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Why is the dollar so important, and what happens when it tanks?

by Lud Thu Nov 24th, 2005 at 07:40:17 AM EST

(Back from the front-page by whataboutbob)

I caught a great article in the Dutch NRC Handelsblad this weekend about the housing bubble in the US, the growing trade imbalance, the downward spiral of US personal savings rates (to below 0), the likely results of this dangerous situation, and how these results will affect Europe and the rest of the world. It was paired up with a docu-drama on Dutch TV called "The day the dollar falls", featuring a collection of Dutch and American economists (guys like Stephan Roach), which sketched out a likely scenario, from morning trading in Asia to the end of the day in the US, of what a %20 or so drop in the value of the dollar vs. the euro would mean for the world. It wasn't a pretty sight.

I'll try to convey the broad picture of this below the fold, and I would welcome your thoughts and clarifications about some of the issues involved from a more learned economic perspective, as my primary interest in the value of the dollar over the last few years has been how far I can stretch my US savings to fund my rock star lifestyle in Holland, and not on what the ups and downs of the currency markets actually mean to the rest of the world.


The article had some accompanying graphs that gave a very clear picture of how skyrocketing debt among american citizens, financed by an arguably artificial spike in property values, has created a sort of parasitical system where Asian countries essentially dump money into the US so that americans can continue to buy Asian commodoties. Another graph showed the spike in money flowing into the US from the rest of the world--otherwise known as the trade imbalance--which has reached a mind blowing 3.5 billion dollars PER DAY. This money is coming primarily from Asian central banks.

One of the economists in the documentary characterized it roughly as follows:

There's seven people stranded on an island, six asians and one american. Each of them has a task. One of the asians goes out all day and fishes, one of them gathers cocunuts, one of them gets firewood, one of them gathers up leaves and sticks to build shelter. And the american sits around all day underneath the shelter, by the fire, eating the food they spend all day gathering. A modern economist might look at this situation and say, "Hey, that american is vital to this system: if he wasn't there to eat all the food these guys wouldn't have anything to do, they'd just be sitting around wondering what to do with themselves."

The obvious fallacy in that is that of course this american is a parasite--if he wasn't eating up all the food all the asians wouldn't have to work so hard and they could enjoy the fruits of their labor. But this scenario exactly describes what is currently happening in the world economy--the asian countries have spent the last several years dumping money into America to finance our spending sprees on consumer goods produced in Asia. One of these days they are going to stop, and when that happens you will see a large scale realignment in living standards in the world, where Asians are suddenly going to be able to afford a lot of nice things and Americans are suddenly going to have to rethink their spending habits.

So why isn't this happening today, already? And what's in store for europe, if this were to happen? Is this realignment something that would affect the entire west, or would the (comparatively) high rates of personal savings and level trade balances in most European countries spare us the worst effects?

There were a lot of other effects that were touched on, the most perplexing of which involved things like runs on banks and atms and general financial instability outside the US, as well as the predictable realignments of things like the currency pricing of oil and concerns about valuing of goods that have already been sold but not delivered, etc. All in all it was a very interesting, rather frightening story, and pushed me closer to the belief that our western way of life is pretty much sticks and glue, waiting for that one good shake to knock it all over, and we'll be left wondering how it existed as long as it did...

(thanks, my first diary here)

Display:
a sort of parasitical system where Asian countries essentially dump money into the US so that americans can continue to buy Asian commodoties.
You could call that symbiosis, not parasitism.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Mon Nov 21st, 2005 at 10:00:32 AM EST
I call it parasitism in light of the island example, which illustrates the fallacy of the policies of the asian governments to finance US consumption. The american in that example (and in reality) is sucking off the 'wealth' of the asians, and giving nothing in return.

It makes no sense long term for one group of people to work their asses off so that another group can live in style.

Unless I'm missing something, that is what is happening right now, not because it is mutually beneficial but rather because it is the easy thing to do, and does not involve a serious upending of the current world power structure. It makes sense only in so far as it makes sense that Americans should be able to have a standard of living ten times that of the average Chinese, or that the 4% of the world population living in the US should consume 50% of the world's oil supply.

by Lud on Mon Nov 21st, 2005 at 10:21:53 AM EST
[ Parent ]
China is lending the US money that the US then invests building manufacturing plants in china, employing Chinese workers and buying Chinese products.

China is giving the US what they want (money to shop tillthey drop) and the US is giving the Chinese what they want (a market for their products and transfer of industrial know-how).

The island example wrongly makes it sound like China is getting nothing out of this. The US economy is being hollowed out and the Chinese economy is booming. Maybe China is the parasite, and when they kill their host they will become an independent organism.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Mon Nov 21st, 2005 at 10:57:15 AM EST
[ Parent ]
There's an element of both symbiosis and parasitism.

China does get industrial development, but a lot of it is export-oriented and (at least partly) foreign owned, and not so much of the value remains in China. It is beneficial, but it is artificial growth, and it is not clear if it will be sustainable without US demand.

The US get to live above their means, which is possible thanks to the status of the dollar as reserve currency - the trouble is that they have abused that privilege and are threatening to break the whole system.

As that Economist article we've discussed and which I have promised to review says, China is bringing an oversupply of labor into the world economy, putting downwards pressure on the price of labor, and giving a premium to the relatively rarer capital. But the USA are also flooding the market with money, making capital cheap - thus downwards pressure everywhere on the price of labor, and inflated asset prices.

Deflation form China and inflation from the USA. So long as they more or less balance, we're fine (doing very well if we own assets, not so well if one has a wage-paying job). As soon as the two bubbles diverge, we're all fucked.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Nov 21st, 2005 at 12:51:11 PM EST
[ Parent ]
I suppose the real parasites are the multinationals. They are squeezing the Chinese for labour and the Americans for cash.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Mon Nov 21st, 2005 at 12:54:08 PM EST
[ Parent ]
Exactly. The modern economy in 13 words.


The multinationals are squeezing the Chinese for labour and the Americans for cash

And I would add - they are mocking the Europeans mercilessly for not giving them any easy fat to burn.


In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Nov 21st, 2005 at 01:00:55 PM EST
[ Parent ]
And thanks for the diary!
Welcome to Eurotrib.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Mon Nov 21st, 2005 at 12:51:55 PM EST
[ Parent ]
Crossed my mind too! Great thought provoking diary...and welcome to EuroTrib!!

"Once in awhile we get shown the light, in the strangest of places, if we look at it right" - Hunter/Garcia
by whataboutbob on Mon Nov 21st, 2005 at 01:41:35 PM EST
[ Parent ]
and this is why it will not tank.

While you pay oil with dollar, there is no possibility of tanking.

The moment that Russia, Iran and venezuela do not accept dollars there is a chance of a deep fall  (to avoid a complete disaster...Saudi Arabia will always be there to the rescue).

People need dollars to pay oil, this is why huge black money in South America-Asia is in dollars. Oil, plus black market makes it impossbile to tank, no matter the deficit.

The deficit can make the dollar fall down, an even an important fall (50% more anybody?).

So China can indeed make the dollar fall , but not tank... not as long as oil is payed in dollars.

