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Thursday, July 21, 2005

Is There a "Constructive Option"? 

There is no sign that the Bush Administration contains any significant tolerance for what you call the "constructive option." Indeed, there is no sign that anyone in the Administration has the faintest idea what such a "constructive option" may be - except to persist with what they're doing now.
There is no sign either that, buried in the gobbledegook that he customarily employs, there is any grasp of any "constructive option" by Greenspan. He seems intent on living out his term at the Fed before the temple comes crashing down around him. He never has been as much the solution as he has been the problem; but what he does seem able to do is to delude the Americans and much of the world - and perhaps even himself - that the American economy is going along splendidly and that all will be well. That in itself is quite a feat; but I see no sign that he is even attempting to be any more "constructive" than that.
We get certain developments from time to time, of course, such as today's news about the renminbi, that offer some pretext for suggesting that painless solutions are on the way. However, nothing of a theoretical or a practical policy kind is on the horizon even to confront the array of our economic and other problems, let alone resolve them.
More and more it seems likely that a major economic - and social - collapse will have to do the job for us. When it does, it will be much harder even than in 1929 to forecast what the outcome of the collapse will be. Relationships are so much more intimate and complex, as well as global, than they have ever been before at any time in human history. The instruments, whether of war or peace, are so much more formidable and often so much more frightening than they have ever been before.
Perhaps Asia, as you suggest, will lead Europe towards a more tranquil world. You seem to me to be right that Europe is strangely insisting on destroying itself by following so much of what America is doing. The characteristically European scepticism about American policies seems curiously to be lacking.
Who will suffer most when the collapse does come? The core characteristic of the economic situation of the last couple of decades has been its financial nature - and especially its runaway speculation in a massiveness and variety of financial "products" that is unprecedented.
Will it be the leaders in this speculative financial frenzy who will suffer most? Will it be the United States, Britain and, for example, some smaller countries such as Switzerland who will see their world blown away? Will those who deal in those everyday goods and services that we need most - the farm and mine products, the manufactured items in daily use - survive in the best shape?
It is interesting to reflect on these prospects. My instinct is - and in this I seem to come out somewhere near where you do - that the high-growth Asian economies, including but not restricted to China are likely to survive the turbulence best. However, that's no more than a punt. We could have such misery in Asia and in China in particular that the Chinese become even more aggressive in the next decade or two than the Japanese were in the 1930s and 1940s. All that we can really be sure of is that the economic collapse that we - all of us to some extent - have contrived will have political and strategic implications which it will be extremely difficult to predict and, probably, to control.
My own country of Australia could survive reasonably well but only if we can find a new and more constructive leadership. Even then, the odds are that we'll have to hunker down inside a defensive circle of wagons, if we're to ride out the turbulence as well as our productive potential, our small population, our skills and our social cohesion allow.

James Cumes
http://www.authorsden.com/jameswcumes

----- Original Message -----
From: Arno Mong Daastoel
To: gang8@yahoogroups.com
Cc: David Chiang ; Peter G. Spengler ; Stephen Zarlenga (E-mail) ; John Craig ; Israel Shamir ; Peter Myers ; William Engdahl ; garysantos@tri-isys.com
Sent: Thursday, July 21, 2005 3:15 PM
Subject: Re: [gang8] Chris Dialynas Discusses the Bretton Woods II Currency Regime

James,
Very interesting and factual comments.

I have some comments regarding the future, which is far more difficult and at the same time far easier since it demands no factual knowledge.
;-)

There are two extreme options- and all the options in between:

Constructive or destructive American nationalism?

1). The US re-assumes its production oriented policy by taming the financial sector (and thereby the corporations). This presupposes constructive American nationalism, in the population and especially in leading circles. The result will be a more self-certain US and relaxed relations to potential competitors. Advance of The Common Good is a likely outcome.

2) The US does not re-assume its production-oriented policy, and the US will loose the wealth- and power game. Its reactions may be that of a wounded tiger, like the British Empire one century ago, eager to obstruct any competitor apart from those it could 'control' like the US.
This presupposes destructive American nationalism, in the population and especially in leading circles. The result will be a more desperate US and strained relations to potential competitors. War is a likely outcome.

The difference between the options seems to be whether American nationalism will take the constructive or the destructive road, and when. A constructive reaction cannot be delayed too long. If it does, a destructive reaction is likely, since the constructive option would be lost. But as mentioned at the outset, a combination is possible.

An obvious way out, is for competitors to advice the US to ‘go constructive’, since this would be in their own long-term interest regarding peace and stability. If not they risk their own demise.

Will Asia save the West from itself?

Europe is drowning itself in the same kind of policies that is destroying the US, and although there are signs of rebellion, it remains for these to gain any power.
India, Japan and especially China do not seem to be victims of the same kind of illusions that the West is suffering from. It remains to be seen, whether Asia sees any reason to save the West from itself.

