Tag Archives: Landes

Deja Vu – Part 3, Lessons from the US economy,1979-1985

26 Dec

In my last blog entry I mentioned three US currency policy decisions over the years 1979 to 1995 (https://ravendragon.wordpress.com/2010/12/16/deja-vu-%E2%80%93-part-2-lessons-from-the-us-economy1973-1993/). Each decision was a response to the decreasing returns in US industry. In this blog entry I will outline each of these decisions in greater detail.

As mentioned the 70’s saw Nixon embark on a policy of federal deficits and extreme monetary ease. One aim of the policy was to lower the value of the dollar in order to sustain the competitive position of US manufacturing. This policy helped the US ride the 1974-5 oil crisis. On the one hand the policy was a great success vis-à-vis US manufacturing. Nonetheless, such extreme Keynesian measures lead to over production and over capacity. In addition, it prevented the much needed exit (what Brenner calls “the medicine of shakeout”) of many lower return companies from the market place. The upshot was an overall continued decrease in returns, which eventually dis-incentivised manufacturers from increasing output. With massive deficits (i.e. increased money supply), and little to no increase in output, the US began to suffer inflation. Simultaneously and related, massive deficits led to run on the USD, threatening its status as a global reserve currency.

Before we see how the US tackled this issue, let’s pause and understand that this dynamic sounds rather similar to the US today. Today the US is running a policy of extreme monetary ease, MASSIVE federal deficits, and has relatively uncompetitive manufacturing compared with countries like China. It led to inflation in the late 70’s. The risks of inflation in the coming years ia fairly apparent wouldn’t you say? In addition I believe today’s policy is aimed at helping US exporters/manufacturers, whether it’s explicitly stated or not.

In 1979/1980 the US enacted the Reagan-Thatcher Monetarist revolution, which reduced corporate taxes, increased unemployment, and removed controls on capital. The aim of the policy was to provide the US economy with a serious dose of “the medicine of shakeout” and purge the US economy of the low profit manufacturing firms that had become an ill of previous Keynesian expansionism, thereby controlling inflation and the currency. However, this time the pendulum had swung too far the other way. Record interest rates and the associated rising USD almost caused a US crash with the threat of contagion.

How did the US (and the global economy) get out of this situation? The government started the Reagan military buildup – purely Keynesian in nature, though most right-wingers would feel queasy to admit it! In addition Reagan enacted a program of huge tax cuts for the wealthy. These 2 policies combined did offset the government’s tight monetarist policies, yet they equally reopened US trade and current account deficits. The deficits required to pay for the military buildup were in fact larger than the deficits in the late 70’s. However, the combination of high US interest rates ensured there was no run on the dollar this time. In fact the currency (aided by a push of capital flows from the Japanese) appreciated considerably.

The Reaganites liked the combination of high interest rates and low inflation. Why? It played to the theme on increased the strength of US financing capital. However, it caused severe pain to US manufacturing. Under extreme pressure from congress, the Whitehouse was forced into a U-turn.

On 22 September 1985 the G5 met to sign the Plaza accords, under which the G5 powers agreed (under US pressure) to relieve the stress on US manufacturing by reducing the USD exchange rate. Over the coming few years the US administration passed a number of pieces of protectionist legislation (including the Omnibus Trade and Competition Act of 1985, and the Structural Impediments Act of 1989). Whilst simultaneously closing home markets to foreign imports the US was forcing its exports and FDI onto overseas markets.

So we see a continued US policy of not dealing with the real structural issue of lowering returns and non-competitiveness. Ford, Nixon, Carter, and even Reagan continued a policy of using the US currency as a band aid to be placed over a brewing problem. We know that since the late 80’s the US has continued in the same vein as we are facing similar structural issues today, and similar short-term currency play and Keynesian remedies are being used by the Feb and President Obama’s administration. As I’ve said before, this pattern of behavior is not a good sign that the US will deal with its structural issues. I will stress again that I am not against a band aid, as long as a real medicine is given in combination.

