (principally China and the Asian NICs) to indefinitely absorb investment adjustments made by those in the “capital account” regions surely must have limits. The Federal Reserve flow of funds analysis points to an even bigger number of $7.6 trillion of US financial assets held by the rest of the world. In this context, a 5 per cent "trim" is equivalent to a $380.6b desired sale by the foreign private sector of US dollar denominated financial assets. This would amount to a 40 per cent surge in foreign official holdings in one year (one quarter?), assuming the Dooley et al mechanism is put in motion, and foreign central banks monetize the purchase of these desired foreign private sales. This is a peculiar form of international economic stability which depends on grotesquely large currency intervention over years to keep the currency of the centre country from collapsing.......

.....Unfortunately, the U.S. is a country with a trade deficit and must also borrow to pay the interest on its debt. Because the interest rate on that debt exceeds the U.S.’s growth rate, the compounding of capitalized interest payments alone will tend to raise the nation’s relative indebtedness. Because the U.S. is such a vast economy, it cannot eliminate its current account deficit as readily as a smaller economy. When it tries to improve its trade balance through devaluation or through restrictive demand management, its sheer size affects the economies of its trading partners adversely and to an appreciable degree. Understandably, they object and resist. When foreign economies resist dollar devaluation and the dissipation of their current account surpluses, the U.S. may have to raise interest rates in order to induce creditors to continue financing its debt build-up. For this reason, it is reasonable to expect that the chronic U.S. current account deficit and mounting external debt will ultimately raise long term U.S. interest rates. And this, in turn, will speed up the compounding of the interest due on the U.S. external debt and will make the debt trap dynamics even more vicious. At that point, what author Charles Kindleberger (Manias, Panics, and Crashes, Basic Books, 1989) calls a “credit revulsion” might ensue, producing a catastrophic outcome for the U.S. economy not like that of the early 1980s, the 1994 Mexican crisis, or the Asian financial crisis of 1997/98. Not even US multinationals will patriotically stand in the way of that particular freight train. ...{Article continued}

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