I hate to admit it, but it's true. I read an article today titled "World economy on thin ice - U.N." with the accompanying subtitle "The United Nations blames dire situation on the decline of the U.S. housing and financial sectors." What is the significance of this, and how accurate is the assertion?
To answer these questions, one must go back at least as far as to the 1944 Bretton Woods conference, at which the US was granted the status of holding the world's reserve currency. As mentioned in a previous posting on this blog, the reserve currency status essentially translated into the fact that foreign currencies would be linked, or "pegged," to the US dollar; commodities such as oil and gold would be priced in dollars; and these dollars would be redeemable in gold if a country so chose to make the conversion. An advantage of this system for the US has been the fact that we are allowed to maintain a "current account deficit" -- mainly, carry a trade imbalance by importing far more goods than we export. (In even more simplified terms, consuming much more than producing.)
In the 1960's, the US underwent a significant increase in federal spending, as Presidents Kennedy, Johnson, and Nixon indulged in "guns and butter" programs that ratcheted up the federal budget deficit. These expenditures included the Vietnam War, Medicare and Medicaid, various other Great Society initiatives under LBJ, and so on and so forth. With all this spending, and not enough economic output to match it, the US went to the tried and true method of simply printing the needed currency.
This decision did not sit well with foreign countries that, by way of the Bretton Woods system, were forced to accept US dollars as their reserves. You see, with all of the money-printing occurring in the '60's, the dollar was steadily being devalued, thus decreasing the value of foreign countries' monetary reserves. It was then that many of these countries approached the US government and demanded redemption of their US dollars in gold. The problem was, there wasn't enough gold in our possession to redeem all of our creditors.
So how did we solve this dilemma? Simple: President Nixon simply decoupled the dollar from the gold standard in 1971. This action amounted to the US government telling members of the world economy "trust us" when it comes to our currency; in other words, trust us that our word is good when we say the currency is viable, and can be accepted as a legitimate form of payment with the backing of the full faith and credit of the US and its Treasury.
Fast forwarding about 35 years, and here we are with foreign countries stockpiling US dollars in their reserves, with little choice but to trust the US that our economy and our currency are healthy and able to withstand the recent perturbations in our financial system. As the article pointed out, these perturbations include the overall credit and housing crises that have wracked our economy. Both of these crises can be traced back to the monetary policy of the US Treasury and the Fed, due to the expansion of credit and the money supply, and the resulting debasement of the currency as inflation naturally follows.
Or is the only choice to trust us? The dollar as reserve currency is not carved in stone, and already, entities like the economic Group of 7 (G-7) have hinted that extreme weakness in the dollar could lead to significant changes in the global economic system. Change such as de-emphasizing the dollar as reserve currency, and possibly switching to another, stronger alternative. If this becomes the case, the consequences for our economy will be dire in comparison to what we are experiencing today. The reason being, once other countries are no longer obligated to accept the dollar in their economic transactions, there will be little reason to accept it at all, as it will be worth so little these countries will have lost any incentive to deal economically with the US. And why should they? We hardly produce anything anymore, and our massive appetite for consumption could gradually be replaced by other emerging economies with more robust currencies and trading potential. It will be at that point that the standard of living for Americans will plummet, and our economy will resemble those of third world nations. Then we will understand what the term "Great Depression" really means.
Friday, May 16, 2008
Saturday, May 3, 2008
Al Qaeda Understands the Gravity of Our Economic Situation
Now that I have your attention...
I'm posting an excerpt from the 2004 book "Imperial Hubris: Why the West is Losing the War on Terror," by Michael Scheuer. The book is an incisive examination of US foreign policy in the Middle East, but that fact aside, and given this blog focuses on economic issues, I want to hone in on a 2002 quote by al Qaeda's Abu-Ubayd al-Qurashi as provided by Scheuer. This quote appeared in the al Qaeda publication Al-Ansar and augurs prophetically as our economy teeters in 2008:
"On the other hand, we find that God has graciously enabled the mujahedin to understand the [American] enemy's essence and nature, and indeed his center of gravity. A conviction has formed among the mujahedin that American public opinion is not the center of gravity in America....This time it is clearly apparent that the American economy is the American center of gravity. This is what Shaykh Usama bin Ladin has said quite explicitly. Supporting this penetrating strategic view is that the Disunited States of America are a mixture of nationalities, ethnic groups, and races united only by the 'American Dream,' or, to put it more correctly, worship of the dollar, which they openly call 'the Almighty Dollar.' May God be exalted greatly above what they say! Furthermore, the entire American war effort is based on pumping enormous wealth at all times, money being, as has been said, the sinew of war."
Food for thought...how does America sustain a war that costs anywhere from approximately $500 billion to $1 trillion a year, while simultaneously meeting enormous fiscal social obligations to its populace and funding a gargantuan bureaucracy...while producing and saving little if anything?