Arno
www.daastol.com

Wednesday, July 20, 2005

Bretton Woods and American Power 

The PIMCO piece below provides a very interesting analysis. There are some factual points about which we can quibble. For example, Chris refers to OECD when he means OECD's predecessor, OEEC.
His analysis is weak too in the impression he gives of the environment post-WW2. He does not seem to understand the strength of our determination then to avoid the miseries and disasters of the Great Depression of the 1930s and their impact, of course, on political and strategic developments.
It is in this context that he gives too little credit to the advantages that the IMF arrangements conferred on the international community between 1945 and 1969, including the more friendly environment they created for relatively liberal, non-discriminatory trade under GATT.
Although Chris pays some attention to the speculative nature of the world economy since 1969 and, more especially, since 1980, he tends to understate the extent of the speculative frenzy. (The "frenzy" has become so normal - so much a part now of our everyday existence - that we no longer see it as a frenzy any more!!)
In this context, he does not seem to appreciate the significance of "free-floating exchange rates". He does not use that or a similar term at all. However, it is free-floating exchange rates which have given a major stimulus to the creation and chronic stimulation of a speculative world economy. I saw a figure the other day that $US100 billion is poised to take advantage of a possible/probable relaxation of the peg on the renminbi. I don't know whether that figure is correct; but it is certainly perfectly plausible in the light of the conditions operating in the foreign-exchange markets. (The figure might well be much higher!)
The Bretton Woods arrangements were of course intended to correct the pre-WW2 situation in which a variety of countries used exchange-rate devices of many "creative" kinds to protect or promote their hard-hit economies during the Great Depression. If I remember correctly, they were part of what was described as "beggar-my-neighbour policies" that succeeded in beggaring everyone and creating conflicts that sharpened the urge to resort to violence - in the hope that one country or another would survive and prosper.
In this sense, the Bretton-Woods arrangements were part of the program for peace after the war that embraced the creation of the United Nations - with real responsibilities for maintaining conditions of stable economic growth and full employment - and the specialised agencies for, among others, agriculture, labour (the old ILO), civil aviation, health and trade (ITO failed but GATT succeeded).
Somewhere along the line, we lost track of our postwar purposes - and our "idealism", I suppose - and this can be seen in Chris' incomplete understanding of what we were trying to do.
I repeat that there is much in his analysis that is sound. However, one weakness is the inadequacy of his explanation of why we slipped or stumbled from BW1 into BW2. Within this, there is an inadequacy in his treatment of inflation or stagflation which was, of course, the major feature of the years after 1969 and whose impact - a shifting or shifted impact - has never gone away.
We tend to forget just how powerful an economy the United States was in the 1960s. They fought the Cold War - with economic and other aid to actual or potential "strategic" partners around the world - they fought the Vietnam war, they established President Lyndon Johnson's Great Society and they even put a man on the moon. That last was not just a scientific achievement; it was an economic achievement of a high order - and one that neither the United States nor any other country has been willing to attempt since.
After all this, there was some modest inflation - it was no more than that - when Nixon took office in January 1969. His Administration and the Fed tried to cut it down - my recollection may be faulty, but I think the rate then was about 3% or it may have been a little higher.
They applied monetary and fiscal policies which were intended to "damp down" the economy; but Nixon said explicitly that everyone would be looked after - he wasn't moderating the "Great Society." So industrial production fell but consumption - the jobless got just about as much as when employed - stayed up. More demand was chasing fewer goods and services. Instead of going down, inflation went up. Indeed, it soared, giving us "stagflation."
Even as early as that, there were some signs of the right and the wrong way to go. Britain got a boost in its exports to the US, the extra demand caused inflation to rise and the British imposed much the same monetary and fiscal restraints as the Americans had done. The result? Britain got stagflation too. (Incidentally, Ted Heath, who has just died, was Prime Minister from 1970 to 1974 and he tried, for a while, to "grow" the British economy out of inflation by boosting demand. In a muddled way, he saw that growth was the answer; but that growth should have been through investment, productivity and production, not through consumption which only made things worse.)
West Germany and Japan did get it right. The postwar economic miracles in both countries were then going strong. Both countries had replaced their devastated economies with state-of-the-art capital equipment and, when the post-1969 boost in demand came from the United States, they were able to boost their own fixed-capital investment, productivity and production without causing inflation in their own countries. They did, in effect, what the Nixon Administration and the Fed should have done in the first place.
However, West Germany and Japan - and a few other countries - were not able to meet the excess demand of the United States and some other countries such as Britain, and high inflation or stagflation persisted - and was boosted by the first oil shock in 1973 and the later oil shock in 1979.
In other words, there was still a considerable slice of excess demand to be met and consequently an opportunity for those who could meet the demand to profit from it.
So the Asian Tigers were born. Hong Kong, Singapore,Taiwan, South Korea began to establish or enlarge those industries which could meet the excess consumer demand in the United States and other developed countries, including my own country of Australia. (I had tried, from 1970 onwards, to get my government to adopt policies that would enable us to join the Tigers. Instead the government chose to join the United States in error.)
It was in 1979 that Deng announced his changes in economic policy in China. His idea was said to be to follow the path that Japan had taken in developing its economy. To a large extent, China did that, although the fundamental fact was that China became one of the Tigers. Because of its size, it became an economy that dwarfed the Tigers. Because of its size too, it threatened - and still does threaten more each day - to transform the world environment, not only the physical environment but the political and strategic environment as well.
We must now go back to the beginning of the 1970s to see how the original Bretton-Woods arrangements were transformed into something quite different, indeed in some ways into their very opposite and into a reversion in some important respects to the dark, discriminatory and disordered days of the 1930s.
Because the US monetary and fiscal policies of 1969 and subsequently did not "cure" inflation but only made things worse, the United States was forced to cut the link with gold in 1971. That meant that the orderly regulation of exchange rates was brought to an end. Governments or central banks could set their own rates without any requirement to get approval from the IMF. As time passed, it was seen to be not only acceptable but a valuable factor to have free-floating exchange rates, decided - it was sanctimoniously assumed - by the market.
The IMF collapse in 1971 did not complete the path to the scenario we now have in 2005, with the huge deficits in the American balance of trade and payments and huge surpluses of dollars or dollar assets held by the supplying countries.
That could happen only as time passed and the supplying countries were "tooled-up" to meet the excess demand more adequately. That happened in the 1980s and brought about what appeared to be reduction of inflation to acceptable levels. In fact, there never was such a reduction but only a shift in its impact from domestic price rises to deficits in the balance of trade and payments.
That persists to this day and in fact has been intensified in the past few years with an accumulation of debt by virtually everyone in the United States - individual Americans, households, corporations and governments. The cycle has been to manage existing debt by incurring more and more debt. (I should interpolate here that the American experience has been mirrored, to some extent, elsewhere and particularly by Australia. Some elements are different. For example, Australian public debt is small whereas its trade and payments deficit sometimes matches or exceeds that of the US as a percentage of GNP.)
All of this has led to the emigration of much of American industry overseas. Manufacturing industry has been gutted and highly skilled service industries - high-tech industries - are now headed for China, India and other countries.
Chris does not go into the political and strategic consequences of these developments. Once it used to be said that what was good for General Motors was good for the United States. We can be less certain now that what is good for modern corporations, especially in their emigration policies, is good for United States national security - or of course for social cohesion and political stability.
Again, we must bear in mind that the United States became a superpower because of the economic might it was able to deploy, for example, in the Kennedy and Johnson years of the 1960s. Its political and strategic authority was based on this formidable economic strength.
Since 1969, not only has American economic power been in decline - most importantly, relative decline - but it has become increasingly obvious that the US Government and, indeed, Americans generally, do not know how to deal with the predicament they have got themselves into.
The question now is how far this decline in economic power has to go - and will go - before it undermines the superpower status of the United States and leads into a period of intense political and strategic instability.
Chris does not really go into this further question which must be of intense concern ro all of us.


James Cumes
http://www.authorsden.com/jameswcumes

----- Original Message -----
From: Arno Mong Daastoel
To: David Chiang ; Peter Myers ; gang8@yahoogroups.com ; John Craig (CPDS)
Sent: Tuesday, July 19, 2005 9:15 PM
Subject: [gang8] Chris Dialynas Discusses the Bretton Woods II Currency Regime
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www.pimco.com/LeftNav/PIMCO+Spotlight/2005/Secular+Forum+Spotlight+Dialynas.htm


PIMCO’s Secular Forum: Looking Beyond the Business CycleBill Powers Discusses PIMCO's Latest Cyclical Outlook and Strategy

Chris Dialynas Discusses the Bretton Woods II Currency Regime

Chris P. DialynasManaging Director, Portfolio Manager and Senior Member of PIMCO’s Investment Strategy Group
Click here to read Chris Dialynas' biography
The "Bretton Woods II" currency arrangement, under which China, Japan and other nations are fixing their currencies at undervalued levels relative to the dollar by funding the U.S. current account deficit, will be a key topic at PIMCO's upcoming 2005 Secular Forum.
For some insight into the investment implications of Bretton Woods II and the issues PIMCO will be discussing at the Secular Forum, we spoke to PIMCO Managing Director Chris Dialynas. See his paper Trouble Ahead-Trouble Behind for a more detailed analysis of his opinions on these topics.

