The Trade Deficit and the Gold Standard
The Almighty US Dollar
The American capital market can not be fathomed without considering forces beyond national borders.
In 2000, foreign corporations broke the back of the bull market by taking advantage of extremely low capital costs and by selling equities that neutralized the upward price-pressure of buybacks.
When foreign investors began to avoid buying into an over-valued stock market, the Great Bubble popped.
Spending More Than One Earns
Ordinarily, nations, like people, cannot for long spend more than they earn.
Countries that produce a surplus of goods or services that have value on the international market can sell this surplus to acquire goods and services that they consider valuable, produced by other countries.
For a country to buy more on the world market than it sells, it must borrow from investors in other countries.
In this way, international trade seems to enrich people in countries that exchange surplus production to their mutual benefit.
Countries that produce little of value in the international market cannot participate in this exchange and are poorer for a lack of industrial or agricultural products.
For a country to buy more on the international market than it sells, it must borrow from investors in other countries.
When a country cannot pay foreign investors and defaults on its debts, an international financial crisis occurs.
Since the U.S. went off the gold standard in 1971, this has happened every few years somewhere in the world.
The impact on citizens of the defaulting country is usually dire.
There is unemployment, increased poverty and crime, riots, death and political turmoil, loss of sovereignty, and transfer of assets to foreigners.
The Gold Standard Is Long Gone
From the early 1800s until 1914, the leading world powers promised to redeem their currency in gold or silver at a fixed rate.
When banks in one country accumulated a surplus of currency of another country, they would arrange to have precious metals transferred, thereby settling the trade imbalance between the countries.
Since 1870, Great Britain, Germany, France, and the United States adopted a mono-metallic gold standard.
Under the gold standard, to settle international debts, countries had to ship gold
To settle international debts, the country that had to ship gold would have its reserves reduced, thereby being forced to issue less currency, causing temporary deflation and unemployment.
The country with excess gold could issue more currency, stimulating the economy and increasing imports or foreign investments, thereby contributing to the next cycle in the balance of payments.
Until 1914, the British pound sterling was the preferred international currency. The Bank of England had sufficient reserves to buy or sell gold in unlimited amounts to any country or person who wished to trade at their bid and asked prices, called the 'gold points'.
The British pound sterling was the favorite currency for investors for almost one hundred years, offering reasonable protection against inflation.
The rise of democracy and the working classes, the unbearable cost of war, the adoption of socialist agendas, the insult of war reparations, the confiscation of 'enemy' bank accounts, and the rise of central banking with the manipulation of the economy for political ends, contributed to the collapse of the British free gold standard in 1914.
How Financial Leadership Passed to the U.S.
During the 1920s, sputtering attempts to restart the old world order failed.
The U.S. went off the free gold standard during the 1930s, keeping gold only as a medium of exchange between central banks.
After World War II, the International Monetary Fund administered the dollar-gold standard, and the U.S. dollar became the new world currency.
From 1971 onwards, the dollar has had no backing in gold
However, by 1971, the cost of the War in Vietnam, the inflationary weight of Great Society programs, the decline of American industry, and the economic recovery of Japan and Europe, forced the U.S. off the gold standard for good.
From 1971 onwards, the dollar was the international currency by custom, but there has been no backing in gold.
Wall Street often cites U.S. Treasury securities as a benchmark of riskless investment.
This ignores government default on payment in gold by Franklin Roosevelt during the 1930s (with regards to individual investors) and by Richard Nixon in 1971 (with regards to central banks) and the long-term devaluation of the dollar by inflation. There is no riskless investment.
In cutting the link with gold, the U.S. Treasury Department was no longer constrained in issuing money.
Furthermore, foreigners may hold unlimited amounts of dollars.
Much of the activity in dollar bank accounts and U.S. currency takes place overseas, beyond the reach of the Federal Reserve Bank.
By the 1980s, Germany and Japan had again become industrial powers with excess goods to sell the world.
Emerging nations had also industrialized, notably Brazil, Taiwan, and Korea. Brazil had developed a domestic, automobile industry from scratch in one generation.
With Baby Boomers seeking the fast buck, Great Society legislation discouraging domestic industry, and a world eager to accumulate dollars and sell goods to the U.S., the stage was set for the rapid deindustrialization of America.
Why the Dollar is King
Over the last fifty years, multinational corporations have sought to boost profits by selling excess capacity from thousands of factories to a world market.
By the millennium, trade barriers had been lowered, many countries had joined the World Trade Organization, and globalization had become the watchword.
International trade involves the exchange of two commodities – the goods or services that are for sale and the currency that is offered in return.
When an Indonesian coffee exporter sells to a buyer in India, the contract will probably call for payment in U.S. dollars. There are reasons for this:
Exchange Risk: The Indonesian Rupiah, even before the crisis of 1997, steadily lost value against the U.S. dollar because of higher internal inflation in Indonesia.
Universal Tender: The Indonesian exporter can use dollars to buy goods in almost any other country. This would not be the case if the deal was made in Indian Rupee or Indonesian Rupiah.
Taxation: The government of Indonesia, like all governments, wants to be able to seize assets of its citizens through taxation.
Although the exporter may have to convert some dollars received into Rupiah to pay local wages and material costs, the profits may be kept abroad in dollar bank accounts, perhaps in the Cayman Islands.
By manipulating invoices, using offshore distributors, and other tricks, the exporter can keep some profits out of the country and beyond the grasp of local tax collectors
Repayment of Foreign Loans: International banks lend to Indonesian companies and these loans are often denominated in dollars. If the Indonesian exporter were to transact in Rupiah or Rupee, he would not obtain the dollars needed to pay foreign bankers.