In the next blog entry I will hope to conclude my economic history lesson. But this is a blog about China, so I will be putting this history in the context of Chinese production and trade. In a nutshell I can already see that the US’s failure to deal with the issue of its lowering returns is a boon for the Chinese, in both the short and long-term future. More next time!

See you all in 2011.

Happy New Year

再见
新年快乐
乔恩 (https://ravendragon.wordpress.com/about/)

 

 

Deja Vu – Part 2, Lessons from the US economy,1973-1993

16 Dec

In my last blog entry I outlined the period of 1950 to 1973 as one of uneven business development between the US and its trading partners Japan and Germany (https://ravendragon.wordpress.com/2010/12/13/deja-vu-part-1-lesson-from-the-us-economy1950-1973/). It was this uneven development, I argued, that precipitated an oversupply of productivity that led to a general decline in returns over 1965-1973. I would like to contend that over the ensuing 20 years (1973-1993), oversupply was in fact exacerbated by both governments and businesses alike.

Theoretically, the market lives under an evolutionary arms race – survival of the fittest. In other words, when profits shrink, it should present a barrier to new market entrants, and ‘kill’ those companies with a cost of capital higher than their returns. However, in reality such spontaneous mechanisms do not always exist. Higher cost incumbents resist leaving the market, as their assets (both tangible and intangible) cannot switch lines. Instead, high cost producers tend to invest further capital in improving their productivity. This in turn creates an impetus for higher return companies to follow suit, which creates a cycle of lower profits/returns. Put simply, there’s no spontaneous mechanism for companies to exit the market!

On the other side, a fall in profitability precipitates the search for lower production costs. Countries and regions with lower labor costs are thereby incentivized to join the production band wagon. Over the past 2 decades Asian economies (especially China) made rapid inroads into the manufactured goods market. Yet such new entrants simply push down the profitability and returns of the industry even further. Put simply, as returns fall, there’s no spontaneous mechanism to prevent new market participants!

Over the years 1973 to 1993 world governments continued to deal with the issue of reduced returns with currency revaluations, much as we saw in my last blog entry. In 1979-80 the world witnessed the Reagan-Thatcher Monetarist response, which reversed the devaluation of the USD made during the 70’s. The 1985 Plaza accord resumed a policy of devaluing the dollar. In 1995, the US government once again reversed its policy of devaluation.

But before we get into the details, remember that the purpose of this series of blog entries is not a history lesson or political polemic, but to try and see parallels with today’s global economic, and assess the likely response of our governments over the coming years.

Without yet delving into details, I can already see that despite a serious structural issue leading to reduced returns, world governments did not contend with the core issues. Instead, they perused short-term policies aimed at plugging the hole, mainly in the guise of currency games.

This does not bode well as a precedent for dealing with today’s issues: the US “balance sheet” and the trade imbalance between China and the US.

Let’s not get ahead of ourselves though. In my next entry I will discuss what led to those three currency policies over 1973 to 1993, and the impact of each of those policies. Armed with that information we will be much better armed to try and shed some light on the coming few years.

 

Note – It’s been a while since I wrote in my series on building a core China portfolio (https://ravendragon.wordpress.com/category/building-a-core-china-portfolio/), but I hope to return to it sometime in the new-year.

Zai Jian

Deja Vu – Part 1, Lessons from the US economy,1950-1973

13 Dec

I remember a conversation with a colleague in the office kitchen one Monday afternoon. The conversation occurred during my first banking job over a decade ago. I asked “How was your weekend?” to which my colleague replied, “My boyfriend took me to the Imperial War Museum over the weekend. They had something on about Musso, Musso, Musso… some Italian bloke.” “Mussolini?” I interjected, “Yes…” she said “…that’s the one. I was never one for history. Don’t understand the point in it. It’s all dead and gone now”. We had a brief discussion about the importance of history giving identity, and the opportunity to learn from trends and mistakes. At the time it struck me that this lady had just as many votes as me in a general election (only kidding!) Nonetheless, over 10 years on I decided to take my own advice and use history to understand some of the dynamics presently at work in global economics, and to use this information to help understand what is likely to happen in the coming years.

