FF: Oregon Steel
Brazil, Russia, India and China have been the centerpiece of global growth over the last five years. Even among lesser known nations, stock markets have risen 300-400% while their GDP’s have mushroomed 8-11% annually. I can imagine one of these countries powering along because of special circumstances, but when the entire globe is driving forward at 80 mph, we might want to pull over and ask: who owns the gas?
The BRIC nations have mediocre banking systems that could not possibly fuel this growth. You discover, however, that the U.S., Japan, E.U. and U.K. have strong banking systems. So when the latter group drops interest rates to 0-1% to boost its own economic activity, the former group experiences a boom-boom growth spurt.
Our lowering of interest rates has fueled yet another problem: an enormous imbalance in the Balance of Payments. At the end of 2005, net investment equaled -$2.693 trillion. This refers to the financial account, which has increased substantially over 2006. If you study the Balance of Payments, you learn that the financial account should revolve around zero. So you see that the purchase of Oregon Steel by the Russian company Evraz Group is simply another example of foreign purchases of U.S. investments that have pulled way away from healthy fundamentals. The build-up of U.S. Treasuries in the hands of foreign investors is another.
The magic of economics is that currencies shift to bring balance back whenever an imbalance exists. Unfortunately, central banks around the world have tried to suspend the dollar allowing these imbalances to worsen. Under a traditional gold standard, this type of manipulation would be quickly halted since our reserves would shrink, our money supply would contract and the BRIC nations wouldn’t have a pot to . . . well, sell to us.
Milton Friedman’s passing is sad, but so are his economic theories that govern our monetary policy. The short and simple version: our money supply should equal GDP. So whenever we run a trade deficit, our money supply is so large that it not only covers our GDP, but it covers the GDP of other countries. Not only that, but it provides these countries with the money to purchase our assets leading to a hugh surplus in the financial account. Evraz Group, in a roundabout way, is buying Oregon Steel with money that originated over the last several years at Oregon banks. Thanks fiat money! Thanks Milton!
Eventually, the U.S. outflow of money for imports and the foreign inflow of money for investments will reverse because of currency shifts. It has to happen! When this happens (1) foreign assets become easier to buy, which is good because we can perhaps buy Evraz Group, but (2) this type of correction is normally marked by high inflation as imports become more expensive, (3) dollar-denominated commodities like gasoline are pressured upwards and (4) interest rates will correct upwards as foreign investors sell off U.S. assets. A Federal Reserve paper estimates that interest rates have been 1.5% lower because of these imbalances. What happens when they go 1.5% higher as they correct?
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December 8, 2006 |
Jenson Hagen | Comments (18 so far)
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Comments
Posted by: Zak J. | Dec 8, 2006 11:43:21 AM
There's an excellent related essay by Robert Samuelson on this topic in today's Washington Post.
Posted by: Scott | Dec 8, 2006 1:17:16 PM
Dave,
Didn't you mean Gov't spending and budgets have been mis-managed?
The economy isn't "managed" by any one person or group. Taking a look at the Dow Jones above 12,000 and the unemmployment rates at 4.5% demonstrate the economy is working quite well. The gov't may influence how the economy solves problems, but it doesn't control the flow of goods and services. The profit motive takes care of that whether it is part of the taxed economy, or black market.
It is quite interesting the Jenson references Milton Friedman (who fervently believed that the Gov't should let markets solve things and not force everything through power hungry Republicans and Democrats) on a blog-site that is frequented by readers who are trying to frantically expand the welfare/union state.
Posted by: peter | Dec 8, 2006 1:36:10 PM
Interesting piece, are you an economist? I do have one qibble, the IMF shows that Brazil's GDP/growth per capita has averages around 1% annually for the last 10 years.
The highest annual real GDP growth I see is 5.1% for 2005. The only number that is even close to your 8-11% is PPP (purchasing power parity), but only for one year (2005). What metric are you using?
