Did Washington crash the economy trying to quietly support the export of manufacturing jobs?
Replacing Paul Krugman’s incomplete model of why governments pursuing their domestic economic policy goals must have a trade surplus, with our own model – that Krugman can only be correct if there is one country – the holder of the reserve currency – that can act as the global net importer of global surpluses – we have tried to show, at least in theory, that the result of this essentially imperial model of global trade is the loss of manufacturing jobs in the United States, as these jobs are forced off shore by a growing glut of capacity in places like China.
Now, Yves Smith has posted an important article to Naked Capital trashing Chairman Ben Bernanke’s justification for Federal Reserve policy in the run up to the Great Recession, which, we believe, lends further credence to our model of the American Dollar Empire, and which points to the Wall Street financial crisis as a massive collapse of the essential mechanism funding that empire.
The article, written by former New York Federal Reserve economist Richard Alford, questions Bernanke’s argument for the easy money policies the Reserve has followed at least since the Clinton Administration. We believe it presents strong circumstantial evidence that Washington had been deliberately and aggressively pursuing the export of manufacturing jobs, principally to China. Alford does not go so far as to endorse such a charge, but assembles all the evidence needed to refute Bernanke’s claims that low interest rates were designed instead to prevent deflation.
Alford begin with Bernanke’s own definition of deflation, which, as he explains in a 2002 speech, consists of two essential ingredients:
- Deflation is defined as a general decline in prices, with emphasis on the word “general.” At any given time, especially in a low-inflation economy like that of our recent experience, prices of some goods and services will be falling. Price declines in a specific sector may occur because productivity is rising and costs are falling more quickly in that sector than elsewhere or because the demand for the output of that sector is weak relative to the demand for other goods and services. Sector-specific price declines, uncomfortable as they may be for producers in that sector, are generally not a problem for the economy as a whole and do not constitute deflation. Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices, such as the consumer price index, register ongoing declines. And,
- Deflation is in almost all cases a side effect of a collapse of aggregate demand–a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending–namely, recession, rising unemployment, and financial stress.
Alford accepts this proposition:
“Bernanke therefore defines a deflation as a generalized, broad-based, widespread decline in prices brought on by a severe drop in spending. The 425 bps of rate cuts in the Fed funds target during 2001 was presented as necessary to prevent a demand-lead deflationary spiral.”
Alford then goes on to argue that the economy, during the period from 1995 to 2006, showed none of the signs of deflation as defined by Bernanke. In particular, he introduces evidence to support two important arguments:
First, there was never a generalized decline in prices – prices of certain goods were falling, but this limited to durable goods (according to the Wiki, “Examples of consumer durable goods include cars, appliances, business equipment, electronic equipment, home furnishings and fixtures, houseware and accessories, photographic equipment, recreational goods, sporting goods, toys and games.”). Second, Alford argues the fall in the prices of durable goods was not confined to periods of economic weakness as would be expected if they resulted from a fall in consumer demand. Instead, falling prices for durable goods continued from 1996 to 2006 – that is, through both periods of economic expansion and a period of recession.
So were companies having a problem selling durable goods? Alford shows that sales of durable goods were strong during that period and increased even more rapidly than other items. With this, Alford establishes pretty clearly that whatever was happening did not fit into Bernanke’s argument that prices in general were falling because of too little consumer demand.
Lower prices and higher quantities are not consistent with a drop in demand and producers having to cut prices to find buyers. They are indicative of a positive supply shock – an outward shift of the supply curve in this case for consumer durables.
According to Wikipedia, a positive supply shock occurs when a change in the production of a good happens that permanently lowers its cost of production. An example of this would be the difference in the cost of producing a book when people had to spend months tediously copying it by hand, versus now when you can simply right click on it and choose copy.
Alford also argues that overall demand in the economy exceeded its potential output over the period from 1995 to 2007 – in fact, even during the 2001 recession demand was higher than the US economy could potentially produce.
Given Bernanke’s definition of deflation, the US did not experience deflation at any point between 1996 and 2006, nor were there imminent bouts of deflation. Disinflation was localized in consumer durables and US economic agents remained willing to buy more than the US could produce. There was, however, a significant decline in the relative prices of consumer durables/tradable goods.
He then asks, “What was the underlying problem if it wasn’t insufficient US-based demand?” And offers these three:
1. globalization which lowered the prices of tradable goods,
2. a Dollar unable to adjust to maintain anything close to external balance, and
3. the absence of any developments or policies to promote/maintain US international competitiveness.