Q: PIMCO often refers to the "Bretton Woods II" (BWII) currency arrangement. Would you explain what this refers to?Dialynas: The Bretton Woods II arrangement refers to a presumed arrangement between the U.S. and, in particular, Asian countries wherein there is a semi-fixed, informal currency arrangement. You can think of it as the Fed producing money supply that goes through the banking system to consumers, who then consume underpriced imported goods via the "fixed" exchange rate, a large portion of which are produced in Asia. Asia takes the money and then purchases U.S. bonds—in other words, lending it back to the U.S.—and then the cycle repeats itself over and over again. Asia finances U.S. consumption and the budget deficit. It all begins with the U.S. government running expansionary policies that create demand, and with high rates of saving by foreigners who desire to lend to the U.S. It is the incorrect "fixing" of the exchange rates that is a necessary element that perpetuates this process.
The Bretton Woods II arrangement is informal and presumed to exist, whereas under the original Bretton Woods arrangement, currencies were actually formally fixed and linked directly to gold. It also included the formation of the IMF and World Bank, as well as many other formal grand arrangements.
Q: How did the Bretton Woods II arrangement come about?Dialynas: The current arrangement is presumed to exist because it satisfies the needs of both parties, Asian countries and the U.S., for different reasons. It also presumably satisfies the needs of the two blocs in Asia—China and Japan—for different reasons as well.
The U.S. has a huge savings shortfall and tremendous capital needs, and therefore a need to import capital. So the U.S. allows this arrangement to exist despite the fact that it creates adverse economic externalities. The Chinese are presumed to agree to this arrangement because they presumably need to produce products for export to the U.S., in particular, and to create jobs for their people who are migrating from the farm to industry. Japan has a need to export products to avoid a very severe recession and given the demographically mature population in Japan, there is a need for that population to accumulate assets that they can presumably rely upon in retirement.
Because of that set of circumstances, the presumption is that the arrangement is symbiotic and mutually beneficial for everybody.
Q: What are some of the externalities of Bretton Woods II for the U.S.?Dialynas: The externality of this arrangement is obviously debt buildup and an increasing current account deficit in the U.S. We are continuing to borrow and borrow and borrow to finance personal consumption and the needs of the federal government. Debt continues to build and accumulate in the U.S. and obviously the debt can’t accumulate forever. We need to make payments on that debt and eventually repay it.
The higher debt levels constrain Federal Reserve policy because the higher rates go, the greater the likelihood that something breaks as a result of increased financing costs. It also means that the higher rates go, the greater the impact on the federal deficit. Eventually we may need to borrow to finance the coupon payments on Treasury securities.
In addition, there is this huge disparity in wages between workers in China and workers in the U.S. that obviously gives the Chinese economy a tremendous relative production advantage. It also means that there is a tremendous incentive for U.S. companies to outsource production to China, or outsource labor to India and other lower-wage-per-value-added countries.
That’s important because it has an impact on the job market in the U.S., where any given amount of fiscal or monetary stimulus results in less job formation than previously, which ultimately leads to some form of social unrest. It also means that there is a good amount of capital flight from the U.S. because you can regard this outsourcing, especially in the form of direct investment in plant and equipment in other countries, as capital flight. Capital flight is symptomatic of debtor nations, whereas foreign investment occurs in countries enjoying trade surpluses.
It really comes down to a distribution issue. Shareholders benefit, at least in the short run, from the low cost of labor in other countries and the whole globalization process, the availability of low cost, quality goods benefits the U.S. consumers, but U.S. workers lose in this arrangement. And in the long run, it probably isn’t a very good arrangement for shareholders because there is very little to ensure that the capital invested abroad can be recovered and that it won’t in fact be nationalized, or otherwise confiscated, one day. There is a substantial difference between having capital and plant and equipment in your home country and domiciling assets in another country where you have much less control and where the laws and rules could change substantially overnight.
The loss of jobs and the outsourcing also mean that the U.S. is de-industrializing. To the extent that we de-industrialize, then obviously the industrial base gets smaller. As our debts get larger and larger, the need to dedicate resources toward repayment of that debt becomes greater. It also becomes more difficult because the industrial base, which can be relied upon to produce goods to sell abroad, is diminished.
The natural adjustment process is an exchange rate adjustment. The exchange rate adjustment cannot occur in a BWII fixed rate regime. The de-industrialization eventually nullifies the efficacy of the exchange rate adjustment solution. It becomes ineffective because we do not have the resources that provide for the production that can be priced competitively in a new relative exchange rate regime. In essence, de-industrialization nullifies the currency adjustment solution because the elasticity of production with respect to the exchange rate has declined.
In my view, which is perhaps a little bit extreme, this set of imbalances leads to very nasty things like wars—political, economic and military. That has certainly been the case historically and it’s hard to see why it would be very different this time around.
Q: How does the Bretton Woods II arrangement differ from the original Bretton Woods pact?Dialynas: The original Bretton Woods arrangement, which most people would argue endured until the mid to late 1960s and started in 1944, was a post-World War II reconstruction arrangement that was based upon a particular set of circumstances, which obviously included the destruction of industry in Japan and Europe as a result of the war. The industry of much of Europe and Japan was destroyed and the U.K. was essentially bankrupt and facing deflation as a result of the tremendous costs of World War I and World War II. The U.S. at that time was the trade-surplus nation in the world and, clearly after World War II, the supreme military leader, although there was a presumption at the time that Russia also had very high military capabilities.
The other interesting point is that at the time of the Bretton Woods negotiations, post-World War II, by 1945 U.S. industrial production was more than double what it was in 1939. The U.S. produced one half of the world’s coal, two-thirds of the world’s oil, more than a half of the world’s electricity, and controlled 80% of the world’s gold reserves (excluding the Soviet Union), and of course at the time was the only country that had an atomic bomb.
So you can see that the original conditions in Bretton Woods I were much different than the prevailing state of the world today, and the purpose of Bretton Woods was to rebuild Europe, to rebuild the global economy and rebuild Japan post-war. The notion was that you could have greater stability in the global economy if exchange rates were relatively constant, and in this case, fixed to gold within a very narrow band. In that sense, the exchange rate risk would be taken out of global transactions. Bretton Woods I was the result of a huge geopolitical clash. Bretton Woods II is a convenient mechanism but one that provides for a clash of geopolitical objectives.
In fact, the Bretton Woods regime did not work well at the outset. The U.S. needed to recycle its trade surplus into other countries to finance industrial development but had difficulty doing so. Under Bretton Woods, the International Monetary Fund and the World Bank were created and authorized to lend to countries. Japan and Europe had very little industry from which to build cash flow.
The system did not work very well and it became apparent, at least to some people, that a greater export of capital from the U.S. to the European countries was necessary to facilitate investment and the re-establishment of industry. So the Marshall Plan was established, wherein actual grants, as opposed to loans, were made to provide capital to European countries. The Organization for Economic Coordination and Development (OECD) was subsequently established to supervise and monitor the allocation of the Marshall Plan grants. It was the combination of fixed exchange rates, the IMF, the World Bank and the Marshall Plan that together seemed to be a reasonably successful economic architecture. But again, it was successful because the goal was to rebuild and restabilize the global economy.
In the case of Bretton Woods II, we have a plan that is, first, not a formal plan. There is always the day-to-day potential for change, for someone to say "we’re not playing this game any more, we’re going to do something different." This obviously means that there is less stability to the system. But it also seems to me that it’s a plan or an arrangement that leads to greater instability in the global economy and actually increases the existing imbalances, as opposed to trying to stabilize the imbalances with a tendency toward rebalancing.
So, Bretton Woods I was a fixed exchange rate regime that provided stability to rebuild Europe and Japan following World War II. The global creditor nation, the U.S. provided capital to the globe to finance investment. In the case of Bretton Woods II, the biggest global consumers, the U.S. citizenry, are provided with goods and financing for the purchase of goods from foreigners who are producing the goods and who are, as a result, accumulating massive amounts of reserves.
So in BWII, there is a transfer of wealth from the debtors to the creditors and that wealth transfer is constantly increasing. The longer this system continues the greater the imbalance between the foreign creditors and the U.S. debtor. Future generations of Americans will labor to service and retire the present generation’s obligations.
The bottom line is that Bretton Woods II will result in a more imbalanced global economy. It’s a system that is destabilizing rather than stabilizing and that is a very, very important difference.
Q: You mentioned the potential for conflict because of the instabilities associated with Bretton Woods II. Another topic PIMCO will be discussing at the Secular Forum is the potential for global conflict over resources, including oil. Is there a connection between these two secular forces?Dialynas: It is interesting because the presumption that we have a semi-fixed exchange rate system is a farce because the greater the imbalance, the greater the inclination to speculate against the debtor country in favor of the large creditor countries. This suggests that there will be a lot of speculation in Chinese assets, including property, for purposes of not only the productivity of the asset or property, but to capitalize on the revaluation of the currency as well. That means this presumed stable exchange rate regime has engendered a much riskier financial environment because as the trade imbalances grow and grow, then the risk associated with speculation against the debtor country currency becomes lower and lower.
The recycling of money is in essence providing externalities in the form of a higher U.S. dollar than should otherwise be the case, lower U.S. interest rates than would otherwise be the case, much tighter credit spreads because foreign investors are such huge buyers of U.S. corporate bonds, and lower mortgage rates because they are also investing in U.S. mortgage-backed securities. And they obviously own a lot of Treasury and agency securities. So the U.S. has much lower interest rates generally. This process has led to artificially low interest rates, low inflation rates, and an overvalued currency, and it probably manifests itself in the domestic economy in much higher housing prices, so perhaps a housing bubble as well.
The system that is advertised as Bretton Woods II, a semi-fixed exchange rate stable system, by virtue of the system itself, creates greater imbalances and a much more speculative environment. That takes us to the commodity complex. The natural equilibrating mechanism for trade balance is exchange rate adjustment and under BWI, the transfer of gold from one country to another settled trade imbalances. Gold was the stable value global asset.
If you think the dollar is at some point vulnerable to a decline in purchasing power then you obviously want to purchase hard assets now because those hard assets will retain their value in global terms if they are globally traded assets like gold, diamonds, or oil, among many other commodities. This is particularly true if the yield on dollar denominated bonds is very low.
But just as importantly, if you think that this imbalance leads to the potential for more military action, then there would be a natural tendency, it would seem to me, for leaders of foreign countries to begin stockpiling assets that they might deem valuable in time of war. Just as the U.S., during an election year, refused to open the strategic oil reserve, then you would think there would be copycat countries that, if they had not already, would establish strategic oil reserves and fill them. In that event, you get precautionary demand for oil so that the oil comes out of the ground and goes right back in to the ground. The demand for oil looks very high and prices go up based upon not only commercial demand, but also actual precautionary demand and the speculative demand derived from this BWII system.
The BWII system results in speculation and instability. Importantly, the growth rates of "emerging" economies, like China, are quite high in a BWII system as are the infrastructure requirements. The transformation of growth to newly industrialized areas results in additional demand for commodities that are inputs to the infrastructure development, resulting in a structural demand for particular commodities.
Q: You’ve touched on some of the investment implications of Bretton Woods II, which is obviously the reason PIMCO will be discussing the topic at the Secular Forum. What questions regarding Bretton Woods II will PIMCO be looking to resolve at the Secular Forum?Dialynas: It’s going to be a question of how long all of the things we’ve talked about can last, why Bretton Woods II might fall apart and the financial market implications of it failing; also whether the imbalances are resolved through market solutions or regulatory solutions. The form of the solutions will have different investment implications.
By regulatory solutions, I’m referring to multi-country, negotiated terms of trade. For example, trade quotas, which are voluntarily managed as opposed to forced solutions like tariffs. For example, if the U.S. put tariffs on every product imported from Asia, that policy would have a particular set of investment implications. Radical exchange rate realignments would be another alternative solution with its unique market impact. A market-forced solution might take the form of a foreign boycott of additional U.S. dollar denominated assets.
Depending upon the form of the solution to resolve the imbalance—if in fact we agree that the imbalances require resolution and are resolved in our secular timeframe—then the implications will be quite significant and quite different in the marketplace with respect to interest rates, yield curve shapes, currency values and credit spreads. The importance of the recycling of dollars is huge in the bond market and really affects everything that we do in our portfolios. In some cases, those solutions will tend to be very reflationary and in others, the deflationary tendency will be quite real. Regional growth rates and inflation rates are significantly impacted by the present regime. A change in regime, away from BWII, will exert substantial real economic affects.
Q: This topic should make for a very interesting discussion at PIMCO’s 2005 Secular Forum. Thank you for the preview, Chris.