Great diary by the way.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Mon Nov 21st, 2005 at 01:37:12 PM EST
We should put our currencies on the oil standard. Expect a diary about it any day.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Mon Nov 21st, 2005 at 03:59:27 PM EST
[ Parent ]
Indeed

Indeed

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Mon Nov 21st, 2005 at 04:33:22 PM EST
[ Parent ]
Absolutely right. The oil standard is the dollar.

Iraq and Iran were just about to start selling oil in Euros and other currencies in 2002, which is why we hastened to invade Iraq.

Iran is still planning on opening an oil bourse in 2006, where oil will be sold in other currencies. In reply, we are getting ready to use tactical nukes on their nuclear research facilities.

Also, I would no depend at all on the Saudis being America's ace in the hole -- they are going to undergo a complete upside down revolution in the next few years.  Most of their population is under 25, and unemployed, and very upset about America being in the Middle East.  The House of Saud already has their escape planes waiting on the runway, and their money and diplomatic arrangements waiting overseas.

Frames exist within larger frames. Draw a larger frame around your opponent's frame; he will appear wrong or insufficient. This is how wizards play.

by Antifa (antifa@bellsouth.net) on Mon Nov 21st, 2005 at 07:34:38 PM EST
[ Parent ]
The war was not about Iraq or Iran selling oil in euros, and Iran's bourse will never work, for very simple reasons.

  • traders need a common currency to work together. Once they've set on one, it's really hard to make them change - hence the fact that a number of commodities are still traded in pound sterling despite the fact that the UK hasn't been the main market for quite a bit of time. The existence of a standard is more important that which one it is. Cf the dominance of Windows as an operating system: it's used because it's used. To switch, you need everybody to switch at the same time. Only a monopolist (or a monopsonist) can force that.

  • in addition, the oil market is not just about oil, today it is about all the financial instruments derived from oil - term sales, derivatives, structured products, etc... The same cosntraints as above apply to these markets, which are even more diverse and globalised than the oil markets. Also traders have all their references, price histories, and standard trading instruments based on the dollar. To change all this, again, would require massive effort and coordination (remember how much effort it took to switch to the euro in 1999)

  • the other thing you need to have a market is a stable and trustworthy regulatory and legal system. People will not go trade in Iran because the risks or abitrary interventions and meddling are too high. The euro can be an alternative to the dollar as a reserve currency because European rule of law and regulation is seen as acceptable, and the currency is backed by a real economy, but Iran stands no chance to impose any switch of any kind for trade, financial instruments or anything else.

Please forget these ideas, they are totally cut from the reality of financial markets.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Nov 22nd, 2005 at 06:27:16 AM EST
[ Parent ]
I don't know the details of the Iranian plan, but do your arguments hold true f.e. for Chinese traders too?

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Tue Nov 22nd, 2005 at 08:21:43 AM EST
[ Parent ]
Please forget these ideas, they are totally cut from the reality of financial markets.

There you go again, bein' all reality-based.  ;-)

Seriously, though, the current administration is admittedly operating in a non-reality-based world, right?  What does reason matter to them?  The very reasons you state for de-bunking this threat are the very reasons I see that the smallest threat is probably very real to these people -- they know all this too.  Plus, they believe, in ways normal people apparently can't grasp, that perception is everything.

I think they very much operate in a perception-based world.  Money isn't a real thing to them -- it's pure power.  They get more by manipulating perceptions.  They manipulate the stock-market, they peddle influence, they dip in and out of industries trading on insider knowledge.  Of course they see currency the same way.  And in this world, what is the reaction going to be if someone starts fucking around with intangibles?

You list these things as very important:  a common currency, existence of a standard, references, trustworthiness, and stability.

There's nothing concrete there.  These are all ideas, giant ones, held together by nothing more than mutual agreement.  I think the warmongers understand exactly the same how important these things are, and that's why they take any threat to the idea very seriously.  It doesn't have to seem real to us, it does to them.  Do you think control of the oil has anything to do with the war?  If so, do you think your idea of control and their's is the same?  Because I don't think they're all that interested in running refineries.

Maybe we can eventually make language a complete impediment to understanding. -Hobbes

by Izzy (izzy at eurotrib dot com) on Tue Nov 22nd, 2005 at 03:06:34 PM EST
[ Parent ]
;-)
by wchurchill on Tue Nov 22nd, 2005 at 04:33:06 PM EST
[ Parent ]
Oh, c'mon!  What can it hurt?  (she asks reaching for the blue face-paint...)

Maybe we can eventually make language a complete impediment to understanding. -Hobbes
by Izzy (izzy at eurotrib dot com) on Tue Nov 22nd, 2005 at 04:48:11 PM EST
[ Parent ]
you are great--lol, seriously to the face paint line.  
by wchurchill on Tue Nov 22nd, 2005 at 05:31:54 PM EST
[ Parent ]
You raise an interesting point, i.e. that they would react to perceptions of a threat rather than to a real threat - and I have no good argument against that...

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Nov 22nd, 2005 at 04:52:03 PM EST
[ Parent ]
It is a common misconception to assume that any rational actor would respond to real threats.

The threat (that one takes into account in one's planning) depends always on one's perception of existing threats. These perceived threats are often different to real threats due various cultural and personal reasons and assumptions.

Usually you do not know real threats until afterwards when things have happened like they did and truth finally starts to filter through. This time lag could take long time depending on organization or person involved.

by Nikita on Wed Nov 23rd, 2005 at 05:56:40 AM EST
[ Parent ]
How is the Gold Standard different from a fiat currency? I mean, where does the intrinsic value of Gold come from? The value of Gold is, at heart, that powerful people (who are basically running a protection racket) will like to wear gold jewellery to display their power. I mean, there's nothing else gold is good for other than making jewellery (and don't bring up electrodes for hydrolisis, or electronic circuits, because powerful people don't care about that).

So, money based on the Gold standard is based on the belief that, if the going gets tough, you can buy the favour of powerful people by giving them gold so they can look pretty.

A fiat currency, all right.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Nov 23rd, 2005 at 06:10:29 AM EST
[ Parent ]
Wait, is this comment supposed to be in reply to my comment?  And if so, do you think that what you and I are both saying is opposed or contradictory to each other?  Because I think what you're saying is exactly my point -- it's not about the intrinsic value at all.  That's what I was getting at.  It doesn't make the "values" or the "threats" to them any less real, it's just that we're dealing with something else entirely besides oil the commodity.  

We're dealing with, I think, the problems associated with whatever is the agreed upon standard, be it gold, oil, seashells, or whatever else.  It is, at bottom, all about trust.  The problem with people like the current administration is that they don't really understand trust.  They only understand loyalty, fear and force.

Maybe we can eventually make language a complete impediment to understanding. -Hobbes

by Izzy (izzy at eurotrib dot com) on Wed Nov 23rd, 2005 at 05:49:31 PM EST
[ Parent ]
I'm just pointing out that people usually think of gold as a sure asset that will not lose its value in a time of crisis, but if you think about what the value of gold hinges on, it's as much of a fiat currency as any other.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Wed Nov 23rd, 2005 at 05:51:46 PM EST
[ Parent ]
Well, it's a tangible symbol of worth and, as long as everyone agrees on its value, it is something to hold on to when trust breaks down.  But, in essence, you're correct.  The problem in discussing these things, is that it's difficult for people to grasp certain intangibles when certain dynamics are in play.

