Earlier this year, I wrote a lot about inflation, and whether or not it would occur. I now believe that the dice has been thrown, that there’s no turning back: there will be large-scale inflation soon enough. The reason: the U.S. has spent almost $12 Trillion in an attempt to re-inflate the economy artificially.
To put it bluntly, the U.S. economy should no longer be described as being on a “sugar rush”. A more accurate analogy would be a cocaine high. What else could account for a 60% surge in stocks while the real unemployment rate is 20%?
Related to this is the U.S. dollar. Inflation hurts the dollar, but that’s far from the whole story. The dollar’s future as the world’s reserve currency is at stake. If everyone who holds dollars or dollar-related assets abroad starts thinking that these dollars will be worth a lot less in the near future, there will be no alternative to a currency crisis.
The fact that the U.S. has the world’s reserve currency enables it to spend far more than it makes. As I have mentioned before, this is the reason why a lot of economists, and especially American economists, are of the mindset that macro-economic models don’t apply to the U.S.. I think there’s some truth to that, because if you don’t HAVE TO ever pay back your loans, you don’t really have to worry about them. However, what happens on the day that you have to start paying?
Some prominent economists, most notably Paul Krugman, are currently claiming that a weak dollar is good for the U.S.. This will help U.S. exports, the theory goes. Also, according to Krugman, the U.S. needs to spend money on stimulus to get the economy going again, in other words through Keynesian spending.
Krugman does not address the potential of the dollar losing its position as the world’s reserve currency, but instead focuses his analysis on the short-term perspective of fighting the crisis and unemployment at all costs. What he does not realize is how real of a danger this is, but I’m sure he realizes the consequences if this were to actually happen. That’s probably why he’s not talking about it.
I believe that it actually wouldn’t take that much for the dollar to lose its position right now. Under the surface, many important international economic players have been discussing replacing the dollar with something else. These players include both wishful thinkers and those who would actually be in financial danger in the short term. If a few of these players were to move away from the dollar, it might set off a chain reaction that could crush the currency.
First this spring, people like Vladimir Putin and Hugo Chavez started talking about the need for replacing the dollar, while barely being able to hide their excitement.
Second, shortly after that, the IMF started dusting off the old idea of international drawing rights, or a basket of currencies. This debate was also helped forward by Joseph Stiglitz and Simon Johnson, both formerly connected to the World Bank and the IMF.
Third, and this is one of the most important ones, China started voicing concerns about the dollar. This time, Geithner had to go to China and give a speech about how great the dollar was doing. China buys a third of U.S. debt on the international market.
Fourth, and this one might turn out to be very important too, Japan elected a new non-conservative government for the first time ever. Japan buys about the same amount of U.S. debt as China does. One of the basic premises of the new Japanese government was that it would stop trying to be the U.S.’s lap dog. We’ll see how that goes, but I don’t think we can expect to see Japan follow Geithner’s every whim.
Fifth, rumor has it that the Arab Gulf states want to get rid of the dollar too. Their incomes are down by more than half since the beginning of the crisis, and they’re getting a little desperate. For the dollar to drop drastically in addition would be disastrous for them.
All these economic players are not dumb, they understand, in contrast to people like Krugman, that there are some very real dangers connected to owning dollars at the present time. They may run the risk of losing their savings and day-to-day incomes at the same time.
The number one question then becomes: Why does the world need the dollar?
The dollar was instituted as the world’s reserve currency at a time when the U.S. was a world leader in production as well as consumption. This meant that the dollar was both “as safe as houses” and “as good as gold”. An advanced economy with a competitive industry would be less likely to resort to irresponsible fiscal practices, and an insatiable, highly materialistic American consumer could keep the smoke in the chimneys in factories around the world. In other words, the U.S. was the economic engine of the world, and that’s why it made sense to use the dollar as the reserve currency.
However, the U.S. is not in the same position either in terms of production or consumption, and definitely not in terms of fiscal responsibility. The American manufacturing industry is not competitive, and the American service industry turned out to be smoke and mirrors on Wall Street. There is no way that the American consumer is going to get back to spending the way they used to, because it was all built on credit.
I believe that there is a shift happening in the world economy right now. In terms of the future developments of the balance of power between the big three blocks, Asia, the EU and the U.S., this is how I think about it:
It is clear to see that China will only continue to increase both its sophistication and volume of trade. The recent crisis has only strengthened the country’s position. The U.S. is no longer China’s biggest trading partner, the EU is. Japan is also increasing trade with China, and so is India.
It seems that the EU will continue to do what it is currently doing: to be competitive in very advanced industries, while not growing or shrinking much either way. I’m basing this on a continued focus on industrial policies, a good access to education and in general a less volatile society.
With respect to the U.S., it is very hard to see what the country has going for it. Where is the growth going to come? What is going to improve? The country has no industrial policy, and will not get one soon. One year at an American University costs as much as a Mercedes E-Class. The political system is deadlocked by lobbyists who bribe individual politicians. Industry resistance to innovation digs the grave of American manufacturing. More importantly: the country is bankrupt.
I believe that the world economy will shift, and that the dependence on the U.S. will have to be lowered. This will mean more power for Asia, and a tighter relationship to that continent on the part of both the U.S. and the EU. This will also mean that the dollar will most likely be given up as the world’s reserve currency.
What will this mean for the U.S.? Simply put: a drastic reduction in material prosperity across the board.
Moreover, I advise that the winner-takes-all voting system should be destroyed.