Also, are you really advocating a return to the gold standard? Though Uncle Ben (Bernanke) has spoke of inflation targeting (which is a sort of soft monetarism, i guess), we haven't seen our monetary policy reflect Friedman's ideas since paul volker stepped down after bringing the american economy (along with inflation, and jimmy carter) to a screeching halt. alan greenspan (and by all indications, bernanke) have governed the fed as conservative inflationists: flat prices, wages, and benefits for the working stiffs and asset inflation for the rich.
Posted by: Dave Porter | Dec 8, 2006 6:56:53 PM
Scott,
I'll yield to your point on mismanagement - it's the government that's the main culprit. Mismanagement by a company loses them money and maybe puts the company out of business. It is bad for the stockholders, employees and their communities, but need not hurt the overall economy much. Only a few very big companies can make bad business decisions, I'm thinking of the auto industry for example, that affect our national economy.
But are you dreaming of getting governments out of the rule making roles they play in global economy? Or in our domestic economy? Do you think there can be a "free market" without governments making and enforcing rules?
Peter,
Do you have proposed monetary policies that will avoid the 1.5% rise in interest rate ( a correction from international imbalances in Jenson original question) and avoid other negative side effects? I think the US is in a serious dilemma. The current situation cannot continue forever. None of the remedies are painless. A few could be disasters. Do you have a preference?
Zak,
I like the Samuelson article. But he is not reassuring either: "It sounds easy, but, especially for major exporters, the needed changes go well beyond twisting a few simple economic dials. They involve altering government policies, industrial structures and even popular attitudes. It's unclear whether these changes can be made. If not, a weak dollar might herald a weak global economy -- which would be bad for everyone."
Tell me interest rates can rise and it won't trigger Prestowitz's nightmare scenario. Or tell me there something we can do in Oregon to weather this approaching economic storm.
Posted by: Jenson | Dec 8, 2006 7:54:17 PM
If people want to see 2005 GDP rates for all nations.
If people want to learn more about what happens when you have global imbalances such as ours, learn about Bretton Woods. This accord fixed exchange rates and caused Balance of Payment imbalances. Bretton Woods ended in 1971. We had record inflation in the late 70's/early 80's as a result of these imbalances correcting. Now image record inflation combined with record debt levels. I'm not convinced that we won't see a minor depression in this country.
Posted by: Tom Civiletti | Dec 9, 2006 12:09:53 AM
On the topic of the mismanaged economy:
Posted by: Karl Smiley | Dec 9, 2006 10:01:16 AM
Scott,
Taking a look at the Dow Jones above 12,000 and the unemmployment rates at 4.5% demonstrate the economy is working quite well.
Yeah, the economy is great for those who live off "investments". For wofking americans, who are working more to earn less and spending more on necessities to boot, it sucks! Big time.
Posted by: Jenson | Dec 9, 2006 4:02:29 PM
Employment is a lagging indicator. The Federal Reserve has a great graph that shows how employment reached a peak as past recessions began. People in the 1920's experienced low inflation, low unemployment and high stock values. It's hard to understand how the good times can end.
Whatever the case, in good times and in bad, people that live within their means, save and maintain low debt levels will be just fine. It's the ones that have racked up credit card debt, bought homes with no-money-down-interest-only loans and put all their money in stocks that will feel the pain of the boom bust cycle.
Posted by: lin qiao | Dec 9, 2006 7:38:50 PM
Comment to Dave Porter about what's in his report regarding the Chinese language: yes, it is difficult. I've been trying to learn Mandarin for several years (the name I use here is my Chinese name). But I think people tend to focus too much on the exotica, such as the writing system. Also, I find it sort of odd and insulting, frankly, that the rationale offered for making Chinese-language instruction more widely available is all along the lines of "we need Chinese speakers to do business with the Chinese." Consider for comparison: are students of Spanish told to learn that language so the US can do business better with Soanish-speaking countries? Never heard that line when I studied Spanish; rather, I heard how nice it would be to be able to talk to people when I traveled, to appreciate the wonderful Spanish-language literature and poetry.