And I wouldn't say that the whole idea of gold was to bribe favors from the powerful.  I'd say it was a tangible manifestation of something of agreed upon value that could be used to back up pieces of paper that we would trade -- something to show so it wasn't all just trust.

But, if a monarch or country printed pieces of paper based on gold that was hidden somewhere, but in reality that gold had been looted -- would the rulers still fight to protect the hiding spot?  It's been shown throughout history that they'll fight harder to protect the revelation that there's no gold than they would to protect the actual gold.

So at what point does it make a difference?  And when one thing is a symbol of something else that may or may not even exist, does that make the subsequent warring any less real?  Because I'd argue that much of the behavior we're witnessing right now is a result of something like gold fever, even though there's no gold involved.  

The oil, having some useful purpose, actually clouds our vision when we're trying to understand what's going on.  Just because we have a fiat currency, doesn't eliminate the human impulses behind certain behaviors we've seen in the past.  That's why I think some things can be about the oil and have nothing to do with oil at the same time.

Maybe we can eventually make language a complete impediment to understanding. -Hobbes

by Izzy (izzy at eurotrib dot com) on Wed Nov 23rd, 2005 at 06:16:05 PM EST
[ Parent ]
"A symbol of worth that everyone agrees on" is a fiat currency. It is a symbol, and its value is consensual.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Wed Nov 23rd, 2005 at 06:23:10 PM EST
[ Parent ]
Exactly my original point!  My point (in case it is as really fucking confusing to you at this point as it has become to me), is that there can be a percieved threat to this idea and that, because it is intangible, it will be fought more ferociously.  What point are you making?  And please, please to not bring math into it!  My head's gonna explode already!!

Maybe we can eventually make language a complete impediment to understanding. -Hobbes
by Izzy (izzy at eurotrib dot com) on Wed Nov 23rd, 2005 at 06:30:45 PM EST
[ Parent ]
We're just agreeing to agree.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Wed Nov 23rd, 2005 at 06:38:55 PM EST
[ Parent ]
Oh, thank goodness!  Can we tell each other how smart and wonderful we are now?  Migeru, you're like a brother to me!!  Well, except that math thing would be sort of freakish in my family, but besides that...

Maybe we can eventually make language a complete impediment to understanding. -Hobbes
by Izzy (izzy at eurotrib dot com) on Wed Nov 23rd, 2005 at 06:46:09 PM EST
[ Parent ]
You're so smart and wonderful, please spare me the compliments.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Wed Nov 23rd, 2005 at 06:48:51 PM EST
[ Parent ]
you pay me in Euro's or yen, or pounds or dollars.  On today's real time money markets, if you pay me in yen and I want euro's, I just convert at the exchange rate to euro's.  If there is a time lag on your payment, I just hedge through the currency markets.  This is not an issue.

The dollar is the leading currency, and that's why most prices are set in dollars on the worldwide market--but not all prices, some are in pounds, euro's etc.  who cares?  it's not important--at least not important among the heavily traded currencies like I have mentioned.  Now the baht--different question--like buying a small cap market stock, with limited liquidity.

The dollar is used simply because if people want to have assets in a currency other than their own, they often pick the dollar--because the US economy is so stable.  That could change some day.  the currency of choice was the pound years ago, now it's the dollar.  but the issue is where people leave their money in a situation like I describe.  Has nothing to do with whether the Saudi's quote their prices in yen or dollars.  traders have calculators and convert.  traders have markets and hedge.  no big deal.  heavily traded currencies are fungible.

by wchurchill on Tue Nov 22nd, 2005 at 12:27:21 AM EST
[ Parent ]
Are you sure there will be no problem if Iran Venezuela and Russia would announce that they would not accept dollars?

They just say.. no problem America.. you can buy.. but before you have to change currency and pay me in euros, because this is what I want to have in the bank, society, foreign assets...

Dollar will almost completely tank.. why you should have a black market in dollars then? OF course if CHina can take all the slack of debt plus currency then maybe it will not fall.. but they would not do it.

Dollar is oil plus black market plus debt financed by China.

Lose one leg and it is really bothering, lose two and its a disaster, lose three and it is the end of the dollar.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Tue Nov 22nd, 2005 at 03:46:36 AM EST
[ Parent ]
would just pay in Euro's.  The exchange rate between Euro's and dollars is up to date to the second.  Why would it be a problem?  The financial markets for currencies are incredibly fluid--maybe like I said before, less so for the baht.
by wchurchill on Tue Nov 22nd, 2005 at 04:19:03 AM EST
[ Parent ]
Ok, what about governments' currency reserves?

You can only hedge using currency futures for so long. Truly long-term hedging requires rolling futures, and that is risky. In the least traumatic scenario everyone's present holdings are fully hedged and they would let their dollar reserves run out (not completely, it is understood), replacing them with a combination of Euro, Yen and Pound.

Assuming everytone is fully hedged and they convert their reserves smoothly, I'd give it 18 months from the point when Oil is no longer traded solely in USD until the dollar tanks.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Tue Nov 22nd, 2005 at 05:16:27 AM EST
[ Parent ]
I think an American company probably would pay in euros if they had to, you're right.

But the name of the currency of transaction isn't really what's important. I doubt they'd be very happy having to pay 60 euros a barrel, assuming that 60 euros is worth $90 or more. That is a significant price increase.

Which of course would be passed onto the consumer, meaning a 50% or more increase in fuel prices. Something tells me the alarm bells would be ringing.

by Lud on Tue Nov 22nd, 2005 at 06:12:12 AM EST
[ Parent ]
and the price of a barrel of oil is $60--if someone wanted to be paid in Euros they would get 40 Euro's, no price increase.  assuming the market clearing price is $60/40 Euro/whatever yen, the market wouldn't clear if you tried to raise the price by 50%.  
by wchurchill on Tue Nov 22nd, 2005 at 11:16:54 AM EST
[ Parent ]
it's going to be because dollars are worth less. right?

You still seem to assume that the dollar is special, regardless, that the price of oil would just adjust itself to the falling dollar. According to the economists in this documentary, the price of oil would remain the same for everyone else in the world whose currency does not tank. Americans (and those who still had their dollars) would be, basically, fucked.

I'm sure there's more to it than that but I think your statement ignores the fact that rapid currency devaluations have real world consequences. It's not as if when the Brazilian real went down 75% against the dollar that somehow they could still pay the same amount for stuff. No, suddenly everything got a lot more expensive!

by Lud on Tue Nov 22nd, 2005 at 01:43:10 PM EST
[ Parent ]
a barrel of oil last Friday cost $56, or 47.43 euros, based on today's $1.00 to .847 euro exchange.  I didn't understand you were suggesting a steep decline in the dollar, to $1.00 to .67 euros, which I guess you are suggesting.  

and then you are further suggesting that the oil cartels decide to set their prices in euros.

and then you are suggesting the cost per barrel goes up to 60 euros from 47.43--or a 26% increase from today's prices.

sure, that all could happen.  in fact it really already did, except for the oil sheiks deciding to denominate oil in euros.  over the last 4 years or so the $1 has fallen from, I think, something like 1.25 euros to .85 today.  That is larger than the continued fall to .67 euros that you suggest.

furthermore, wasn't a barrel of oil something like $25 four years ago--whatever, I think it's up 100% ish, quite a bit more than the 26% you suggest.

so Americans have a big increase in oil prices--124%.  Europeans have a smaller increase since the euro is stronger against the weaaker dollar.  $25 was 31.75 euros, $56 is 47.43 euros, only a 49% increase for Europeans.