Past performance is no guarantee of future results. This article contains the current opinions of the manager and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Such opinions are subject to change without notice. This article is distributed for educational purposes only. Information contained herein has been obtained from sources believed reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660. ©2005, PIMCO.

Tuesday, July 19, 2005

Globalisation of Disaster 

William Greider says -

"But to describe plausible remedies is to explain why none are likely. The webs of mutual interests connecting government, corporate boardrooms and Wall Street are too deeply woven, as are habits of thought among policy makers and politicians. So I do not expect anything fundamental will be altered in time. We are going to find out if the dissenters are right."


This is an analysis that must be of concern to all of us. In many ways, it reflects the views I have been expressing for some time, about the self-destruction of the single superpower, the prospect of a politically and strategically dangerous interregnum and the ultimate emergence of a successor to the United States, probably it would seem at this stage, China.

Greider is a man whose views deserve careful attention. It is interesting that he starts this piece with the words -

"DURING the cold war, as the Soviet economic system slowly unraveled, internal reform was impossible because highly placed officials who recognized the systemic disorders could not talk about them honestly."

Although there are many differences, there are also many ways in which the decline of the United States resembles the road to collapse of the Soviet Union fifteen years ago. The "dishonesty" of the administration is not confined to the official data and analysis. That dishonesty is shared by almost the whole of the analytic and academic corps - the think-tanks and the universities, as well as the corporate leaaders and "thinkers".

As Greider says, the thinking and the policies that have led to this situation - as well as the deep and self-serving self-interest of so many - is so embedded that we cannot expect any significant "reform" soon. The remedy will come perhaps only catastrophically when collapse of the whole economic system does the job of reformation for us - and does it painfully, not only for the United States itself, but for many, probably most and perhaps virtually all other countries around the world.

"Globalisation" will crystallise into a globalisation of disaster.