I'm posting an excerpt from the 2004 book "Imperial Hubris: Why the West is Losing the War on Terror," by Michael Scheuer. The book is an incisive examination of US foreign policy in the Middle East, but that fact aside, and given this blog focuses on economic issues, I want to hone in on a 2002 quote by al Qaeda's Abu-Ubayd al-Qurashi as provided by Scheuer. This quote appeared in the al Qaeda publication Al-Ansar and augurs prophetically as our economy teeters in 2008:
"On the other hand, we find that God has graciously enabled the mujahedin to understand the [American] enemy's essence and nature, and indeed his center of gravity. A conviction has formed among the mujahedin that American public opinion is not the center of gravity in America....This time it is clearly apparent that the American economy is the American center of gravity. This is what Shaykh Usama bin Ladin has said quite explicitly. Supporting this penetrating strategic view is that the Disunited States of America are a mixture of nationalities, ethnic groups, and races united only by the 'American Dream,' or, to put it more correctly, worship of the dollar, which they openly call 'the Almighty Dollar.' May God be exalted greatly above what they say! Furthermore, the entire American war effort is based on pumping enormous wealth at all times, money being, as has been said, the sinew of war."
Food for thought...how does America sustain a war that costs anywhere from approximately $500 billion to $1 trillion a year, while simultaneously meeting enormous fiscal social obligations to its populace and funding a gargantuan bureaucracy...while producing and saving little if anything?
Fire Up the Printing Presses
So this past week the government distributed tax rebate checks to the populace early, in order to attempt to jump start the ailing economy. The checks, part of an "economic stimulus plan," have made the whole of our citizenry unwitting participants in their own economic distress.
Before examining that statement closer, let's begin by firmly establishing the fact that any classical economist must surely be rolling over in his or her grave right now at the notion that an economy can be stimulated by the printing of fiat (paper-not-backed-by-anything-but-forced-to-be-accepted-by-government-decree) currency, thus adding to already staggeringly high levels of inflation. This illusion of wealth has consistently proven to be the downfall of once-vibrant economies and nations, yet our country remains in a halcyon state of economic perception.
Let's discuss inflation for a moment. Inflation is good...if you're one of the first entities to receive the freshly printed paper currency. This is because you have the transient opportunity to spend or invest that money before the effects of the inflation have seeped into the economy and prices have subsequently risen. A very good analogy here -- albeit one borrowed liberally from "The Creature from Jekyll Island" -- would be manifest in a game of Monopoly. Assume there were two participants in the game, and one of the participants opened a second Monopoly board game and took all the money from it for his own. By doing this he would immediately have magnified his purchasing and investing power. It's likely he could buy up all the real estate on the board before the other participant even had a chance to compete. Now consider what would result if both participants got their hands on the money simultaneously. Given the theoretical perfect timing of this event, all of the prices on the board for real estate and luxury items and whatnot would rise in unison. Thus, the extra money would have allowed for nothing but the payment of higher prices for the desired assets.
The problem with the second part of the analogy is that, in America, the average taxpayer doesn't even get that much of a break. You see, you and I are the last to receive the money on the financial totem pole in the form of our paychecks, and therefore, we are indeed left with the risen prices. But unlike the Monopoly analogy, we do not have the benefit of receiving a commensurate increase in wages to cope with the inflation. So each year, prices rise, goods become more expensive, and our wages fall further and further behind the price curve. Eventually, we turn to credit to be able to afford the things we want in life. When was the last time your friends, neighbors, or family members bought their car in cash? Or their plasma TV? New furniture? Vacation? Anything? The reality is, if you're anywhere near the median income in America, you buy necessities with your paycheck and finance almost everything else by loan or credit card. And now, with the latest financial debacle left steaming on middle America's doorstep, even the necessities like food and gas are rapidly cutting deeper and deeper into household budgets.
I'm sure by now most of you have seen the video clips on TV of US Treasury checks rolling hot off the printing presses in voluminous sheets. Those who save their check will soon regret it, as spiraling inflation will make the saved money increasingly worthless. The 2% the bank is giving you in your savings account will hardly make a dent in the 8-15+% inflation we're experiencing. Sure, the economic data like the Consumer Price Index (CPI) -- the official government barometer of inflation -- tells you that inflation is only 2-3%. (Isn't it amazing how the CPI is always either 2 or 3% every month? It hardly ever changes...in the context of a $14 trillion economy, shouldn't it fluctuate just a little bit?) The problem with this statistic is that it does not include the three things you care most about: food, gas, and the cost of your home. Interestingly enough, home prices died a recent death vis-a-vis the CPI...by 2006 they were going so high so fast the government just excised them from the CPI lest it end up skyrocketing. (They replaced them with rent prices.) Presto!...a little accounting adjustment here and there and we're right back at...2 to 3%.
Hopefully I've talked you out of saving the welfare check you just received. (If I haven't, save yourself the cost of an inflated postage stamp for mail-in deposits and just stuff the check under your mattress...same deal.) No, these checks are more likely to be spent by consumers on everything from the necessities to luxury items. And you might ask why I said earlier that these consumers are unwittingly participating in their own economic distress? The government printed this money with nothing of value backing it; therefore, the paper money will circulate into the economy, eventually raising prices and leaving cash-strapped consumers shaking their heads at the gas pumps and grocery aisles in 6 months, wondering how gas and food prices just jumped another 20%. The consumer has become the method of delivery for the inflation in this scenario: the government printed the worthless money, you spend it and inject it into the money supply.