So go back to my original post, which was money is fungible.  I wasn't saying currencies don't adjjust,,,,they of course do.  And that adjustment in fact makes all of the outcomes that you describe happen--not only in your suggested case, but in the last four years.  It doesn't require the oil cartels to price in Euro's.

by wchurchill on Tue Nov 22nd, 2005 at 03:29:00 PM EST
[ Parent ]
The Euro was worth about $1.10 when it was created, but not being a circulating currency it immediately tanked to about $0.90. As soon as it started to circulate in January 2002, its value went up to $1.20 (all approximate figures).

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Wed Nov 23rd, 2005 at 06:13:33 AM EST
[ Parent ]
This is the point where the US is implodes.  

The foremost virue of dollars is that the can buy oil.  If the oil producers quit accepting dollars, a key reason for wanting them disappears, and the value has to drop.  So finding someone who will accept your dollars and give you euros to buy oil becomes a problem.  

A lower price for dollars would be good for American exports, except that we have off-shored most of that, and the increased price of oil to farmers and such industries that have remained offsets the export price advantage.  

Meanwhile the main part of American life, based on automobiles and cheap oil to run them, shuts down.  Panic and chaos.  

That's why the neo-cons are fighting a global war for oil.  And that's why, so far, a majority of Americans are letting them do it.  

The Fates are kind.

by Gaianne on Fri Nov 25th, 2005 at 03:51:58 AM EST
[ Parent ]
It does matter in what currency you pay.

If you pay in dollars, the US government can always print more money to buy the goods - a real privilege, called seigneuriage. Also, American companies do not have to worry about exchange rate risk - as you point out, the market is extremely liquid, and you should be able to buy whatever other currency is used, but you still take a risk on that rate. Again, a real advantage for US companies. If you borrow in your own currency, you let others take the currency risk, a great privilege.

On the other hand, the war in Iraq was NOT about Saddam's threat to switch currencies - as I explain in another comment in this thread.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Nov 22nd, 2005 at 06:18:19 AM EST
[ Parent ]
and the alleged currency switch--very clearly written and explained.

thank you for the great word seigneuriage.  it may be deep in my old memory banks somewhere, but I had to look it up.  the good articles seemed to be in French, and Google translated, more or less.  my french is not that good to read directly and understand.

let me see how close we are in our thinking on this point, because like you said earlier, we sometimes talk past each other.  I agree seigneuriage is a benefit to the US.  but is it not an earned benefit?, that is dependent on the trust of the world in the long term strength of the US economy, and the ability of the US to appropriately manage its debt.  My economic history is a little weak, but I think Great Britain had this position of privlege many years ago, but their economy did not remain strong, and foreigners lost their trust in the ability of the Brits to manage their finances.  So over time, the market decided to remove this trust from the UK, and it ended up in the US.

It's a benefit to the US because as long as they have this trust, they can effectively borrow money, from their own citizens and the world, by simply printing money.  But the flip side of printing money is increasing the national debt, in the form of US Treasury notes.  Foreigners look at US 10 year notes today, and at this very second they can buy such a note which will pay them 4.461% per year, in dollars, for the next 10 years if they choose to hold it.  That is the market clearing price.  (Another diary maybe someday, but this is an incredible innovation in itself that has come with computer technology and well managed financial markets--it makes these financial choices available to you and me, the small guys, and not just the wealth barons.)

So what I'm trying to say is that the US provides a good investment for people outside the US.  They can invest in a stable currency and economy, rather than only having the option of investing in  their own country, and therefore, their own currency.  Why is it viewed as good?  Because the market which changes in real time, says that 4.461% is a good return if it's in dollars.  If the market doesn't believe that, they'll buy fewer notes, the interest rate will have to go up to clear the market.  So this system self regulates.

Traders can do this at anytime with other currencies.  Some traders are viewing the Euro as strong, and buying Euro's today as a good investment.  (I think someone pointed out that Warren Buffet recently disclosed a big loss by betting on the Euro.  On the other hand, many traders made huge gains by doing this during the dollars fall of the last several years.)  So the US has to earn this trust every day--to a very hard group of people, slick investment people who just want to increase their return.  They'd write off seigneurage for the US in a heartbeat, if they lost faith in the US economy, and the US management of it's debt.

If you borrow in your own currency, you let others take the currency risk, a great privilege.
So yes I agree with this, but it's a privlege earned every day, it can be lost, and it's a benefit to both sides.  

Am I in line with your thinking, and just saying it  in another way (some might say a longwinded way)?  Or am I missing something here?

by wchurchill on Tue Nov 22nd, 2005 at 12:10:12 PM EST
[ Parent ]
The valuation of the Euro seems to be very vulnerable to the latest political news in Europe. Nothing to do with the fundamentals.

Also, it is pretty obvious that the Pound has been a tad overvalued relative to the Euro for a while. The same retail item will often be priced the same numerically in Dollars, Euros and Pounds.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Tue Nov 22nd, 2005 at 12:15:00 PM EST
[ Parent ]
I've never seen that. 1.75 to 1 is a pretty big difference.
by Lud on Tue Nov 22nd, 2005 at 01:45:06 PM EST
[ Parent ]
It is trust earned. What a lot of people are worried about these days is that the USA are abusing this trust by taking on more debt than they should, thus threatening to weaken their own currency - and also the instrument used by others to trade and store value.

As Nixon's Secretary of Treasury said: "the dollar is our currency and your problem". We live withe this "problem" for so long as its collective benefits outweigh its costs. The USA are busily increasing that cost today.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Nov 22nd, 2005 at 02:59:58 PM EST
[ Parent ]
rather the US wasn't skating so close to the edge.  I know we have different views on this US economy, and if yours prove to be correct, the US and my investment strategy is in trouble, so it makes sense you're more concerned than me.  If my assumptions are right, increased growth will increase tax revenues, start cutting the size of the deficit, and give the world increasing confidence--making me a little less worried than you.
by wchurchill on Tue Nov 22nd, 2005 at 03:20:07 PM EST
[ Parent ]
Increased growth increases the trade deficit, which is putting the US on the edge to a much greater degree than its government budget deficit.

What could turn the US into the world's greatest Argentina is the arrival of $100 per barrel oil.

by capslock on Wed Nov 23rd, 2005 at 08:55:04 PM EST
[ Parent ]
not really true that increased growth increases the trade deficit.  Growth often means more exports, and more internal to the country business.  For example, china is growing like a weed, but obviously not incurring, or increasing a trade deficit.

Trust me, the US is not going to be an Argentina--maybe a UK loss of financial dominace that occured decades ago.  But there just is no logical analogy between the US and Argentina.  Just to test your belief in that concept, it means the dollar will absolutely plummet, so you should put a ton of your savings into shorting the dollar, and leverage that bet.  If you're right, you'll be a multimillionaire--but I wouldn't do it if I were you.

by wchurchill on Thu Nov 24th, 2005 at 02:05:37 AM EST
[ Parent ]
WChurchill, what do you have to say to the IMF's warnings about the imbalances in the US economy, and its global consequences?