James Cumes
http://www.authorsden.com/jameswcumes
###http://www.authorsden.com/jameswcumes


Published on Monday, July 18, 2005 by the New York Times
America's Truth Deficit
by William Greider

WASHINGTON -- DURING the cold war, as the Soviet economic system slowly unraveled, internal reform was impossible because highly placed officials who recognized the systemic disorders could not talk about them honestly. The United States is now in an equivalent predicament. Its weakening position in the global trading system is obvious and ominous, yet leaders in politics, business, finance and the news media are not willing to discuss candidly what is happening and why. Instead, they recycle the usual bromides about the benefits of free trade and assurances that everything will work out for the best.
Much like Soviet leaders, the American establishment is enthralled by utopian convictions - the market orthodoxy of free trade globalization. The United States is heading for yet another record trade deficit in 2005, possibly 25 percent larger than last year's. Our economy's international debt position - accumulated from many years of tolerating larger and larger trade deficits - began compounding ferociously in the last five years. Our net foreign indebtedness is now more than 25 percent of gross domestic product and at the current pace will reach 50 percent in four or five years .
For years, elite opinion dismissed the buildup of foreign indebtedness as a trivial issue. Now that it is too large to deny, they concede the trend is "unsustainable." That's an economist's euphemism which means: things cannot go on like this, not without ugly consequences for American living standards. But why alarm the public? The authorities assure us timely policy adjustments will fix the matter.
Reporters and editors typically take cues from the same influential sources and learned experts in business, finance and government. If the news media decided to cast these facts as the story of the world's only superpower losing ground in global competition and becoming financially dependent on strategic rivals like China, the public would take greater notice. But governing elites would regard such clarity as inflammatory. America's awesome trade problem is instead portrayed as something else - an esoteric technical dispute about currency values, the dollar versus the Chinese yuan. The context is guaranteed to baffle and benumb citizens.
The possibility that the United States can no longer afford globalization, at least not as it now functions, is what opinion leaders do not wish to discuss. A few brave dissenters have stated the matter plainly and called for significant policy shifts to stop the hemorrhaging. Warren Buffett, the legendary investor, says the United States is destined to become not an "ownership society," but a "sharecropper society." But his analysis, and others like it, are brushed aside.
An authentic debate might start by asking heretical questions: Why is the United States one of the few advanced economies that suffers from perennial trade deficits? Why do new trade agreements, despite official promises, always leave the United States with a deeper deficit hole, with another wave of jobs moving overseas? How do the authorities explain the 30-year stagnation of working-class wages that is peculiar to America? Are we supposed to believe that everyone else is simply more competitive or slyly breaking the rules? In the last three decades, American policymakers have succeeded in closing the trade gap with only one event - a recession.
The American predicament is shaped by operating dynamics grounded in the global system, singularly embraced by Washington because Washington originated most of them. At the outset, these practices were both virtuous and self-interested for the United States - encouraging industrialization in poor countries, binding cold war allies together with trade and investment, furthering the global advance of American business and finance. With its wide-open market, America played - and still plays - buyer of last resort for world exports. Its leading companies and banks gained access to developing new markets, often by sharing jobs, production and technology with others. American policymakers also got to run the world.
The utopian expectations behind this arrangement turned out to be wrong, judging by empirical evidence rather than theory. But why wrong? American political debate is enveloped by the ideology of free trade, but "free trade" does not actually describe the global economic system. A more accurate description would be "managed trade" - a dense web of bargaining and deal-making among governments and multinational corporations, all with self-interested objectives that the marketplace doesn't determine or deliver. Every sovereign nation, the United States included, uses its vast arsenal of policies to pursue its national interest.
But on the crucial question of how policy makers define "national interest," Washington stands alone. Western Europe, whatever its problems, manages economic policy to maintain modest trade surpluses. Japan manages to insure far larger surpluses in recessions (its export income subsidizes inefficient domestic employers). China strives to acquire a larger, more advanced industrial base at the expense of worker incomes and bank profits. Germany and Japan, despite vast differences, both manage to keep advanced manufacturing sectors anchored at home and to defend domestic wage levels and social guarantees. When they do disperse production and jobs overseas, as they must, they do so strategically.
By contrast, Washington defines "national interest" primarily in terms of advancing the global reach of our multinational enterprises. Elites are persuaded by the reigning orthodoxy that subsidiary domestic interests will ultimately benefit too. The distinctive power of America's globalized companies is reflected in trade patterns. Nearly half of American exports and imports are not traded in open markets - the price auction idealized by neoclassical economics - but within the companies themselves, moving materials and components back and forth among their far-flung factories. A trade deficit does not show on the company's balance sheet, only on the nation's. In recent years, much of the trade deficit has reflected the value-added production and jobs that companies moved elsewhere.
The United States is thus especially vulnerable to the downward pressures on working-class wages that exist on both ends of the global system. American producers are generally free - and even encouraged by Washington - to shift production to low-wage locations. Companies regularly use this cost-cutting technique as a competitive weapon without regard to the domestic consequences. The practice works for companies and investors, but not so well for a nation.
INDEED, the cumulative effects of retarding labor incomes worldwide repeatedly threatens stagnation or worse for the entire system. Workers, to put it crudely, cannot buy what the world can make. Too much capital leads to the speculative "bubbles" that bounce around the world, visiting financial crisis on rich and poor alike.
At a different moment in history, American leadership might have stepped up to these disorders and led the way to solutions. If globalization is to continue without encountering more crisis and random destruction, governments must together shift the balance of power so labor incomes can rise in step with rising productivity and profits. If the United States is to avert its own reckoning, it must take decisive action to draw firm limits on its exposure to trade deficits, that is, resign its position as the open-armed buyer of last resort. In effect, Washington would also reform its own national interest imperatives so that they more closely resemble what other nations already embrace. Ultimately, American remedial action may protect the global system from its own crisis - the moment when trading partners discover they have just lost their best customer.
But to describe plausible remedies is to explain why none are likely. The webs of mutual interests connecting government, corporate boardrooms and Wall Street are too deeply woven, as are habits of thought among policy makers and politicians. So I do not expect anything fundamental will be altered in time. We are going to find out if the dissenters are right.
William Greider, the national affairs columnist of The Nation, is the author of "One World, Ready or Not."
Copyright 2005 New York Times
###http://www.authorsden.com/jameswcumes

