Monday, July 11, 2005

"How to Deal with the Rise of China" (2) 

Thanks, John.
A lot of people will agree with you. As seen from my viewpoint, that is a very large part of the problem.
The IMF did not impose a "gold standard". Certainly that was not the intention of Keynes and White or those who signed the Articles of Agreement in 1944. Rather was it an attempt to give a stability to the foreign exchange market that we had not had in the 1930s. It was an attempt to enable countries to maintain that stability and to get help when they needed it to maintain that stability.
But stability was not absolute. IMF members could adjust rates by 10% without the Fund's approval and further adjustments were possible within the rules and subject to Fund approval.
The dollar link with gold gave a certain stability - and, I suppose, what might be seen as a "criterion" for stability - but it did not prevent flexibility of exchange rates.
The "gold standard" was a killer on the side of rigidity. "Free-floating exchange rates" are a killer on the side of flexibility. Excessive flexibility has led through speculation to the near-death or severe injury of fixed-capital investment, productivity and production. The Articles of Agreement of the IMF, as they were applied between the end of the war and 1971, were a compromise between the two, intended to encourage stable economic growth and full employment, in a way which would not cause either depression through excessive rigidity or an environment of exchange manipulation and speculation through excessive flexibility.

You write -

"However the phenomenon of stagflation did not (as your comments seemed to suggest) precede the ending of the gold standard. Significant inflation problems arose only in the late 1970s following the first oil crisis of 1974. It was triggered by an inflationary surge associated with increased oil prices and by fiscal imbalances to some extent, and perpetuated / escalated by strong feedbacks between price and wage rises (which prevented Keynesian type stimulation from increasing real production). It seems likely also that it was perpetuated by the freeing of monetary policy from gold standard constraints."

In fact, Nixon and Burns of the Fed thought inflation had reached unacceptable levels when they took action in July 1969. By later standards, that inflation was comparatively modest but, by their action, they intensified both inflation and unemployment, that is, they introduced us to the phenomenon of "stagflation". The first oil crisis did not hit us until October 1973. That made the existing inflationary situation worse, but it did not cause the inflation which had been warming up nicely for more than four years.
As a little personal piece of evidence of this, I wrote "The Indigent Rich" in 1970. It was, in essence, a critique of the Nixon/Burns policies of 1969 and said that those policies would not cure inflation but would only make things worse. With the customary publication delays, "The Indigent Rich" became generally available in June 1971. The term "stagflation" had not been coined then but the phenomenon itself was well on the way and I had already identified its characteristics. More than two years were to pass before, in October 1973, we had our first "oil crisis."

I might add that, in a later book called "Inflation: A Study in Stability", published in 1974, I did explicitly use the term "stagflation." I wrote that -

"Our failure to try [to match supply with demand] explains why we have so often had 'stagflation'. When insufficiency of supply started to cause inflation, we have applied - and, indeed, we still do apply - monetary and fiscal policies that curtail certain areas of demand, including investment demand, and that curtail production. This reduction of supply while demand necessarily stays up under the pressure of government as well as of private outlays, achieved those twin evils of more unemployment and higher prices."

I commented further that, "when we have reached that point of ultimate frustration, we have then - just as we did in the 1930s - flailed around desperately for remedies." That was in 1974. We did not get our "remedies" until some years later, by which time our external supply sources had matured and we shifted our inflation problem from domestic price rises to deficits in the balances of trade and payments.
We never did and still have not now solved our underlying inflation problem - at least in such countries as the United States and Australia. That "shift" I referred to above is still in place and the question still is how long and to what extent the deficits can be sustained, what can be done to moderate them and what will happen to world trade, payments, economic growth and welfare, if we do not moderate them and a "crash" does the job for us.