The problem with shorting and leveraging is that you may be able to predict the direction of a movement, but not its time scale. So you need deep pockets.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Thu Nov 24th, 2005 at 08:41:03 AM EST
[ Parent ]
 or "seigniorage" in English. That may explain why you couldn't find any "good articles" in English!
by Matt in NYC on Tue Nov 22nd, 2005 at 11:20:53 PM EST
[ Parent ]
thanks matt.  you were 100% right.  really helped me understand this better.
by wchurchill on Tue Nov 22nd, 2005 at 11:42:51 PM EST
[ Parent ]
And why was Iraq invaded?

Because Saddam had swtiched to Euro trading for oil, thus threatening the US military-industrial complex which needs to print money.

This is a fact.

You can't be me, I'm taken

by Sven Triloqvist on Tue Nov 22nd, 2005 at 03:40:34 AM EST
[ Parent ]
No, it was because "Saddam tried to kill my dad".

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Tue Nov 22nd, 2005 at 03:41:32 AM EST
[ Parent ]
currency trading.  It's not an issue.
by wchurchill on Tue Nov 22nd, 2005 at 04:20:26 AM EST
[ Parent ]
This is silly. See my post above which explains whyin more detail.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Nov 22nd, 2005 at 06:28:04 AM EST
[ Parent ]
I just posted an old re-edited diary on this subject 'Passing The Buck'.

You may disagree with the simplistic view that I lay out. But I still say that protection of dollar energy trading was a key factor in the US Administration's thinking on Iraq - especially given that it appears to have been Cheney driven with Oil companies in mind...

You can't be me, I'm taken

by Sven Triloqvist on Tue Nov 22nd, 2005 at 08:07:20 AM EST
[ Parent ]
by wchurchill on Tue Nov 22nd, 2005 at 12:11:31 PM EST
[ Parent ]
You talk a lot about confidence in the long-term health of the US economy. Many people think the US economy has serious structural imbalances that keep getting bigger, and that the dollar's role as reserve currency is to a large extent linked to the US' military might.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Tue Nov 22nd, 2005 at 12:18:07 PM EST
[ Parent ]
 and they could care less about US military might.  they need to make a return for their customers.  Have you ever talked to a trader who said, "I think I can make more money on the Euro, but i think I'll take a lower return on dollars because I like the military."  If you believe the polls, most of them, particularly overseas, are against American policy anyway==so why would they do this?

In terms of long term strength, I'm just looking at productivity trends, growth, and the US position in what I think are key markets for the next 5 years--technology (IT), healthcare, and financial services.  I for one like where the Dow is in terms of the last 5 years, and where the Dow is in terms of the very long term.  I see it positioned perfectly for significant growth, but as you correctly state, others see doom and gloom.  That's good--different opinions make markets work well.  But actually I'm not trying to convince anyone of this, it's a forecast that obviously could be wrong--I only mention it because I find people think very seriously about economics before they bet their pocketbook, their retirement, their future--so you'll know I've thought about it--but still could be wrong.  Since I wrote my growth diary on Sept 15, the Dow is up 2% ish, and the Nasdaq 5% ish (nasdaq has a higher perc entage of the growth stocks I like).  Now my forecast was for 5 years, with ups and downs--so I'm not celebrating--but it's better than a stick in the eye.

by wchurchill on Tue Nov 22nd, 2005 at 01:14:53 PM EST
[ Parent ]
traders of course drive the markets that they are given.

Given that they could have a Euro Oil market if certain major producers switch from dollars, then of course they will find the right price to make a profit.

Traders cannot trade in markets that become defunct. So I don't think you quite understood the argument.

You can't be me, I'm taken

by Sven Triloqvist on Tue Nov 22nd, 2005 at 02:36:13 PM EST
[ Parent ]
is that the Dow has been moving sidewards since 2005. And when you're not looking at the indicators above, but at what the Americans actually can spend (no savings, housing bubble to go bust soon), it's hard for me to see the imminent significant growth. In fact, the argument could also go the other way round: the traders are critical of the soundness of the growth and thus the Dow's not been able to go past the 11000 mark.
by srutis on Tue Nov 22nd, 2005 at 03:57:39 PM EST
[ Parent ]
noticed that the Dow is almost within 1% of 11,000 at today's close.  The Fed seems to be getting concerned about continual interest rate hikes--particularly with the 10 year treasury not going up, because people don't see long term inflation--see Jerome's new story just posted within the last hour.

Now I'm playing this for the med--long term, 5 years, and expect ups and downs,,,,but I am becoming more encouraged with my prognostication based on events this month.

by wchurchill on Tue Nov 22nd, 2005 at 06:17:16 PM EST
[ Parent ]
From the Economist both are year/year figures:

CPI: +3.2%
M3: +7.3%

The DOW is down 1.2% versus CPI and down 5.3% versus M3.  

I concur both figures have problems.  The CPI is notoriously a "political" estimate.  But loss of year/year Purchasing Power needs to be estimated when analyizing investment returns.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Thu Nov 24th, 2005 at 11:27:23 AM EST
[ Parent ]
where Asians are suddenly going to be able to afford a lot of nice things
Not only is this a good thing, but it started 60 years ago in Japan.  Many Asians can afford lots of nice things--think of Japan, Taiwan, South Korea, Singapore.  And many other Asians are following those models--Malaysia, Thailand.  It happened because they found industries to participate in, got in influx of capital to build their infrastructures, became very productive as countries, raised their standards of living tremendously, and then saved and invested in their own countries (and outside).  China is on that same path.

Now I don't want to imply that all of these growing economies are perfect, because they are not.  But if you have visited them over the last few decades, you'll see that they are improving year by year in their standards of living--or just look at their national economic numbers.

But US living standards, didn't fall.  They rose.  Americans, and the world more generally, has benefited from this productivity--just look at these wonderful Japanese cars as an example.

History doesn't repeat itself perfectly, but this same pattern will continue.  The Asians are going to do better and better--their productivity is tremendous, and there are still many areas where workers are vastly underutitilized.  It doesn't require an American collapse.

by wchurchill on Mon Nov 21st, 2005 at 05:23:47 PM EST
I know you are new to the blog (I'm not an old timer), but I think a few months ago some were bemoaning the long hours that Americans work per week.  Fewer vacations, less holidays--an overworked and stressed society.  I don't know a parasite like that myself.

Then does a parasite produce all of these wonderful new technologies that we are all benefitting from--like the computer you're entering this data on.  Like the Internet that allows this wonderful around the world dialogue we have on this website.  The vast majority of IT innovation is being driven out of America--I don't think those techies are spending a lot of time on their lazyboy's eating the food from all those Asians.  And then how about all of the healthcare innovations.  Americans are producing far more than their pro-rata share of these innovations--far, far, far more.  And you may not know this, but when a non-American gets an innovative idea, it's pretty common for him to bring it to the US, where the infrastructure in industry exists to develop that idea into a prototype product, run the gamut of clinical trials to prove that it works.  the place where all the people skills to make all of this happen exist.

I don't have the numbers in front of me, but isn't American GDP growth chugging along at 3.5% or so--very high for such a developed economy.  How do parasites do that?  Productivity improvement is very high.

Then when these asian countries look for the money to build their infrastructures, where do they ususally come to get it--right,, the US.