Sunday, July 17, 2005

Terror and the Self 

Terror and the Self


How often do you fall in love with yourself? That is a serious question, especially in the light of the monstrous acts of terror in London on 7 July.
We tend often - indeed, most often - to fall in love with someone who mirrors our own self, physically and/or spiritually. Not always. Sometimes we have a fling with an off-beat or an opposite; but a partnership with "ourself" tends to be more reliable and lasting.
That preference should prompt us to study ourselves and our own behaviour more closely. What is especially terrifying about the atrocities of 7 July is that they are so typical of human behaviour.
Our falling in love with our mirror image does little harm to ourselves or others; but to express our narcissistic imperative in our romantic lives is not enough. We must join with others who are like ourselves, to enhance our status and power, reinforce our self-respect, gain the respect of others and triumph over ‘alien others’ whether in war, sport or the power of thought or faith.
For virtually all of us, some such joining is an imperative. We don't want to be a loner. We tend to pity or despise those who are.
Previously, I called this joining with others of like mind, creed, activity or whatever, narcissistic transference - the extension of self-love from the self to a 'community' of the self. For most individuals, it is a powerful imperative, indeed the most powerful drive known to individuals and the 'crowds' into which they deliberately or serendipitously merge.
The ‘crowds’ try to enlarge their numbers and instil group disciplines. We see it in love of country - "patriotism" - in religious devotion, in football rowdyism, in a host of associations that form our plural society. Monolithic societies of communism and religious faiths are more likely to channel the whole narcissistic drive into a single overwhelming association of passion for the cause.
The fierce power of narcissistic transference can make a people 'great', if its forms of behaviour and institutional instruments through which it disciplines and commands, are themselves 'great.' On the other hand, those disciplines and commands - and the institutions that use them - often are directed to purposes that are racist, bigoted, murderous and self-destructive.
Hitler sought to glorify the German 'race' at the cost of destroying other groups, especially the Jews. In the Balkans, Serbs massacred those who were not Serbs; Croats and Bosnians those who were not Croats or Bosnians. Massacres in many parts of Africa have had tribal motivations that are essentially narcissistic: diminish or eliminate the ‘other’ for the benefit of the self.
The universality of this behaviour, whether in gross or relatively benign forms, suggests that the narcissistic imperative is not a deviation from the human norm. It is not a madness or illness but embedded in the human personality. Unless controlled, it carries the seeds of self-destruction of the individual and, potentially, the species.
Narcissism, narcissistic transference and institutional narcissism can be especially terrifying where the drives to human behaviour are linked to the passionate irrationality of religion. Cults form, outside or within established religions. Such total loyalties are demanded and sworn that the self is sacrificed for the greater 'glory' of the object of transference. The power of the narcissistic institution to command performance extends to the individual accepting death as a contribution to the status and power of the institution.
Traditionally, we have seen this in the power of the state to command its young men to sacrifice their lives in war. We have seen it in the power of religious cults to command individual or mass suicide or the murder of those who might demur or defect.
Nothing can justify the atrocities of 9/11, Bali, Madrid or London's day of horror on 7 July; but, if we are to avoid our own self-destruction and our potential extinction as a species, we must seek a deeper understanding of our own behavioural drives. We then need to manage those drives so that the human achievement is not swept away by our characteristic strengths of association and communication. Instead, we need to harness our narcissistic imperative to peace and peaceful change, the elimination of disease and poverty and the creation of societies whose narcissistic images are not of conflict but of cohesion for our common human good.

James Cumes


Dr James Cumes is the author of "The Human Mirror: The Narcissistic Imperative in Human Behaviour."

James Cumes
http://www.authorsden.com/jameswcumes

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"
James

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.
http://www.globalpolicy.org/socecon/bwi-wto/2001/braithwa.htm

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
http://cpds.apana.org.au/Teams/Articles/unsustainable_growth.htm

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"
John,

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
http://www.authorsden.com/jameswcumes
----- 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

Sunday, July 10, 2005

"How to Deal with the Rise of China" 

Report by Australian Broadcasting Corporation

On 28 June 2005, a report from the Australian Broadcasting Commission read as follows:

"The ABC has learned that concern about offending China prompted the Australian Government to decline an invitation from the United States to take part in secret talks on how to deal with the rise of China. Calling themselves the 'Halibut Group', the talks were to also involve the UK, Canada, New Zealand and Japan.

Officially, Australia is giving no explanation for its refusal to take part.A spokesman for Foreign Affairs Minister Alexander Downer says 'Australia has a wide range of talks with other countries on a wide range of issues and doesn't tend to talk about them'.But Labor's Robert McClelland wants an explanation.

ROBERT MCCLELLAND: Clearly, in terms of Australia's security and economic interests in the next half a century, issues relating to China, both as a military power and as an economic power, are fundamental to Australia's interests. You would want a clear explanation from the Foreign Minister as to why Australia didn't attend that invitation, but he hasn't provided that.

KIM LANDERS: A spokeswoman from the Chinese Embassy in Canberra says they were not aware of the secret meetings and 'first heard about it on the ABC'. Professor Stuart Harris, from the Department of International Relations at the Australian National University, is a China expert. He's not surprised the Australian Government refused to take part.

STUART HARRIS: I think it was a very sensible decision on the part of Australia. You know, I think there's been enough effort on the part of some parts of the US administration to get Australia involved in a one-sided process vis-à-vis China, and I don't think it's in our interests to go along with that.

PETER CAVE: Professor Stuart Harris from the Australian National University. Kim Landers was our reporter. "


