The confirmation of Saint Paul…
We previously pointed out the anomaly of capacity destruction taking place in the American economy during this crisis. The chart, shown below is unmistakable in this regard: manufacturing capacity, after decades of uninterrupted growth stretching back to the very earliest records available to us, fell for the first time in the last recession – two years in a row – and again, by a much larger margin, in the twelve month period ending in November 2009.
The anomaly was brought to our attention by another blog, and dismissed by still another blog as insignificant – indeed, the writers even argued that it was some sort of triumph of Schumpeter’s creative destruction taking place in the economy. We pointed out that this statement is nonsense on its face: During all those years, as US manufacturing capacity increased, obsolete capacity and uncompetitive capitals have have constantly been driven to devaluation and bankruptcy, yet overall capacity to produce goods in the US has always increased.
For instance, you might remember the Rambler, a car produced by American Motors. There were once dozens of domestic automobile manufacturers in the United States, but the process described above have left only two – Ford and General Motors (three if you want to include the zombie manufacturer, Chrysler). The ability of the US economy to turn out millions of cars has not suffered because of the loss of a large number of domestic producers, but has, to the contrary, increased every year.
Which is to say, it has increased every year until now, perhaps.
We raised the point this data demand be addressed:
The moment capitalism stops expanding manufacturing capacity, is the moment it dies. So, if Wall Street is destroying manufacturing capacity in the United States, you just might want to know where they are expanding it.
A summary of Saint Paul’s confirmation
In a recently released outline of a talk (pdf), Paul Krugman discusses the history of financial crises in the post-war period. According to his accounting, economists once believed a government could pursue its own policy objectives only if it accepted the depreciation of its currency – that is, if it accepted that its national money would, in time, buy fewer foreign made goods and services. An example of the kind of government policy objective Saint Paul is discussing here would be the US pursuit of unrivaled military supremacy. As the US pursued this policy it should have been required to produce a corresponding trade surplus to pay for it. And this means its imports had to fall relative to its exports.
Such a fall could be achieved all at once, if the purchasing power of its money fell relative to foreign currencies:
[G]overnments … found that their commitment to a fixed exchange rate was interfering with attempts to achieve domestic objectives, especially full employment.
The dominant economic model thus suggested the US would be free to spend wildly on military hardware, troops, and equipment, if it accepted, in return, that imports would become more expensive, and exports less expensive. If a country tried to pursue such a policy while maintaining fixed exchange rates with with other currencies, its own currency would come under increasing attacks from speculators until it submitted and devalued it currency.
But, it turned out that the case is not as simple as devaluing a country’s money in order to support the policy objective of its government. As was shown in the case of the Mexico and Argentina crises, and again in the case of the East Asia meltdown, a trade surplus is a real thing, composed of real goods which must come from somewhere:
But it’s not what happened to Mexico after the tequila crisis, or the East Asian economies after the crises of 1997, or Argentina after the collapse of convertibility in 2002. In all these cases the collapse of a fixed rate under speculative attack was followed by a severe contraction in the real economy.
Simply put: It was not enough to devalue the currencies of these nations, real goods and investment had to be diverted from domestic use to exports, and this occasioned a very nasty collapse of the living standards of the countries concerned. The pursuit by government of its own policy objectives meant the very real collapse of domestic consumption.
The key argument was that a currency depreciation set off by speculative attack would sharply worsen balance sheets, as the domestic-currency value of foreign-currency debt rose. This in turn would damage the economy, e.g. by depressing investment, which would feed back into further currency depreciation, and so on. Some models stressed the possibility of multiple equilibria, but even without such multiplicity there was the clear possibility of disproportionate depreciation and output decline from an adverse shock, including the end of a bubble financed by foreign capital.
(Notice here: Krugman completely neglects the impact on the country’s citizens – who experience this disproportionate depreciation and output decline from an adverse shock by selling their children into slavery in exchange for the mean of life. We are concerned, above all, with the impact on investment and commerce, not with the particulars of Thai child slavery markets – coming soon to suburb near you.)
A country could try to avoid this fate by refusing to devalue its currency, but, Krugman warns, the alternative is worse:
Real depreciation without [a currency devaluation] must take place through deflation. And this means that the real value of all debt, not just foreign-currency debt, rises. So the deleveraging crisis will be even worse if you don’t depreciate.
