Mainstream economists are finally waking up to the fact that growing our way out of insolvency will be impossible unless major structural changes are made. by Bill Gee
Monday, August 15, 2011
Now that it looks like the immediate instability caused by the credit downgrade is past, now we have a little time to assess the damage and to determine our long-run economic prospects going into the next decade.
In a column written by Simon Johnson on August 14th, he correctly brought up some very important points regarding the bleak future of economics in this country, namely, that the only way to increase both tax revenues and pay down Public Debt is for our country to add an additional percentage point to economic growth. While a single percentage point does not seem like much, the current environment makes such growth nearly impossible. I would further argue that we have already reached a critical mass where fiat money can no longer facilitate economic growth, and that "growth" in its traditional economic conception can no longer be used.
Downgrade – Good?
It appears that despite my own dire warnings, the credit downgrade of US debt by S&P did not result in the sudden increase of interest rates. In fact, it had the opposite effect. If this had been any other country’s sovereign debt that S&P was downgrading investors would have immediately altered their behavior to the point where interest rates would have immediately gone up at least 1-2 percent. But that did not happen here because US debt remains to be the world’s "Reserve Currency", and as long as that remains true, there will still be demand for US Treasury bonds.
So does that mean that the Tea Party was right and that it makes no difference whether the debt ceiling is raised or not? Not necessarily. The caveat to keeping our interest rates lower than the rest of the world is that the rest of the world needs US dollars in order to conduct business, which makes the US dollar the de facto "world currency". In the event that the world decides to create a new reserve currency, the dollar will quickly lose value and interest rates will soar. Russia, China and the IMF have been pushing for a "Super Sovereign" International Currency since 2008, and the fiasco in Congress over the debt ceiling only helped their cause. It’s just a matter of time before "I-Dollars" replace US Dollars as the world’s reserve currency.
When that happens, there will be a tsunami of currency on the US market as foreign bond holders cash in their US Treasury bonds for new I-Bonds. Here, even an "orderly" transfer will have dire consequences as the Government depends on investors repurchasing more Treasury bonds as their older bonds mature. The Fed will not be able to recall enough currency fast enough to stem the tide of hyperinflation.
Other Barriers to Growth
Even if we didn’t have the looming currency crisis knocking on our door, there are two other significant barriers to economic growth that will make the 3% growth goal through 2016 an impossible dream. These include Income Distribution and Barriers to Innovation.
Professor Johnson correctly points out that Congress is basically held hostage by the special interests of the professional elite in this country, and that they have demonstrated absolutely no interest in giving up a penny of their wealth for the greater good of this country. Basic economic history says that real economic growth can only exist if the fortunes of the majority are able to keep pace with the fortunes of the nation. In other words, growth must be achieved on the grass roots level and not just for a select few Wall Street warlords.
Therefore, we cannot expect the majority of Americans to pull themselves up by their bootstraps if we take away their boots, their socks and their pants. By making deep cuts in education, job training, research grants, and infrastructure just so that the extremely wealthy can invest their money in overseas tax shelters, we are taking away that critical element that made American economic dominance possible. History has shown that empires that work to keep the wealthy rich and the poor impoverished will eventually fail, and Congress has already demonstrated that they are not interested in whether we succeed or fail.
Another area critical to economic growth is Innovation, but Professor Johnson points out that this area is seriously broken. So-called "patent trolls" and "intellectual property trolls" have made a living of killing innovation by using our broken patent and copyright system to their own twisted ends. Now we have thousands of computer software developers and other inventors who are scared to death to bring their products to market for fear that their idea somehow violates some vaguely written patent that was written over a decade ago by an "inventor" that sold it to one of these "troll" law firms.
The result – no innovation here in the US, and all new technology will be developed elsewhere in the world where its inventors are outside of our legal jurisdiction.
The Perfect Storm
For those who point to the restoration of order in the markets as a sign that there is absolutely nothing wrong with the status quo, they are all in for a very rude awakening in the next few years. A perfect storm of currency devaluation and an environment that discourages investment in public goods and innovation will eventually lead to a sudden and dramatic end to the once-proud American Empire. Hopefully what will take its place will be something better as we redefine the meaning of growth as we move further into the 21st Century. However, if those who are in power remain entrenched in their belief in the status quo, then we may be looking at the beginning of a new "Dark Age" much like what we saw following the collapse of Rome where Western Europe suffered from nearly 500 years of stagnant economic growth while the rest of the world managed to get by with a modest standard of living.
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I think your analysis is correct, overall. However, I do see one glitch in it. In order for an IMF super-currency to be accepted by the economy, there's going to have to be something in it that rises above the value of the currencies that back it. Whether a "basket" of world currencies or an SDR-based currency, no matter what we're talking about a currency whose foundation depends on other existing currencies. In other words, there's really nothing that will give the new IMF currency any "oomph" of its own, independent of other currencies.
But if the dollar loses its "coolness" in the eyes of market players, and no other national currency is trusted to replace the dollar, why would an IMF currency based on some combination of dollars and, say, euros, yen, rubles, yuan, and Australian dollars somehow gain acceptance? Even SDRs are ultimately the currency of country X held "on reserve" so to speak, meaning that the SDR is only as good as that currency.
I think this is really the reason why everyone fled to dollars and treasuries during the latest market downtown. There really is nowhere else to run if you're not a gold bug. It may be like the cliche of the horse running back into the burning barn, but unless the horse can see some route that doesn't have fire blocking his path, where else would we expect him to run to?
Posted By: Bill Gee
Date: August 17, 2011 06:48:09 AM
Walt - There was growing evidence that DSK, prior to his forced resignation from the IMF, was working on a way to peg the super-currency to gold and other precious metals. The evidence was his work to remove the US dollar as the sole currency for trading gold and instead use an IMF special vehicle for all international gold transactions. If this is true, then I think this should make you happy if it comes to pass because at last we would have an internationally recognized currency, pegged to precious metals, that would directly compete with the dollar. Your analogy of the horse running back into the burning barn is apt.
Ohm - First of all, welcome to the forum! In previous articles I have suggested many structural changes that I feel are necessary to get us back to a state of growth, but before we can talk about specifics, we should work to redefine growth in the first place. For far too long we have used Gross Domestic Product to define growth, which is a paradigm that contains many faults - specifically, it depends on the creation and purchase of something "new" that is consumed in the market. Therefore, in order for the economy to "grow" we have to constantly be using up natural resources and/or spending our way to oblivion just to convince ourselves that we're moving in the right direction. A better way to measure growth is to structure our economy in a way the measures "Marginal Utility" or some sort of "Satisfaction Index" in which consumers can measure their quality of life rather than simply focusing on what they purchase and consume. With such a paradigm shift, other measures of growth and the structures that support them would be irrelevant.