Analysis

A particular reason for fascination with this report is that the United States and Australia have arrived at their present relationship with China by much the same route and the two are joined in what Australian Governments have, for the past fifty years, regarded as one of their most fundamental security arrangements, the ANZUS Treaty.
To understand the rise of China and particularly its scale and speed, we must go back more than thirty years to the period 1969 to 1971, when post-war stability, largely based on a strong and stable United States dollar, collapsed.
The American attempt to fight inflation through fiscal and monetary measures in 1969 brought only more inflation, spreading the phenomenon of stagflation around the world. In 1971, the Nixon Administration abandoned the link between the United States dollar and gold and precipitated the collapse of the stable international currency system overseen by the International Monetary Fund since 1945. The spread of “free-floating currencies” powerfully reinforced trends towards a highly speculative world economy and diminished the role of GATT and GATT’s successor, the World Trade Organisation (WTO) in the effective regulation of world trade
After 1969, there followed more than a decade of highly visible runaway inflation punctuated, but not fundamentally caused by two major "oil shocks" in 1973 and 1979 and a roller-coaster ride for commodities.
Although the fundamental policies of the United States remained unchanged and, if anything, its reliance on interest-rate policy implemented through the Federal Reserve intensified, inflation, as measured by consumer price rises in the United States, declined to more acceptable levels from the 1980s onwards.
That decline was and continues to be attributed to the monetary policies of the United States, including especially discipline imposed by the Fed's interest-rate policy, dedication to "free" markets and small government, and free-floating exchange rates. Because of this attribution, these policies became ever more deeply embedded as time went on. The tendency was also for other countries to adopt them because they seemed to have worked for the United States – as the United States robustly claimed.
This view seemed to be reinforced by the collapse of the Soviet Union. The “market” was increasingly seen as sovereign and as the key to growth, income, competitiveness and even to employment. Privatisation became a key element in economic policy for mainstream economists and government policymakers.
Coincidentally with the fall in domestic consumer inflation and its attribution to mainstream monetary and free-market policies, a dramatic transformation began to take place in some east and south-east Asian economies. Leaving aside Japan, the smaller economies of Singapore, Hong Kong, Taiwan and South Korea were miraculously transformed over a period of a decade or so from slow growth, relatively backwater, developing economies into the Tiger economies of Asia.
During the same period, changes were occurring in the status of China, some of them highly visible, others unnoticed by most observers. In 1971, Henry Kissinger made and President Nixon foreshadowed his sensational visit to Beijing. Later that year, against at least purported and public opposition from Washington, Mainland China was admitted as the representative of China in the United Nations and took its place as one of the five permanent, veto members of the Security Council.
That elevation of Mainland China to the Security Council, though dramatic, was in fact less significant than the economic changes that had taken place over the previous two years in United States economic policies and that were to acquire much greater significance when Deng Xiaoping initiated changes in economic policy in China in 1979. Deng appeared to take the rapid development of Japan as a model for China to follow.
From that point, the stage was set for China to travel along the same path as that taken by the smaller Asian Tigers.
Compared with the Tigers - or, indeed, with any other country - China is a colossus, in population and potentially in economic power. The momentum of economic transformation and growth built up slowly during the 1980s but it built up ever more surely during the 1990s and into the new millennium. It built up partly through the initiatives embodied in its own economic and social policies; but its scale and speed derived especially from United States policies. The latter not only permitted but dramatically stimulated policies of economic growth through direct and indirect real fixed-capital investment, enhancement of productivity and rapidly expanding production in China.
In short, the United States provided an unprecedented opportunity which the Government of China grasped through its carefully managed transition from a centrally-planned economy to an economy in which private enterprise and the market were deliberately designed to occupy an increasingly important place. The transition was not and seems never to have been envisaged as a reckless plunge into total reliance on a “free market”, whether domestic or international. Rather was the transition envisaged as being from a centrally-planned to a mixed economy. It was neither to an economy in which the government was the sole master of production, distribution and exchange nor to an economy that was unequivocally “free” or overwhelmingly in the hands of “private enterprise” and the “market” in the widely accepted American sense. Nor, of course, was it contemplated that China would be a neo-liberal economy on the United States model.
As a consequence of these developments in the economies of the Asian Tigers, China and gradually India too, United States inflation appeared to be brought under control from around the mid-1980s onwards. It did so, not because domestic demand and supply were brought into some sort of balance, but because supplies were available, in ever greater quantity, especially from east and south-east Asia and, increasingly, from China. What this meant in effect was that the impact of inflation - deriving from pressure of excess demand on an inadequate supply - shifted from domestic price rises to deficits in the balance of trade and payments.
That situation of external imbalance intensified and became more “ideologically” embedded over the years. It was maintained - and intensified - not because it was understood and believed to be desirable - but because it suited the short-term interest of both sides. The supply countries were willing to hold their surplus dollars in idle reserves or in forms which did not disturb other economic situations. Investment and economic growth in the supply countries were stimulated by the assured markets in the United States; and, for its part, the United States received supplies which appeared to keep its inflation under control while satisfying the needs of its consumers. The deficits caused a decline in the value of the United States dollar through the later 1980s and earlier years of the 1990s; but this was gradual, relatively undramatic and sustainable in the light of the surplus countries' willingness to hold dollars. The United States dollar recovered to some extent during the boom years of the later 1990s, only to resume its downward trend after the collapse of the high-tech stock market boom at the turn of the century.
On the American side, there has been a pretty universal ignorance of what has been happening to the fundamentals of the American economy. This ignorance has been shared by a succession of Administrations, as well as think-tanks and academics in the United States – and indeed in most relevant academic and professional institutions worldwide.
On the side of China, it is difficult to say how completely their appreciation of the situation was in the past or how far it extends now. It may be that they not only had the “Japan model” in mind but that they saw clearly how the Tiger economies had been transformed and decided to join in. In other words, it can be postulated that they simply recognised a major economic opportunity and took advantage of it. We cannot be sure but, as time has gone on, the Chinese Government must have become increasingly aware of the monumental opportunities offered to it and the monumental changes that are under way in the world economy and in the economic relationships between major - and minor - national economies. Beyond the economic perspectives, they must be aware of the enormous political and strategic implications of those changes.
Although largely unrecognised, the United States has been, for some decades and continues now, in serious economic decline. In the final analysis, economic power confers political and strategic power. Relative rather than absolute changes in economic power transfer political and strategic power from one country to another. Traditionally, American strength derived from its unrivalled capacity to produce, a capacity that arguably won the Second World War for the Allies and that contributed critically to world reconstruction afterwards. It was that capacity that put men on the moon. It was that capacity that brought victory in the Cold War.
However, by the time the Cold War was won, the United States had already been applying policies for some twenty years which - unacknowledged – put in jeopardy its own destiny as a superpower. Economic trends suggested that its fate might be much the same, in broad terms, as the communist superpower whose overthrow it had, in large measure, contrived. That fate might be inevitable unless the policies which the United States had adopted since 1969 were fundamentally revised.
Even by the late 1980s, but especially through the "New Paradigm" years of the 1990s, and now well into the first decade of the new millennium, the United States has re-identified itself not as the great producer that it was traditionally, but as the great consumer. Its economic growth is now closely related to its insatiable consumption, rather than to its unrivalled production. From being the world's largest creditor, it has become the world's largest debtor. It has the largest external deficit the world economy has ever known. It has a huge budget deficit. Household debt is at record levels. Personal savings are at record lows. Personal equity in real assets has been drawn down to finance consumption excesses that refuse to diminish. Public investment has failed to cover depreciation of public infrastructure which now calls for massive injections of capital to restore the standards of the past. Manufacturing has been gutted. How much of American manufacturing survives is difficult to say. Estimates and “guesstimates” range from 40% to below 20%. The mode of calculation is highly suspect. However, what is clear is that, over the last thirty years, the formidable capacity of the United States to mass produce in quality, at low cost, has been seriously eroded and may perhaps have been devastated.
The apparent devastation continues and extends increasingly to the service industries through outsourcing and off-shoring. The traditional American economy seems to be disappearing over the horizon, leaving behind relatively unskilled and low-paid jobs in the distributive trades - accompanied of course by a recklessly speculative finance capitalism that creates and destroys asset bubbles and corporate and personal fortunes in predictable and destructive cycles. The frequently rosy claims of productivity gains are not sustained by real-income gains for the majority of the working population in the lower and middle income groups. Overall, rather than the “gale of creative destruction” described by Schumpeter, we continue to witness a gale of destructive destruction masterminded by the American policymakers themselves.
Against this background, the broad prognosis must be that the ills of the American economy are so many and so widespread that it can be only a matter of time before some event – possibly a relatively minor financial, political or strategic event - precipitates a major collapse.
That collapse will bring with it major instabilities in the whole political situation in the United States - instabilities which will quickly have their impact on the political and strategic situation throughout the world. What was only a relatively short time ago the assured position of the United States as the unrivalled superpower will be seen to be crumbling or to have already been destroyed. This will be so even though the “shock and awe” military power of the United States could, at least for a time, remain unrivalled. Any idea of a Pax Americana based on that power will have gone. Indeed, the signs of its passing can already be seen in the limited ability of the United States to handle the situation – largely of its own creation - in Iraq and Afghanistan.