America is not perfect either, but parasites--I think not.

by wchurchill on Mon Nov 21st, 2005 at 05:35:07 PM EST
Of course America is not a parasite in the larger context. On the contrary, if there is one thing that makes me proud to be an American it is the fact that Americans bust their ass every day and lead the world in innovation. Nobody can doubt that, and I'm confident that when the current situation collapses America will be in a very good position to rebuild itself and return to a normal, responsible level of existence, and will be again poised to be the world leader economically.

But if there is one thing that I would change about America if I could it's the propensity it has developed in the last ten years not only to live far beyond its means, but to see that as somehow a positive, normal thing.

In this context America is sucking money off of asian countries, albeit with their full cooperation, which technically makes America parasitical in this relationship.

As for money to do anything, yes, America seems to be handing out a lot of money in terms of buying the products of other nations. But when the money being spent is actually the money of the person being paid, I don't see how that can be thought of as being beneficial or responsible.

by Lud on Tue Nov 22nd, 2005 at 04:06:31 AM EST
[ Parent ]
out a mortgage on your home, or a home equity loan.  These people who buy our American stocks and our Treasury bonds are not fools--they're investors.  Someone also buys your mortgage.  Muslims today and early Christians of the past, didn't like usury (interest rates).  Trading today's dollars for tomorrows, and collecting interest.  That is all that's going on here.  If the investors some day decide we can't pay our mortgage, well then it's a problem--but it's never been a problem for a strong economy, and it doens't come about with an "oh my god" kind of thing.  Your mortgage rates just start to go up, and you say, "oh, i'd better change" and you pay off the mortgage.
by wchurchill on Tue Nov 22nd, 2005 at 04:27:21 AM EST
[ Parent ]
Nobody is saying that any kind of borrowing is bad.

But the current situation is (according to people smarter than me) unprecedented--the American economy is getting an infusion of 3.5 billion dollars every day from outside the country in order to continue 'growing'. The average american has stopped living off of his productivity (his income) and has switched to living off his wealth (in general, credit based on the inflated value of his house, which he was able to pay for because of historically low interest rates, which, as you say, will need to rise if america wants people to keep buying dollars).

And again, I guess I just don't share your rosy view. I think that since Reagan's forced optimism of the 80's, and especially since the latest right wing, short sighted, pro business takeover, I think america has lost any rationality it might have had left regarding fiscal responsibility. Big economies can definitely have 'oh my god' kinds of things. I think the argument that 'it hasn't happened before' is pretty weak, indicitive of the current problems in the American model (the 'America is special' mentality), and simply avoids the discussion of how these things actually come to pass in the world.

by Lud on Tue Nov 22nd, 2005 at 04:49:08 AM EST
[ Parent ]
I wish people woke up to the fact that our governments are basically paying for the US occupation of Iraq through the money they lend the US (this was a fact I first saw pointed out in the International Herald Tribune, of all places). It wouldn't be pretty.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Tue Nov 22nd, 2005 at 05:20:06 AM EST
[ Parent ]
The implication of what you are saying, is that American borrowing is bad--or maybe I should use your own word "unprecedented".

And I don't feel "it hasn't happened before".  I tried to say it better in a post to Jerome above.  The UK had the US seigneurage position a long time ago, and lost it, as their economy soured.  So it could happen.  Maybe you could comment on that post, and see if we have a disagreement still.

by wchurchill on Tue Nov 22nd, 2005 at 12:18:47 PM EST
[ Parent ]
and don't take my word that it's 'unprecedented'. Of course opinions about things like this can diverge but I don't think anyone except die hard 'reagan proved deficits don't matter' types are arguing that the current situation is 'normal'. from a article in The Age:

US consumers and businesses have been buying their goods from and outsourcing their services to cheap currency countries, which has stopped what would have otherwise been a natural devaluation of the dollar. As a result, the US current account deficit is now pushing $US800 billion, $US300 billion higher than when, as research house Bridgewater Associates puts it, "private sector capital gave up on the dollar in 2002". It is also the biggest financing task the world has ever known.

The world has changed a lot since the pound lost its status as the world's currency, which correct me if I'm wrong happened around WWII, when the entire world economy was effectively shattered anyway. The rise of asia and the rest of the developing world, globalization...I don't think there's any comparison.

by Lud on Tue Nov 22nd, 2005 at 01:59:35 PM EST
[ Parent ]
runs huge defecits like this for the next 5--10 years, it will be a problem.  But they won't.  The economy is growing nicely--producing higher tax revenues.  The Iraq war won't last forever--leading to a reduction in spending.  The country has run large deficits before--I think larger on a % of GDP basis, and it's adjusted.

And you don't think all of these non-Americans, you mention Asians, are pumping money over to America because they're dumb, do you?  Of course not.  They see a growing economy in America; they see a dollar that is weak by historical standards--so they're hoping that their investments in America will do well, and then if the dollar strengthens, when they bring the money back in their own currencies--they're hoping to make big money.  I'm not sure I would bet against them.

The sky is not falling in America.  In fact the stock markets are warming up over hear.  Might be a good time to put some of the bucks in the savings account, into the stock market--you may be able to squeeze a few more years out of your rock star life style in Holland.

by wchurchill on Mon Nov 21st, 2005 at 05:43:32 PM EST
as a <snark>.  i didn't know if your rock star comment was in jest, but i thought so, and was just playing off it.  welcome to the site.
by wchurchill on Tue Nov 22nd, 2005 at 12:03:00 AM EST
[ Parent ]
That the US Government announced last week it was going to quit publishing MP3 figures.  

As I understand it, by looking at the MP3 figures you can tell when the big players are toying with the markets to make them come our right, so apparently we are not supposed to know they are doing it.  Having the economy look good through the first half of 2006 seems to be the plan, and we are not supposed to notice how much fresh money is being pumped into the economy to keep the charade going.  

The logic here is obvious to anyone familiar with drug addiction:  When you are about to crash, snort another couple lines!

After the election in November, expect the wheels to come off.  

The Fates are kind.

by Gaianne on Tue Nov 22nd, 2005 at 06:17:53 AM EST
[ Parent ]
They don't want double-plus ungood thinkers - c'est moi - noticing M3 is rising by 7.3% over last year while wages rose a dramatic (snark) 2.6% over last year.

The muse of poetry strikes:

Oh dear!  Where can the money be?
It's not going to wage power parity.
There is a slight haze of obscurity.
"Bubbles," his thumbs on the scale.

(OK.  Mayhap it's the 'Moose' of poetry.)

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Tue Nov 22nd, 2005 at 05:37:15 PM EST
[ Parent ]
Very good.  :D

The Fates are kind.
by Gaianne on Tue Nov 22nd, 2005 at 09:39:58 PM EST
[ Parent ]
well I certainly don't share your optimism that somehow with a shrinking high-income tax base (due to irresponsible tax cuts on corporate profits and the super rich, which is where all the growth is), an again population, exploding military spending (if you think Iraq is the end of that road you're definitely an optimist) and a general malaise on the rest of the economy that somehow America is going to 'grow' its way out of the deficit. Serious economists have blown this argument off for a long time.

And I don't think anyone per se is dumb here, either the Americans living far beyond their means or the Asians who are financing it. But to assume that somehow they are doing this for good, far sighted reasons is incredibly naive I think. A far more plausible explanation is that they are doing it for the reason most of us do the things we do--it seems like the easiest thing to do at the moment to accomplish their goals.  