Lastly, as if the above weren't bad enough, most of the items Americans will be buying with their checks at Wal-mart, electronics stores, and so forth are made in China or by other burgeoning economies. So not only will taxpayers be facilitating higher prices to be paid at a later date, but they will also aid in the enrichment of foreign countries. This is the reality within the US economy, one that is based 70% on consumer spending with a hollowed-out production base that has largely relocated to distant shores.
Before examining that statement closer, let's begin by firmly establishing the fact that any classical economist must surely be rolling over in his or her grave right now at the notion that an economy can be stimulated by the printing of fiat (paper-not-backed-by-anything-but-forced-to-be-accepted-by-government-decree) currency, thus adding to already staggeringly high levels of inflation. This illusion of wealth has consistently proven to be the downfall of once-vibrant economies and nations, yet our country remains in a halcyon state of economic perception.
Let's discuss inflation for a moment. Inflation is good...if you're one of the first entities to receive the freshly printed paper currency. This is because you have the transient opportunity to spend or invest that money before the effects of the inflation have seeped into the economy and prices have subsequently risen. A very good analogy here -- albeit one borrowed liberally from "The Creature from Jekyll Island" -- would be manifest in a game of Monopoly. Assume there were two participants in the game, and one of the participants opened a second Monopoly board game and took all the money from it for his own. By doing this he would immediately have magnified his purchasing and investing power. It's likely he could buy up all the real estate on the board before the other participant even had a chance to compete. Now consider what would result if both participants got their hands on the money simultaneously. Given the theoretical perfect timing of this event, all of the prices on the board for real estate and luxury items and whatnot would rise in unison. Thus, the extra money would have allowed for nothing but the payment of higher prices for the desired assets.
The problem with the second part of the analogy is that, in America, the average taxpayer doesn't even get that much of a break. You see, you and I are the last to receive the money on the financial totem pole in the form of our paychecks, and therefore, we are indeed left with the risen prices. But unlike the Monopoly analogy, we do not have the benefit of receiving a commensurate increase in wages to cope with the inflation. So each year, prices rise, goods become more expensive, and our wages fall further and further behind the price curve. Eventually, we turn to credit to be able to afford the things we want in life. When was the last time your friends, neighbors, or family members bought their car in cash? Or their plasma TV? New furniture? Vacation? Anything? The reality is, if you're anywhere near the median income in America, you buy necessities with your paycheck and finance almost everything else by loan or credit card. And now, with the latest financial debacle left steaming on middle America's doorstep, even the necessities like food and gas are rapidly cutting deeper and deeper into household budgets.
I'm sure by now most of you have seen the video clips on TV of US Treasury checks rolling hot off the printing presses in voluminous sheets. Those who save their check will soon regret it, as spiraling inflation will make the saved money increasingly worthless. The 2% the bank is giving you in your savings account will hardly make a dent in the 8-15+% inflation we're experiencing. Sure, the economic data like the Consumer Price Index (CPI) -- the official government barometer of inflation -- tells you that inflation is only 2-3%. (Isn't it amazing how the CPI is always either 2 or 3% every month? It hardly ever changes...in the context of a $14 trillion economy, shouldn't it fluctuate just a little bit?) The problem with this statistic is that it does not include the three things you care most about: food, gas, and the cost of your home. Interestingly enough, home prices died a recent death vis-a-vis the CPI...by 2006 they were going so high so fast the government just excised them from the CPI lest it end up skyrocketing. (They replaced them with rent prices.) Presto!...a little accounting adjustment here and there and we're right back at...2 to 3%.
Hopefully I've talked you out of saving the welfare check you just received. (If I haven't, save yourself the cost of an inflated postage stamp for mail-in deposits and just stuff the check under your mattress...same deal.) No, these checks are more likely to be spent by consumers on everything from the necessities to luxury items. And you might ask why I said earlier that these consumers are unwittingly participating in their own economic distress? The government printed this money with nothing of value backing it; therefore, the paper money will circulate into the economy, eventually raising prices and leaving cash-strapped consumers shaking their heads at the gas pumps and grocery aisles in 6 months, wondering how gas and food prices just jumped another 20%. The consumer has become the method of delivery for the inflation in this scenario: the government printed the worthless money, you spend it and inject it into the money supply.
Lastly, as if the above weren't bad enough, most of the items Americans will be buying with their checks at Wal-mart, electronics stores, and so forth are made in China or by other burgeoning economies. So not only will taxpayers be facilitating higher prices to be paid at a later date, but they will also aid in the enrichment of foreign countries. This is the reality within the US economy, one that is based 70% on consumer spending with a hollowed-out production base that has largely relocated to distant shores.
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