When such a collapse does occur, there will be no other power capable of taking the place of the United States. Neither the European Union nor any of its members have demonstrated – nor do they claim - any such capacity. As it appears at the moment, the likely successor may be China but, even if that succession does eventually come to pass, there will be an extremely dangerous interregnum in which there could be not only widespread economic and social turmoil, but also a high risk of armed conflict, extending possibly to war among the great or major powers. The only way out of this potential catastrophe – if indeed there now is one - is to re-evaluate mainstream economic policies of the last thirty and especially the last twenty years, and to revert to policies nearer the American tradition. Essentially, these policies will be based on achieving economic growth and employment through domestic fixed-capital investment, high real productivity and production.
How does this suggest we should "deal with the rise of China"?
So far as Australia is concerned, we must note, first of all, that Australian economic policies have shadowed American policies in the long drift to disaster since 1969. Australia's use of interest-rate policies that stimulate or allow and then collapse asset-price inflation while intensifying consumer-price inflation, has been as typical in Australia as in the United States. Over time, those policies have been instrumental in shifting inflation from domestic price rises to the external balances. In some ways, Australian trade deficits have been even more chronic and persistent than the American and have often tended to represent an even higher proportion of the Gross National Product. The manufacturing sector has been gutted. The disappearance of so many skilled jobs has weakened the trades unions and destroyed the stable growth and full employment policies that were typical of the period from the end of the Second World War until 1969.
The Australian Government therefore needs, as much as the United States, to reform its own economic and social policies if it is not itself to experience catastrophic collapse. A corollary is that, until it brings itself to acknowledge the shortcomings of its own policies, it is unlikely to exert any pressure on the United States to confront its self-destructive policies and draw back from the political and strategic consequences that those policies entail.
That brings us to the other vital factor in the Australian position: its ANZUS treaty link with the United States. Superficially, that link would appear to have been strengthened even further through the support given by the Australian Government to United States action in Afghanistan and Iraq and the close personal relations apparently formed between President Bush and Prime Minister Howard.
If there has in fact been a proposal by the United States for a “secret” meeting on how to deal with the rise of China and if Australia has said "No", that would seem to conflict with embedded Australian policy on security through close partnership with the United States.
If indeed there has been a "No", it would seem likely that the response derives from causes other than national-security concerns. One might be the robust development of trade relations with China for some years past and the particularly dynamic market in commodities that Australia has now found in China and anticipates as growing strongly in the future. This actual and prospective dynamism follows many years in which commodity markets have been subdued and their revival therefore offers the best chance in a long time for Australia to improve its trading position, enjoy buoyant markets for its products and reduce its external trade and payments deficits. That is especially so in the light of the gutting of the Australian manufacturing sector and the growing tendency, shared with the United States, for off-shoring in the services sector.
Despite the current buoyancy in commodity markets, Australia's trade and payments deficits have persisted and tended even to increase. This has been and continues to be attributable to Australia’s strong consumer market and the encouragement that government policies continue to give to personal consumption. However, rather than weaken, that only reinforces the welcome that Australia has, in effect, been obliged to give to the improvement in demand for a wide range of commodities and for China’s special place in creating and maintaining that demand. A corollary is no doubt a reluctance to give any “offence”, deriving from national-security concerns, to the government of the economy on which we have become so crucially dependent.
Is this really so? Would an understandable trade interest override critical Australian security considerations? Would Australia rather see American capacity to ensure its own security and help guarantee that of Australia weakened than jeopardise markets for its commodity exports in China?
The decline in American capacity in terms of strategic security could introduce Australia to a new and, in many ways, terrifying world, politically and strategically. The interregnum we have referred to above could introduce a period of worldwide and chronic security crisis with special impact on the Asian and Pacific region. If that were to lead eventually to actual replacement of the United States by China as the world’s single superpower, then China would loom to the north of Australia as an economic, political and strategic colossus of a kind that has brought nightmares of many Australians for generations. Australia would be in constant fear of domination in a variety of ways by such a powerful northern neighbour. The threat would be far greater, for example, than that represented by the emergence of Japan in the years before World War Two – and because of whose possible revival, we sought the ANZUS Treaty with the United States after World War Two.
Therefore, the reasonable explanation seems likely to be that the Australian Government does not appreciate the macro trends in the world economic, political and strategic situation and believes that its link with its not completely reliable security “guarantor” will remain at least as reliable in the future as in the past. In other words, the Australian Government is firm in its conviction that the United States is not in decline but in robust growth in power through the economic, political and strategic policies that the United States –and Australia too - continue to pursue.
We cannot be sure of course that any such "secret" meeting as that described in the ABC report has ever been proposed. For the United States to propose such a meeting would be, in diplomatic terms, clumsy and unwise. The suggested participants in the meeting - Britain, Canada, New Zealand, Japan, as well as the United States and Australia - are close partners in a variety of ways and, as Foreign Minister Downer's comment suggests, they can readily consult on almost any issue without making arrangements for a "secret" meeting which, if revealed, might do more harm than good to relations with China and to ways in which the group might "deal with the rise of China."
On the other hand, the Bush Administration has been so clumsy in so many ways that the proposal for a "secret" meeting cannot be regarded as entirely implausible. Whether it is a fact or not, the United States and other countries must at last have begun to think a little more deeply about the implications of "the rise of China" and what they can and should do about it. At least that would suggest some progress in understanding, although any such progress would seem still to be small – and almost unbelievably belated given that the “rise of China” has been going on now for more than twenty years.
On the basis of what has been said above, the first thing that the United States should do in “dealing with the rise of China” is to consider the ways and the extent to which it has, through its own policies, brought about the spectacular "rise" of what looks like an increasingly formidable adversary. Those policies have been self-destructive in economic, political and strategic terms. They have enabled American business and corporate interests to thrive, in the short and medium term, at the longer-term cost of American security, prosperity and social cohesion. On that basis, there is no need for a "secret" or other meeting to "deal with the rise of China" but rather a need for a more realistic analysis by the Americans of their own economic policies over the last thirty years and the formulation of policies that will reverse the decline of American power and restore those elements which conferred such formidable power on the United States over the period up to 1969.
That will be difficult because current policies have become so deeply embedded. Moreover, new approaches cannot reverse transformations, in China and elsewhere, that have already been provoked. In many ways, those transformations are to be welcomed. They have brought growth and prosperity to large areas and huge populations in Asia and, in harmonious conditions, they promise to bring further and lasting benefits.
The challenge is now to preserve these beneficial transformations while we carry through the more difficult task of correcting the disastrous trends which their creation has brought about in the United States and in other countries which have followed, to a lesser or greater degree, the American lead.
That applies to Australia. It is difficult to see how, in the present political environment in Australia, much can be accomplished to reform and recast our economic policies. That reform and recasting must necessarily be so fundamental that it calls for a reversal of all those economic and social “certainties” with which the political, academic and other classes in Australia have burdened themselves for more than a generation. They are as fixed in their “wrongness” as their ancestors at the onset of the Great Depression were in those terrible years, especially from 1929 to 1932. Then, we were moved out of our destructive policies only by war and the gradual emergence of economic theories that showed some glimmerings of what might be called more common sense than deep intellectual understanding.
We must bear in mind too that the current Australian Opposition is committed to the policies of the last twenty years or so as deeply as the current Government. Indeed, the Labor Governments of the 1980s and 1990s directly and enthusiastically contributed to the economic and social decline that has afflicted and threatens to devastate the Australian society. Therefore, a simple change of government would likely mean only that the wrong policies will continue to be implemented perhaps more or perhaps less “effectively” by a new team.
The way through the wood in the years of the Great Depression was eventually defined not by governments but by people outside government, such as John Maynard Keynes in Britain. In Australia, they were such people as Professor L.F. Giblin and Joseph Benedict Chifley who was to become Treasurer and then Prime Minister in a wartime government. We must look to such people now, essentially perhaps outside the “political classes” and outside the mainstream academic and intellectual circles.
The challenge is not just to devise a rather better way of managing the Australian economy. It is a matter of finding a new way of managing the United States economy and those other economies around the world on whose stability and prosperity we – all of us - mutually depend. Even that however is far from all that is at stake. Not only economic stability but social, political and strategic stability, in the Asian and Pacific region and around the world, will ultimately depend on whether we can so rethink and reform our economic policies as to get safely through the years – even perhaps the months – immediately ahead.
Whether we are chatting formally or informally, at a “secret” or a public meeting, that is “How to deal with the rise of China”; and, at the same time, preserve our peaceful and cooperative relations with the United States, China and others involved in promoting peaceful change in a peaceful world.

James Cumes
http://www.authorsden.com/jameswcumes

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