It is a fact that the japanese and chinese have been buying up billions of dollars in order to artificially keep their currencies lower in relation to the dollar so that their exports are not priced out of the market in the US. That can only go on for so long.

The proper, natural outcome for this situation--and there is wide agreement on this--is that the world is going to have to equalize somewhat. The US standard of living is unsustainable; this doesn't mean it will collapse, but it cannot go on the way it is, with perpetual, structural consumer and government debt. And it only makes sense that sooner or later the investor countries will skip the middle man (America) and start buying their OWN products.

by Lud on Tue Nov 22nd, 2005 at 04:28:05 AM EST
[ Parent ]
disagree.  We'll just have to see what happens.  You of course should be shorting the dollar if you believe your theory--which I agree could be true.  but that's not my bet, and I'm long in growth stocks in America and Asian (non-Japanese) mutual funds.  It's the reason there is stock and currency markets--if everyone thought the same thing, there couldn't really be a market.  Good luck!
by wchurchill on Tue Nov 22nd, 2005 at 04:36:40 AM EST
[ Parent ]
If you believe this blog,
http://www.rgemonitor.com/blog/setser/108356
 the asian are not funding the whole american bill anymore, at least at the state level; Bank of  Japan is  out of the business for instance. You have petrodollars coming in instead.
Maybe it is more stable? think of a middle-age prince collecting a tax on the land resources; The prince was not a parasite, but a mighty warrior; it lasted quite long as a system. What leads back at the oil-currency debate there.

By the way, the blog is interesting if you want to follow the topic of economic global imbalance, and probably known to the economist crowd here. As the author says himself, he is quite pessimistic about the dollar since some time now, but at the moment facts are proving him wrong, what does puzzle him.

What I have not seen in this blog and never had the courage to ask in its comments , being my english and economist skills too poor, is how sure are we that the deficit of the US with china is a real threat considering the following.
At least 60% of the volume of export resort to multinational or american companies. The chinese goods cost 1 to produce, and are sold for 10 in the west -ask any industrial manager, but I shouldn't lay too far. Where are the nine other dollars landing? If we say 2 to 5 end in the pocket of the retailer, where do we find the remaining at least 5 bucks in the trade statistics?
Between Shangai and Albuquerque, over the Cayman Islands or London, someone has to decide, and I don't believe that "someone" like paying taxes. But at the end, I don't know of any American successful businessman who wish to buy the Mansion with pool in China for his retirement, so maybe you can count that the money will still flow from "abroad" into the US, at the end of the day.
I don't know if someone can quantify that factor, but I would love to know.

La répartie est dans l'escalier. Elle revient de suite.

by lacordaire on Tue Nov 22nd, 2005 at 06:37:37 AM EST
The chinese goods cost 1 to produce, and are sold for 10 in the west -ask any industrial manager, but I shouldn't lay too far. Where are the nine other dollars landing? If we say 2 to 5 end in the pocket of the retailer, where do we find the remaining at least 5 bucks in the trade statistics?
Assume that there are 10 intermediaries between the producer and the consumer. If each intermediary makes a 25% margin you get your 900% price increase. No single intermediary makes more than 200% of the original price (the $2 retailer makes in your example). The total GDP is 4600% of the production cost. Never underestimate the power of geometric progressions.

By the way, this is why the argument that "oil only makes up 2% of the GDP (or whatever %)" is fallacious. After oil input has fed several layers of intermediaries, each of them making a modest profit, the economic impact of oil is not commensurate with its GDP impact.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Tue Nov 22nd, 2005 at 06:54:01 AM EST
[ Parent ]
the benefit the consumer is getting in this whole equation.  he/she is buying goods at, say 10--30% lower than they would otherwise get them.  And I think we've learned from the US auto industry's collapse with Japanese competition, that these goods can be great quality,,,with cars, better.

Second, I don't know if you meant your comment on the "middleman" to be pejorative or not.  But the traders, the distributors, the marketeers, the transportation, the Internet that gives more visibility to smaller and foreign producers, etc. etc. etc. are critical to these products arriving in the US and Europe.  They are not production costs, but there are lots of real costs in there.  True in the beginning there may be some nice profit margins, but soon other suppliers and other channels of distribution start competing, and prices and margins fall.

by wchurchill on Tue Nov 22nd, 2005 at 12:51:51 PM EST
[ Parent ]
Please don't read any value judgements into this post of mine, especially since I use the neutral term intermediary instead of the loaded middleman (nobody talks about cutting out the intermediary).

I also make a point about the effect that adding a layer of intermediaries has on the GDP.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Tue Nov 22nd, 2005 at 12:58:25 PM EST
[ Parent ]
clarification.  It was the layering comment that made me ask.  but I understand now.
by wchurchill on Tue Nov 22nd, 2005 at 01:16:51 PM EST
[ Parent ]
THanks for your response, but I still wonder where those layers end in the trade statistics.
Transport is not so expensive, so long as it is not a bulk product. I remember reading some examples, where the shipping cost was astonishingly low.
For the others costs, I guess the intermediary can choose where he makes his invoices from. Are the dollars he cashes prone to end in America, even if they appears to be in the trade deficit today, or could they end somewhere else if you have a switch in the opinion about USA / dollar as a safe heaven?

La répartie est dans l'escalier. Elle revient de suite.
by lacordaire on Tue Nov 22nd, 2005 at 05:27:59 PM EST
[ Parent ]
I'm sorry that I don't have time to write a longer comment, but lacordaire is right that Asians are no longer buying lots of Treasury Bonds - over the last 6-12 months, that role has shifted to petrodollars out of London.  I believe that the Federal Reserve Bank's Flow of Funds report gives the details.  

The Asian central banks had a clear mercantilistic purpose behind their buying, but the motivation for this new money isn't as clear.  Are they reaching for yield?  After all, US Treasury Bonds yield 1 percent more than Eurozone bonds, or 3 percent more than Yen bonds.  Are they seeking security?  Maybe, but then why are they also buying corporate bonds and equities?  Are they paying protection money to keep the US Army out of their nice little kingdoms?  That seems unlikely, but stranger things have happened.

by corncam on Tue Nov 22nd, 2005 at 02:03:25 PM EST
[ Parent ]
in a portfolio of US Treasuries, corporate bonds and corporate equities, presumably he is doing so to makie money.  Accepting your numbers, the interest rates are higher here, so for the fixed income portion of the portfolio he is getting a better return than elsewhere.  He obviously knows that future currency movements can help or hurt him, so he likely thinks that it's unlikely the dollar will devaluate more than 1% ish--if it does he loses the extra 1% of interest rate, and he may think the currency will appreciate, giving him a higher gain.  He likely also believe the US stock markets are undervalued, as I do, and sees that as a nice opportunity.

I would agree with that view on US equities.  I would also agree with the view on the dollar in the medium term--3 to 5 years.  I don't know what will happen in the next several years.  But I wouldn't be surprised if that is a real winning investment strategy over the next five years.

by wchurchill on Tue Nov 22nd, 2005 at 02:46:15 PM EST
[ Parent ]
The financial markets of the world are not static.  They are dynamic.  Massively changing one fundamental input such as the perceived value of the dollar has a massive shift in the totality of the system.