The US experienced disinflation and unemployment not because of a decline in the willingness of US-based economic agents to spend, i.e. the Bernanke explanation for deflation. Globalization was a shift in the world supply of tradable goods that lowered their prices. With the Dollar unable to adjust, some domestically produced, internationally tradable goods became non-competitive. US imports grew relative to US exports. The trade deficit/current account drove a progressively wider wedge between spending on final goods and services by US-based economic agents (FSDP) and the demand for US output (GDP).
While Washington was trying to encourage consumer spending, the problem wasn’t your willingness to buy that 42 inch, high-definition, wide-screen television from Best Buy with easy credit terms of zero percent interest for 18 months – the real problem was where the televisions were being manufactured!
During the period 1996 and 2006, there was a fundamental mismatch between the causes of the disinflation and unemployment and the policy steps taken in response. Policymakers employed the tools of counter-cyclical domestic aggregate demand management when the cause of the problems was a structural/permanent external supply shift. Policy in general – not just monetary policy – was inappropriate. Trade and Dollar/currency policy were inappropriate in that they failed to exist … Fed policy increased the demand for interest rate-sensitive goods such as housing and financial assets. The prolonged period of low rates altered investor and consumer behavior on a massive scale between 2001 and 2006. Fed policy incented economic agents to borrow short-term and buy real estate and financial assets. It incented financial firms to engage in regulatory avoidance and arbitrage, as well as to lobby regulators to relax limits on the sizes of balance sheets relative to capital. It also increased consumption and depressed savings through wealth effects.
Based on the above analysis, Alford argues that Washington’s current policy emphasis on stimulus and low interest rates are mistaken. Stimulus only treats the symptoms of the underlying problem without addressing its cause: the trade deficit. Policy should instead focus on increasing exports of goods and investment related to this.
Alford’s argument is loaded up with qualifiers and suspiciously technical language and references – usually a tip off that an economist is employing devious devices to make his point. But, based on the data he presents, it is possible to conclude, as Alford does, that years of loose monetary policy by the Federal Reserve, designed to combat deflation, was the wrong policy for the period. Indeed, the rebuttal Alford makes to Bernanke’s argument seems so very strong that we might easily overlook the fact that Alford never establishes that the Federal Reserve had any control over US interest rates during this period. Alford seems to be describing what was actually occurring, but, he is really only arguing against Bernanke’s justification for the Fed’s official policy! Bernanke’s justification for Federal Reserve policy on interest rates from 1995 to 2006 is the threat posed by deflation during that period. What Alford establishes is not that the policy was wrong, but that the justification for it doesn’t explain the low interest rates.
To put it another way, Alford never asks, “What other set of economic priorities might also justify low interest rates?” Bernanke is not stupid – he just thinks we are. He is looking at the same data Alford is looking at during this period 1995-2006. He knows there is no threat posed by deflation, and that what the economy is experiencing is a so-called supply shock as new capacity in China and other nations begin to spew out exports headed for the United States in great volume.
To make the significance of this point clear, let’s show another piece of data:
This is the Federal Reserve’s chart of unemployment going back to the series beginning in 1948. As you can see the grey bars show periods of recession, as defined by the National Bureau of Economic Research (NBER). The NBER is a private, non-governmental organization of economists, which sponsors the Business Cycle Dating Committee, whose members included, until last year, Christina Romer, Chair of the Messiah’s Council of Economic Advisers.
The NBER defines a recession this way:
A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.”
In the mix of determinants of a recession is the level of employment, but, as you can see, beginning with the 1991 recession, so little emphasis was placed on employment/unemployment that, for the first time in the history of the series, the recession was judged to over well before unemployment peaked. This happened again in the 2001 recession following the collapse of the internet bubble. In the present recession, most economists claim that the recession is over, and, rising unemployment is occurring in what they have labeled a jobless recovery.
In other words, since 1991, a recession has been quietly redefined so as to exclude a rising unemployment rate. This has occurred even as the Federal Reserve has maintained that its easy money policies are designed to increase demand in order to maintain full employment.
The importance of Alford’s argument is that he demonstrates, not that the policy was inappropriate, but that it was never meant to maintain full employment. If Washington, during the very same period, did not consider rising unemployment to be a policy level indicator when it came to figuring out whether the country was in a recession or not, there is likely no argument to be made that it influenced Fed policy on interest rates.
We just want to throw this out there – because we are obviously nuts, and, therefore, have no credibility – that the Federal Reserve designed its policy to support the export of manufacturing jobs from the United States to China. The deteriorating export balance of the United States has not been an unfortunate by-product of an inappropriate monetary policy, nor of a lack of trade and currency policies, as Alford argues. Washington has a consistent policy for all three:
Washington designed it to facilitate capital flight.