James Cumes .http://www.authorsden.com/jameswcumes
----- Original Message -----
From: John Craig
To: 'James'
Cc: 'David Chiang' ; 'qasim kz' ; 'reginald little' ; max@mailstar.net ; 'norie huddle' ; 'kristen nordhaug' ; 'tausch, arno' ; 'peter g. spengler' ; 'stephen zarlenga (e-mail)' ; 'gunnar tomasson' ; 'arno mong daastoel' ; philev@e-znet.com ; 'israel shamir' ; 'peter wakefield sault' ; 'gavin oughton' ; 'henry c.k. liu' ; 'peter kirsch' ; 'abe killian' ; 'william engdahl' ; 'virginia rainesco' ; msc.salzburg@utanet.at ; 'gary santos' ; 'pietro p.masina' ; 'andre gunder frank' ; 'gunning pat' ; reporternotebook@aol.com ; 'jeffa' ; antloew@yahoo.com.au ; 'Josef Imrich' ; 'W A Park' ; 'basil bolt' ; MSchaefer2000@cs.com ; richebacher@aol.com ; cresscourt@chello.at
Sent: Monday, July 11, 2005 3:29 AM
Subject: RE: "How to Deal with the Rise of China"

You suggested that:
* present (dangerous) fiscal imbalances are a continuation of policies that led to breakdown of stable international currency system;
* you were unsure which developing nation with an export-led development strategy I was referring to pre 1971;
* it is a fallacy to blame anyone but US government for the present difficulties.

By way of background to my response to your suggestions, I note that the analysis I was quoting in relation to the pre 1971 situation was Braithwaite J. and Peter D. 'Bretton Woods: Birth and Breakdown', Global Business Regulation, 2001.

In the period leading up to the end of the gold standard in 1971, the primary influence on the US current account from a 'developing' nation with an export-led strategy would naturally have been Japan - as the 'tigers' only had an influence much later (as you noted).

While the 'guns and butter' fiscal policies of US were another factor in this situation (and in imbalances in 2005), it is also relevant to consider the constraining effect that a gold gold standard can have on counter-cyclical public spending during a severe recession. This was, I understand, one of the factors which made it difficult for governments to deal with the depression of the 1930s (ie any government which endeavoured to take the lead in stimulatory spending would generate a current account deficit, and pressure on its gold reserves). Richard Duncan's recent analysis of the Dollar Crisis pointed out that the emergence of the $US standard was one factor in the emergence of a much faster rate of global growth than had previously been possible (and also that this dynamic is no longer sustainable).
see http://cpds.apana.org.au/Teams/Archive/monetary_systems.htm#22_5_05

However the phenomenon of stagflation did not (as your comments seemed to suggest) precede the ending of the gold standard. Significant inflation problems arose only in the late 1970s following the first oil crisis of 1974. It was triggered by an inflationary surge associated with increased oil prices and by fiscal imbalances to some extent, and perpetuated / escalated by strong feedbacks between price and wage rises (which prevented Keynesian type stimulation from increasing real production). It seems likely also that it was perpetuated by the freeing of monetary policy from gold standard constraints.

In relation to the US trade and payments imbalances, the source of this does seem heavily linked to the export-driven developmental strategies and to the characteristics of monetary and financial systems which have been widely used in East Asia (especially but not only in Japan, China) - see Structural Incompatibility Puts Global Growth at Risk

The latter argues in particular that:
* those export-led strategies impose a deflationary demand deficit on the global economy - which would lead to recession unless they are counterbalanced by excess demand from elsewhere (and the US has primarily taken this role presumably in order to allow global growth to be sustained and other countries to gain a stake in economic stability);
* current account surpluses (which have translated into US deficits) are needed to protect insolvent banking systems which emerge when profitability is not treated as an important economic goal (as emerges under neo-Confucian economic models because economic transactions tend to be coordinated by relationships amongst social elites, rather than by calculation of financial outcomes);
* reform efforts need to focus on the financial and monetary systems in East Asia (not on trade policies or exchange rates - as these can have little effect; nor on US policy, though a shift towards fiscal balance would be useful as Greenspan has suggested). Moreover if the problem is not overcome by such reforms, the financial dislocation which is approaching will, as Richard Duncan's 'Dollar Crisis' also implies, primarily adversely affect East Asia because of balance-sheet weaknesses that result from the methods used for economic / business management;
* the latter effect is likely to be most severe in China (and any economies whose growth has been driven by China) because China has been endeavouring to normalize its economy (ie create a closer balance between supply and demand) - and has reduced the current-account-surplus protection of its insolved banking institutions by doing so.