International commodity markets, from oil to coffee, are generally organized to trade in U.S. dollars.
The same is true for non-commodity goods and services. Part of the profits from international trade accumulates in dollar bank accounts held by non-Americans.
These dollar bank accounts are often outside the United States and beyond the control of the U.S. Federal Reserve Bank.
The Inflation-Devaluation Cycle
Since the U.S. went off the gold standard in 1971, there has been no brake on the amount of dollars in circulation.
Dollar inflation is inevitable, and this drives inflation in other world currencies.
When Indonesian or Argentine exporters have difficulty selling in the international market, they may either lower their prices or encourage their governments to devalue their currency against the dollar.
Competition among foreign exporters and failure of foreigners to repay dollar loans makes the dollar appear stronger
If the exporters have dollar reserves, devaluation will not only make it easier for them to sell their goods, but will also increase their wealth in local currency.
However, devaluation makes it harder or impossible to repay dollar loans, resulting in periodic country-wide defaults.
Gradually, competition among exporters and failure to repay dollar loans causes a steady devaluation of other currencies against the dollar.
This makes the dollar appear stronger — a practical store of value.
Benefits of Deindustrialization
In the United States – the owner of the world currency franchise – a strong dollar reduces competitiveness of American industry.
This disadvantage is amplified by higher production costs in American factories because of mandated minimum wages, expensive insurance, tort liability, the inefficiency of unionized labor, and government meddling in hundreds of areas, from the environment and work standards to sexual and race relations.
Foreign workers can provide smarter labor at less cost than in the U.S.
In offshore emerging markets there is greater unemployment as well as lower labor costs.
Foreign workers can be selected from the high end of the Bell Curve, providing smarter labor at less cost than in the U.S.
There is inexorable pressure for American producers to move abroad, and there is no objection from the U.S. government.
American consumers, on the other hand, seem to benefit from residing in a country that has the world currency.
Foreigners vie to offer goods at prices that beat domestic producers.
Foreign producers are happy to be paid in dollars, rather than Rupiah, Rupee, or Pesos.
Foreign suppliers may hold profits in dollar accounts that feed through various channels to provide consumer credit that encourages Americans to spend more than they earn.
Many Americans in the lower half of the population – often poorly educated, part-time service workers – would be forced to live at Third World levels if it were not for the boon of the dollar as the international currency and liberal foreign funding of consumer credit, government deficits, and home mortgages.
Deindustrialization: The Dark Side
Deindustrialization caused American workers to lose better paying jobs at factories and to accept jobs in the lower-wage service sector.
Since there are plenty of dollars to finance consumer spending, employment stays high, although U.S. living standards erode.
Some economists justify this strange policy saying that globalization enriches all, since the common people are able to buy more goods at lower prices.
American industrial workers have become shop clerks, selling goods produced abroad
However, this is not necessarily the case, since the benefits are not equally shared among American workers.
During the 1990s, shopping in the Mangga Dua Mall in North Jakarta, Indonesia, one could easily find a shirt selling for seven dollars that would cost seventy dollars in a department store in the United States – identical in terms of brand, quality, and manufacturer.
Low labor costs in Indonesia are not fully passed on to the U.S. consumer.
The difference goes to intermediaries who take advantage of people’s vulnerability for designer labels and trade marks.
This rewards merchandisers, designers, lawyers, advertising agencies, store owners, and consumer financiers – not the ultimate consumer.
The American worker, instead of standing on a factory floor earning fifteen dollars an hour, now stands in a retail store, selling offshore goods for seven dollars an hour.
Unequal Fruits of Globalization
The people on the upper half of the Bell Curve, with degrees in business administration, do well with globalization, while the gap between rich and poor widens.
Economists who work for the government or who hold tenure at universities may also do well.
Government economists do well under globalization
The service sector can be profitable to those with special skills, such as doctors, lawyers, engineers, accountants, financiers, graphic artists, or marketing specialists.
Less educated folk, who might fare reasonably in the productive environment of a factory, have far less economic value in low-skill service jobs, such as store clerks, cooks in fast food restaurants, security guards, and janitors.
No amount of special education can overcome the disadvantage of those born without the natural intelligence needed for better paying jobs in merchandising, finance, and engineering service.
Unless society provides the capital and the working environment for the less endowed to multiply their productivity, many Americans will suffer as factories go abroad.
Dollar Supremacy and the Trade Deficit
Until 1971, the discipline of gold kept the U.S. balance of trade within a narrow range of variation between imports and exports.
Without the shackles of gold, but with the dollar as the international currency, Americans were free to spend as much as they wished in foreign markets.
During the 1980s and 1990s, Americans bought more foreign goods than they sold.
In 2000, the trade deficit was increasing by $1 billion per day
By the millennium, the imbalance between American imports and exports ran about one billion dollars per day.
This went on because the rest of the world wanted to accumulate dollars.
By the first quarter of 2000, foreigners held twenty-three percent of U.S. government securities, forty-one percent of corporate bonds, and nine percent of American equities.
Few believe that the trade deficit will be financed by foreign holders of dollar assets indefinitely.
However, the American trade deficit, in one significant way, differs from the foreign debt that brought havoc to Mexico, Russia, Argentina, Indonesia, and Thailand.
Before proceeding, check your progress:
Self-Test
The U.S. trade deficit has been increasing since 1971 because:
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Deindustrialization of the U.S. has been spurred by:
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Deindustrialization in the United States has led to:
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The Almighty Dollar : continued >
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