Posted by: Dave Porter | Dec 9, 2006 8:44:10 PM
reply to lin qiao,
I would agree there are many good reasons to learn a foreign language. To do business with countries that speak that language is just one. To appreciate another culture and and to get a different perspective on ours culture is another. There are many good reasons. But as a public policy issue, China is very significant for our future. China is an enormous and growing market and will be the source of many product and service innnovations. Our proposal is for a business group, the Oregon Business Plan , so business and economic development are stressed. But the fundamental issue is peace and global stability. As we say in the proposal:
"the central strategic and security issue of the 21st century will be the emergence of China as a world power and how the United States and China relate to each other. If these two great powers can get along, many other problems are solvable. If not, nuclear war and societal chaos are not impossible. If we fail to act as boldly as we can-- breaking a few educational, geo-political and funding mindsets—-future generations will stand in wonder at our failure. History sets hard standards and will not be kind to us or to our children if we fail. We in Oregon have an historic opportunity to act on the stage of world history. Few get such an opportunity. With vision, resolution and cooperation, let us seize this opportunity and meet the challenges of the twenty-first century.
Wake up, Oregon, we can develop robust Mandarin programs and send many students to China to study. We can make history and we can increase the chances for peace in the 21st century. We do not need to wait for the federal government to tell us to do it (they won't). We understand the 21st century. We may not like it, but we are up to its challenges.
Would you support the proposal?
Posted by: Mister Tee | Dec 10, 2006 12:10:26 AM
Jenson:
Congratulations on your most intellectually sound post to date. Thank you to Dave Porter for trying to elevate the discussion beyond B/O's traditional Bush-Destroyed-The-Economy-Too piffle.
I disagree with both Jenson's and Porter's worst case scenarios (near term, if not longer): global imbalances are likely to remain so long as the largest purchasers of U.S. Treasury debt are willing to sustain the manipulation of exchange rates (aka "strong dollar policy") which they rely on to support the dollarized global economy.
Imagine the U.S. dollar is just a slightly updated version of the sea shells as monetary unit: so long as everybody is willing to agree on how many sea shells a unit of goods should cost, it really doesn't matter that the beaches are littered with shells. What matters is that everybody agrees there is no alternative to sea shells. Thus far, the major holders of U.S. Treasury debt have been willing to hold (in fact, there purchases have been increasing as of late) U.S. Dollar denominated debt despite the dollar's decline.
Dave Porter's summary of a "flat spin" style unwinding of global confidence in the dollar would benefit nobody (with the possible exception of anarchists and precious metals producers). The mere fact that nobody wants it to happen could actually prevent it from happening. To put it into a political framework: if we think the Chinese can "manage" their domestic economy, why not assume the can manage the international economy too?
Posted by: Dave Porter | Dec 10, 2006 10:04:12 AM
Reply to Mister Tee,
I'll admit to being very confused by all the interrelationships of international economics today. It seems it is never quite clear what affects what. But I would not rely upon a strong dollar for our salvation.
The NY Times today has an article by Daniel Altman titled "As the Dollar Falls, Some Dominoes Don't." . In discussing the dollar's 18% drop sinces it high of February, 2002, the article states: " Central banks will eventually take the same cue, he added, if they continue to see the value of their dollar-denominated reserves plummet. “People say central banks don’t care if they lose money,” Professor Portes said. “That’s just not true. I’ve talked to central bankers who have said, ‘I’m not going to be the last one out of this room if a fire breaks out.’ ”
Indeed, central banks have already started to diversify holdings away from the dollar, which is a factor behind its drop. But this process hasn’t created a crisis yet, nor has it substantially cut the funds available for businesses and consumers in the United States."
The word "yet" worries me. I would also note that Prestowitz in his book cited in my earlier post states: "To preempt the gathering financial crisis and ensure a sounder basis for the third wave of globalization, the United States should take the lead in a global effort to reduce the role of the dollar. It must do so gradually and cautiously."