-----Original Message-----From: James [mailto:jcumes@chello.at] Sent: Sunday, July 10, 2005 9:30 PMTo: John Craig @ CPDSCc: 'David Chiang'; 'qasim kz'; 'reginald little'; max@mailstar.net; 'norie huddle'; 'kristen nordhaug'; 'tausch, arno'; 'peter g. spengler'; 'stephen zarlenga (e-mail)'; 'gunnar tomasson'; 'arno mong daastoel'; philev@e-znet.com; 'israel shamir'; 'peter wakefield sault'; 'gavin oughton'; 'henry c.k. liu'; 'peter kirsch'; 'abe killian'; 'william engdahl'; 'virginia rainesco'; msc.salzburg@utanet.at; 'gary santos'; 'pietro p.masina'; 'andre gunder frank'; 'gunning pat'; reporternotebook@aol.com; 'jeffa'; antloew@yahoo.com.au; Josef Imrich; W A Park; 'basil bolt'; MSchaefer2000@cs.com; richebacher@aol.com; cresscourt@chello.atSubject: Re: "How to Deal with the Rise of China"

You say -

>The interesting point about this (which I found recently in analysis of the history of present >situation) is the strong parallel between 1971 and present situation

Yes, you are right - and more than right: it has been a continuing situation deriving from much the same policies.
In the years immediately after the fiscal and monetary restraints imposed by the Nixon Administration and the Fed from July 1969 onwards, countries like Japan and (West) Germany were suppliers who managed to hold their own investment, productivity and production up while keeping their inflation down. The United States still experienced severe stagflation of course; and some countries, such as Britain, which tried to supply the United States demand, caught a dose of severe stagflation themselves.
I'm not quite sure which countries you mean to identify when you refer to "the export driven strategies of various developing nations".
The Asian Tigers could be taken to fit your description as the situation matured and they were able to "gear up" to grab the opportunities offering - in countries such as Australia as well as the United States of course. However, that "gearing up" took some time and, in practical terms, the Tigers were not able to effect a major shift of inflation in the United States from domestic price rises to the external balances until the 1980s.
You seem again to be suggesting that it was not the United States but other countries - your "export driven strategies of various developing nations" - who were responsible for the collapse of the stable international system - not a "gold-standard" system but a stable though flexible system based on a strong US dollar linked to gold - in 1971. Many - perhaps a large majority - of Americans, as well as others like yourself, still tend to take this view of where the responsibility lies. "It's someone else's fault, not ours!"
One of the favourite allegations in the current (July 2005) situation is that China is responsible for the United States trade and payments problems and that China should resolve the problem by, for example, easing the peg with the dollar.
That of course is a very superficial and partial view of the situation and one that is likely to contribute little to a resolution of the deep and chronic economic and monetary problems that continue to plague the United States and others - and that threaten stability for all of us, possibly in the relatively short term.
At the same time, I suspect that Beijing will in the end adopt some device that revalues the yuan/renminbi upwards and I would guess that some other Asian governments might well follow.
That is unlikely however to do much to solve the very fundamental problems of the United States. The only country - and the only government - that can do that are the United States and the United States government themselves.
I'm repeating this to others on the list because I feel sure they have views to offer on what are very important issues.
All best wishes.

James Cumes
----- Original Message -----
From: John Craig @ CPDS
To: 'James'
Sent: Sunday, July 10, 2005 12:24 PM
Subject: RE: "How to Deal with the Rise of China"
A point to note about your analysis is that decision to abandon $US convertability to gold in 1971 was forced by the export driven strategies of various developing nations which had led to a $US crisis. Those export driven strategies resulted in the accumulation of large $US foreign exchange reserves, and when the amounts of US debt increased to apparently unsustainable levels, there was a threat of a liquidity crisis as countries with large reserves feared a collapse by $US and started demanding conversion of $US holdings to gold. This was not feasible (as US did not have enough gold) so gold standard was abandoned.

The interesting point about this (which I found recently in analysis of the history of present situation) is the strong parallel between 1971 and present situation
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