Analysts, the press, and even my own blog have been dealing with the issues of the trade imbalance between China and the US, the value of the Yuan vs. the USD (and the potential for a currency war), and the aftermath of the recent credit bubble/crisis. Yet, none of these issues are new. As recently as the past 50 years global trade and economics has played out the same script. The same questions have been asked in the lifetimes of people I sit amongst, albeit between the US on one side, and Germany and Japan on the other. I’ve not seen these precedents referred to by many experts, or by industry colleagues, so the first lesson I’ve learned is that we are very quick to forget, which means are most likely damned to repeat. But let’s not get philosophical yet! Let’s first outline the history.

The “West” enjoyed a long period of boom over the 50’s and most of the 60’s. The boom itself, however, was rooted in a fairly uneven development between the US, Japan, and Germany. Through a combination of “importing” American high-productivity technological advances and domestic low cost elastic labor supplies, Germany and Japan were not only able to catch up with the US in terms of growth, investment and returns but often surpass the superpower.

Until the mid 60’s this was all in the US’s favor. Firstly, it provided new markets for US capital. Secondly, it provided new markets for US goods as Japanese and German consumers prospered (note – at the time it was relatively harder for Japanese and German goods to enter the US market). And thirdly, it was a key component in fighting the cold war.

By 1965 things began to change. The economic development of Japan and Germany presented real competition to the US. Their growth was beginning to become a zero-sum-game (or even negative sum game) from the perspective of the US. During the years 1965-73 Japanese and German exports began to interrupt the easy flow of US goods onto global markets. In addition, their lower cost goods (of equal quality) were increasingly making their way into the US market. The impact was to decrease the return on capital in the US.

The US responded by lowering prices (i.e. lowering their returns to the cost of capital), capping wage growth, and updating plants and machinery in an attempt to produce more efficiently. However, its greatest weapon was the devaluation of the dollar.

Between 1969 and 1973 the dollar devalued by around 50% against the German Mark, and between 1971 and 1973 by about 30% against the Japanese Yen. How?

In the early 70’s the US followed a combined policy of lower interest rates, a policy of easy credit, and eventually the total abandonment of fixed currency rates in favor of a free floating currency by 1973. As the US government pursued a policy of fiscal stimulus in 1970, interest rates fell, and the Fed abetted with a policy of easy credit, I am struck by Nixon’s comment at the time that “We are all Keynesians now!”

Granted the story is a little more complex in terms of which parts of policy were a priori thought out, and which parts were responses. The balance of payments, impacts on the stocks markets, and inflation in Japan and Germany cannot be ignored. Nonetheless, the general picture of 8 years of economic struggle (to borrow a phrase from David S Landes) over 1965-1973, the reduction in the competitive position of US returns, and the Keynesian and currency devaluation responses are clear.

The devaluation of the dollar led to a turnaround in US manufacturing sector that restrained wage growth and productivity growth had blatantly been unable to achieve.  Profits, investments and productivity returned to US manufacturing, and the trade imbalances with Japan and Germany closed. The impact in the Japan and Germany was the opposite, as they sought to keep sales by suffering lower returns.

I will return with a second installment of this story in the coming weeks, and a closer of analysis of the meaning of these events for today’s economy and global trade. Nonetheless I want to end with a couple of points to consider already:

  • We don’t need all of the subsequent history to begin to see parallels with the state of the US economy in 2010 and the early 70’s, as well as parallels between modern US and China relations, and historical relations between the US and its trading partners in the 60’s.
  • I want to leave you with an additional question. Why did the capitalist system result in such a decline in US productivity and returns over the period we’ve discussed? Is the capitalist dynamic insufficient when it comes to ensuring the rejection of waste and barring the entrant of excess? We will return to this issue as well.