Friday, January 23, 2009

Creating a basis for credible economic growth

For some time now, I have been constructing a two-part (hypo)thesis about the future of the US economy. I am still putting together the pieces, and learning as much as I can, but here it is: About a year and a half ago, after three years of significant study, I began to say out loud to people willing to hear things like this, that within the next five to ten years the dollar would face a day of significant reckoning. I began to believe this because the massive growth of GDP and expansion of the money supply the past three decades have been, as I began to see it, the result of illegitimate and unsustainable systemic actions by the country's elite economic actors. In short, we have borrowed too much relative to how much we have produced. So our economic growth has lacked credibility: the reality does not match the myths we have told ourselves, namely, that our 'fundamentals were sound.'. As soon as, my hypothesis went, the relevant participants in the world economy recognized this -- say, the American government, the Chinese government, American investors, foreign investors -- major change would then be upon us in terms of the dollar and Americans' purchasing power.

Let me explain some of the details, as I see them. Our growth the past three decades has been disproportionately greater than the production of valuable goods, services, or knowledge that should be its basis. And our money-supply expansion has not been the result of greater gold reserves. Rather, it is the result of international political power, the 'right' to disproportionately shape the world's exchange rates, and massively unbalancec capital flows toward US bond markets. In short, we've been living on credit because the rest of the world -- especially China -- have been financing and re-financing our debt.

As such, our growth and monetary actions have been the result of a massive credit-grab unprecedented in the history of mankind.

This is why the relationship between the US and China strikes me as so important, and why I so often write about it in this space. China is the reason we've been able to engage in this credit-grab. Without China we likely wouldn't have been able to so immensely leverage our capital and expand our bottom lines. Therefore, if the relationship between the US and China changes, or is changing, and I think it is, this is a major event. The reason: China's willingness to grow its surplus, constrain its population's standard of living, and finance the US dollar through long-term treasury purchases is the single biggest basis of American growth during this era. As soon as China changes these actions, the American economy will return to a level of wealth more proportionate to the value we add to the world economy through our production of goods, services, and knowledge. We will still be wealthy, but not nearly like we've experienced the past decade. My sense is that America is slowly returning to a more production-based economy, while China will become more consumption-oriented.

This will put the world's economy in a better balance, and America's economic growth -- once we can get it started again -- will be more legitimate, sustainable, and equally distributed within our population. That is, our growth will again be credible. But our standard of living will recede for the next decade or two. How much it will recece, I don't know. We'll have to wait and see.

As a result of all this, the most important thing we can do is recognize that credibility is a multilateral construct. Credibility exists in the eye of the beholder. We cannot force other people around the world to interpret the US economy as legitimate. We cannot force them to behave in a certain way. We can't forever expect the rest of the world to interpret their own economic interests as financing ours. Especially if we continue to act irresponsibly with bad loans and even worse wars. We must create an economy that, once again, inspires confidence in the minds of others. Only after we have created this credibility, will our standard of living begin to return levels we've grown accustomed to.

To this end, we should immediately begin to build the social insitutions it will take to create the goods, services, and knowledge that the whole world craves, and that the US is in the best position to produce. Less finance, more practical creativity.

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