Refuse to devalue your currency, Krugman warns, and risk a complete collapse of your financial system in a catastrophic deflationary episode as debts become unrepayable, and banking grinds to a halt.
Kiss your assets goodbye
When these economists looked at the United States prior to the financial crisis, the warning signs of impending doom were so clearly evident as to constitute a “Wile E. Coyote moment”: No one seemed to realize yet that the ground under the US economy had disappeared. One reason for this: The US trade deficit was financed entirely by dollars, and Washington could print those dollars in whatever quantity was necessary to satisfy the terms of its debt.
Even if it would not do this, the dollar is the world reserve currency – it was the currency against which all the other nations found it necessary devalue their own currencies when they were in the same predicament. How can you devalue your currency against itself? The logic of the model failed when applied to the United States. And, when a model fails when applied to the number one economy on the planet, it reveals its essential absurdity in every case where it is alleged to have worked.
So what happens when a country cannot or will not devalue it currency, but, but holds no significant reserves of foreign currencies – when virtually all of its debts are denominated in its own currency? The answer is Japan. Years of deflation and economic mailaise, imploding prices for assets and goods, and nothing seems likely to reverse it.
… the example that comes closest to the situation facing the United States today is that of Japan after its late-80s bubble burst, leaving serious debt problems behind. And a maximum-likelihood estimate of how long it will take to recover, based on the Japanese example, is … forever. OK, strictly speaking it’s 18 years, since that’s how long it has been since the Japanese bubble burst, and Japan has never really escaped from its deflationary trap.
The Messiah and his economic advisers are banking on some sort of reasonable recovery timeline, but, at best, they are engaged in magical thinking – at worst, they know the likely results of this crisis as well as Krugman does, and only hope to anchor your expectations that tomorrow, next week, or next month some indicator from somewhere will provide some hope to you that the worst is over.
It is not.
Why it is not takes us back to that point about why when a model doesn’t work for the United States it is absurd. Recall, Krugman’s model states that if a country – let’s call it the United States – want to pursue a policy objective – let’s call it unrivaled military supremacy – it must let its currency depreciate until it has an export surplus. Clearly this is not true for the United States, which vigorously pursues military supremacy even as it runs massive export deficits. And, even if it were true, the special curcumstances of the United States – that it is owner of the world reserve currency – means it cannot devalue the dollar against itself.
What is true for every other country, can not be true for the United States.
But, is it true for every other country? Suppose, for example, that every other country likewise wanted to pursue some domestic policy objective. They would all have to produce export surpluses. And, if every nation is producing an export surplus, who is importing these surpluses? Are the surpluses simply piling up on the loading docks of every nation?
This absurd economic model suggest that it can only work if some nation, or group of nations, violates the model and become the designated importer of the surpluses of all the export surplus nations. The model, in other words, screams out that it is stupid! – an incomplete picture of what is actually taking place.
Which is why Krugman has to append a caveat to the model:
After all, a vicious circle of deleveraging could arise as easily on the asset side as on the liability side, as noted in Krugman (2002). It should have been easy to put the evidence of a mammoth housing bubble together with the concepts of third-generation crisis theory to see how a nasty deleveraging cycle could occur without the “original sin” of dependence on foreign-currency debt.
We wondered what Krugman meant by the term asset side deleveraging, and went looking for a definition on the web – no luck. The term doesn’t appear in the literature so far as we can tell. Then it occurred to us: This economic doublespeak is designed to obscure exactly what is currently taking place in the American economy right now. Asset side deleveraging is a fancy term for incredibly swollen prices of all forms of assets – stocks, homes, etc – an asset bubble, driving what has to become an ever increasing level of debt.
Krugman is essentially saying that debt in the United States wasn’t increasing fast enough to absorb the output which could be generated by all the new capacity being brought online in the world market. And, since an accurate restatement of the economic model Krugman has described must include the existence of a designated global importer with sufficient means to absorb all the surplus goods being produced by export surplus nations, capacity has to be reduced in the one place where the model suggests exports are unnecessary, but imports are required: The United States.
Consequently, the United States is experiencing a severe bout of deindustrialization as state-side factories are summarily closed and workers are dumped in the streets. Facilitated by a massive global overcapacity of capital, the pursuit of military supremacy by Washington is literally stripping the United States of its manufacturing capacity and moving it offshore.