Posted by: Switch | Dec 11, 2006 4:27:52 PM
CIA Worldfactbook
Current account balance
Japan: $ 165,600,000,000
US: $ -829,100,000,000
(2005 est)
Nuff said!
Posted by: Mister Tee | Dec 11, 2006 5:55:14 PM
U.S.A.'s Gross Domestic Product: $12.3 Trillion
-population rising
Japan's Gross Dometic Product: $4.03 Trillion
-population declining
Posted by: Jenson | Dec 11, 2006 7:39:20 PM
That's only an annual figure. The cumulative imbalance including 2006 is more along the lines of $5 Trillion.
Posted by: Dave Porter | Dec 11, 2006 8:30:35 PM
So, I was wondering what risk factors the current revenue estimates for Oregon considered. The Executive Summary, December 2006, Economic Forecast by the Oregon Office of Economic Analysis states in part:
"The major risks now facing the Oregon economy are:
• A major slowdown in the U.S economy and a global downturn triggered by the U.S. The U.S. economy has been an important engine of growth for the global economy. If the U.S. economy falters, the whole world will feel the impact. Asia, in particular, will be severely affected by it due to its large exposure to the U.S. economy.
• A hard landing in China. The Chinese economy is growing very fast. Building construction and other business investment are largely responsible for the economic growth. Central government efforts to curb growth have produced minimal success. Limited experience in macro policy making may result in an undesirable set of policy measures. A major slowdown in China will hurt most Asian economies, along with commodity exporting countries including Canada. Canada and Asian countries are the major destinations of Oregon’s exports. The manufacturing sector will be negatively impacted....
• A sharp fall of the U.S. dollar. As the dollar depreciates against other foreign currencies, U.S. exports are promoted as U.S. products become more price-competitive (or less expensive). Oregon’s manufacturing sector has a large dependency on international markets. If the U.S. dollar falls too quickly, this could harm Oregon’s trading partners because the lower dollar makes imports more expensive to U.S. consumers. As U.S. trading partners export less to the U.S., their economies may weaken and lower their demand for Oregon products. In the end, a controlled lowering of the U.S. dollar is most beneficial to the Oregon economy."
So a little lower for the dollar's value, but not too much or too fast, is good for Oregon. But as the dollar corrects lower interest rate go up for all the reason Jenson suggested. Higher interests rates have a generally negative effect on our economy, but when and how much will make all the difference.
Posted by: gl | Dec 13, 2006 1:11:22 PM
rather then using the CIA worldfact book ( we all know how great their intel was) try using a Bloomberg terminal, you find substancially different and more accurate facts
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Posted by: Dave Porter | Dec 8, 2006 10:50:38 AM
There could be a soft landing or a domestic and international disaster. As Clyde Prestowitz in "Three Billion New Capitalists: The Great Shift of Wealth and Power to the East" writes: "The nightmare scenario - an economic 9/11 - is a sudden, massive sell-off of dollars; a world financial panic whose trigger might be as minor, relatively speaking, as the assassination of a second-rate archduke in a third-rate European city. A collapse of the dollar and its consequent abandonment as the world's reserve currency would create a deep recession in the United States. Gas and fuel prices would soar, anything imported would suddenly become much more expensive, interest rates would jump, as would unemployment. The "stagflation" of the 1970's - slow growth and high unemployment combined with double-digit interest rates-would look like a walk in the park. And since the United States is at present the world's only major net importer, all of the exporters that depend on it for their economic stability would suffer severely as well. It's the thought of these consequences that make the big dollar holders so nervous, and makes them, for now, hold on to their excess dollars."
Our economy has been totally mismanged and it's scary. And beyond the worldwide economic ruin, international cooperation would break down and wars would erupt. Peoples around the world would be so vulnerable and angry that they would blame and envy their neighbors.
I am particularly concerned about China-US relations during the rest of the 21st century. Both countries would be under severe stress in such a scenario. Nuclear exchanges would not be impossible. As I have argued in our proposal "Developing the China Connection through Educational Programs," we need to give our children the skills to get through such a crisis.