If the oil market, tomorrow, switched to the Euro we would see a fall in the PPP of the dollar, a rise in the relative PPP of the Euro, further fall in the dollar as all of the dollar denominated finanical instruments are now worth less and owners start bailing out, a rise in the relative Euro/dollar valuation as the scarity of the Euro relative to the dollar comes into play, a sudden influx of dollars entering the American economy as some players trade financial instruments for hard asset instruments or even hard assets themselves, a dramatic spike of inflation in the US as these bucks flow in, a dramatic spike of valuation of the Euro versus every other currency, the US, and the world's, financial industry would come under intense pressure as their balance sheets go south, a switch in relative valuation of industrial production in China back to the US, a drop in the valuation of industrial production in the Euro Zone, and a fall of oil prices due to increased supply stemming from the lessened ability of the US consumer to buy gas for transportation.  

And that's just off the top of my head.  

How bad things would get would be dependent on the relative size of the moves of the differing inputs versus each other leading to movement of the totality of the system into a new equilibrium.    

Example, a currency is fungible when a buyer and a seller agree on a price.  If nobody is accepting dollars then, at that moment, the buck isn't worth anything in the other currency.  This is what happened to Indonesia a couple of years ago.  Nobody wanted the rupiah and so were not willing to exchange their local currency for the rupiah to purchase goods priced in rupiah and so it collapsed.  Once it was seen to collapse buyers waited to be able to glean large arbitrage profits from relative movements of two, or more, currencies.  The collapse started to end when trans-national corporations started snarfling up assets - such as factories - on the cheap among others factors which finally initiated a positive feedback cycle.  And a new equilibrium.

But an "new equilibrium" does not necessarily mean 'better.'  It could be 'worse.'  Given the centrality, currently, of the US in the world's economy a collapse of the buck would mean, my feeling is, 'worse' is much more likely.  

As things now stand.  

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Tue Nov 22nd, 2005 at 03:20:54 PM EST
This is what I was looking for. Great explanation.

In the show this is also something that happened, people stopped accepting dollars in forex transactions. That puzzled me, but now that I think of it it makes perfect sense.

One thing that still does not make sense to me is this: at a certain point (in the show) the eurozone artificially instituted and exchange rate of 1.17 to the dollar. Why would they do that? To keep eurozone businesses competitive (like China artificially controlling the value of the yuan)? Any idea?

by Lud on Tue Nov 22nd, 2005 at 04:00:44 PM EST
[ Parent ]
Fixing a currency ratio has any number of reasons but they all resolve to, IMHO, establishing firm perceptual and transactional links between the differing currencies and the underlying economies.

If you know 1.17 dollars can buy 1 Euro worth of goods/services in the EU then a dollar will fluxuate around 1.17 Euros +/- externalities like transportation cost, market avaliability of the goods/services, arbitraging opportunities, and yadda-yadda.   At the same time it, more-or-less, fixes relative labour cost of producing the goods/services which tend to be the largest expense of those goods/services.  

Using the Yuan ...

Right now the trans-nationals can "buy" in low cost labour zones (e.g., Mainland China) and "sell" in high cost labour zones (e.g., US) and pocket the difference PLUS the difference (~ 30% of wage rate) in employee cost.  A $10/hr worker in the US costs $13 but in China that same worker would only be paid $1.25/hr and total costs of $1.625 with each worker producing the same amount of goods having the same selling price in the US.  Stablilizing selling cost of the good at $15 - just for illustration - the profit on the US worker is $2 versus $13.375 profit from the Chinese worker.  

In practice it isn't quite as clear cut, and profitable, but the principle is accurate.

What happens is some bright MBA figures they can increase total profit by lowering the cost of the Chinese made goods by a dollar and only make a measly $12.375 per product but make more by increasing market share -- selling more of 'em.  Everybody manufacturing the product in China does the same, and the US manufacturer has to follow, or go out of business.  But note the US maker has had their profit margin drop a whopping 50%: $1 to $2.   The Chinese makers have accepted a (roughly) 8% drop but they are still receiving a huge profit, compared to the US (EU) maker per item.  

Again, in practice it isn't quite as clear cut but the principle is accurate.

Eventually the US (or EU) maker have to abandon their workers and move to China or they go out of business.

Fixing the currency ratio stops this - for a while.  But the relative "distance" between the high and low labour cost zones will "narrow" over time.  How that plays out is uncertain but usually there is movement towards lower wage rates until some sort of parity, however defined and reached, is realized.  

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Tue Nov 22nd, 2005 at 05:08:38 PM EST
[ Parent ]
thanks for the better numbers.  I would run the example again, but I don't think i need to because all of the trends and conclusions are the same.  I haven't seen any comment back, so I'm assuming people agree with the analysis?
by wchurchill on Wed Nov 23rd, 2005 at 12:23:12 PM EST
I'm not one of those people who have absolute faith in markets, but this documentary sounds more than a little slanted and, as I shall attempt to explain below, idiotic.  There may be elements of a parasitical relationship, if that's what you want to see.

But the analogy is, frankly, shallow and demonstrates a lack of understanding with regard to trade, in my opinion.  Trade is not about what you can export; it's about what you can import -- knowledge and technology, most importantly.  The situation of the Asians and the American on the island is not one involving trade.  (What are the Asians getting in exchange?)  So, no, economists would not say, "This is great.  Otherwise the Asians would have nothing to do!"  They would say, "Jesus Christ, these Asians are dumber than a box of rocks.  They're just giving stuff to the American!"

The analogy completely ignores the concept of incentives and is, therefore, useless in any discussion of economics.  If this is what "modern economists" would say, then the field of economics is doomed, as are the (apparently retarded) Asians.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Thu Nov 24th, 2005 at 04:36:08 PM EST
The analogy is not shallow, if extended by one crucial detail: In fact the reason for the american to stay put all day is that he's guarding the only tree on the island with which one could build a raft. In exchange for all the good he's consuming, he's writing over, branch for tiny branch, the tree to the asians, thinking he's got a tree big enough for him to also build a raft, someday.
by srutis on Thu Nov 24th, 2005 at 05:10:08 PM EST
[ Parent ]
For the analogy to work, as you say, the tree would have to be growing at a fairly strong rate (say, 3.5% per year), and that rate would need to be fast enough to surpass the rate at which the Asians are taking his wealth.  It's not simply a constant draining of the American's resources.  It's not a zero-sum game.

The analogy also assumes the American produces nothing.  He is simply endowed with his wealth (the tree).  In reality, as I said above, the American's output is growing at about 3-3.5% every year -- less than the Asians', but still at a respectable pace.

You would also have to take into account the American's (and, if we chose to add him, the European's) incredible advantage in human capital -- an advantge that is slowly declining, yes, but no less still there.

That's not to say this all isn't a problem.  It is, as people in America's Mid-West, England's North, and Scotland (along with many others in areas of Europe and America) can tell you.

Eventually, China is going to let its currency float, and the sooner it does so, the better, as far as I'm concerned.  Will it be a tough adjustmen period?  Perhaps.  But perhaps not.  Economics is not an exact science -- and I'm thankful for that, since it's impossible to divorce the field from politics -- and no one knows how the adjustment is going to hit.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Fri Nov 25th, 2005 at 12:25:22 PM EST
[ Parent ]


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