Another question for all you Austrians

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Initial post: Oct 28, 2011 3:15:27 PM PDT
Last edited by the author on Mar 6, 2012 3:02:54 PM PST
SECOND QUESTION. Ok, this one is really long. I'm going to put together my understanding of the trade imbalance with China as deduced from the book. The book is a fairy tale (or rather fish tale!) but the names of the countries and politicians are usually easy to figure out. The two key countries related to my question are: Usonia and Sinopia (USA and China, of course). Here's how I put together the sequence of events. My question is, does my "putting together" accurately reflect what's happening in the world today (and reflect Peter Schiff's explanation), and if not, where and why is it inaccurate?

Here goes...

PART A. Basic principle: Sinopia exports consumption to Usonia (ie, Usonians consume). In return, Usonia exports production to Sinopia (ie, Sinopians produce.)

A1. To pay for consumption without adequate production, Usonia and Usonians borrow money.

A2. The lenders can only be producers and savers. Ie, people with real money. Ie, Sinopians. Sinopians lend the money that Usonians borrow by purchasing Usonian debt (government bonds).

A3. Sinopian purchases of massive amounts of Usonian dollars strengthens the dollar vis a vis their own currency.

A4. Thus, Sinopian products are cheap for Usonians. This stimulates Usonians to consume and Sinopians to produce and to sell. And to hire workers.

PART B. So, we have one side producing and one side consuming. Obviously, this can't go on forever. Something has to give. It gives in Usonia, where a housing bubble produced by easy money has just collapsed. Illusional assets are disappearing into thin air, as are jobs dependent on those assets. Usonians demand three solutions.

B1. Jobless Usonians blame Sinopia's weak currency. They demand that Sinopia strengthen its money and boost internal consumption.

B2. They also demand free money in various forms for those made jobless. They also demand free money for Wall Street and auto companies to keep the economy humming.

B3. They demand tariff protection for Usonian industries to keep jobs at home.

The first two solutions are in contradiction with each other. B1 demands a relative weakening of the Usonian dollar. But B2 requires a relative strengthening of the Usonian dollar! Usonians want to eat their cake and have it too.

And B3? Protection of local industry? Some protected industries might start hiring, but other industries will be hurt and have to fire. Why will they be hurt? Because consumers, paying higher prices for protected goods, have less money than before and buy fewer goods overall, hurting producers. And if the protection starts a trade war, things REALLY get bad. We get a downward spiral of rising prices and falling consumption.

Looking into the future, what if Sinopians either...

C1. Do as asked and strengthen their currency vis a vis the dollar? This will require that they stop propping up the dollar with purchases of Usonian debt (ie, Usonian govt. bonds). They might even start SELLING bonds that they've already purchased, further weakening (as they were asked to do) the dollar. Or,

C2. Decide that Sinopia needs more money to pay for some domestic crisis or other, and therefore start selling their dollar-denominated bonds (much better than raising taxes!). Or,

C3. Begin to realize that paper printed by an under-producing nation isn't really worth that much, and decide to get out before the value of the dollar drops. IE, they start selling Usonian dollars. (My own addendum: the country next door to Sinopia, which has recently been ravaged by a costly tsunami might also decide that selling dollars - it has a ton, too - is more in its national interest than raising taxes).

The Solution? Strengthen the dollar and the economy by turning off the printing presses. This will hurt for a while but it will redirect resources away from malinvestments (like Fannie and Freddie, who have `fishier' names in the fable) towards real production. You could also throw in some tax increases but those will be counter-productive if they inhibit capital investment.

However, radical cutting is not going to happen unless we get a Greek-like crisis because you don't normally win elections by turning off the printing presses. So the result in the book may be our fate. (BTW, even a Greek-like crisis may be inadequate. Just read in the paper today that one Greek legislator says that even the so-called "draconian" cuts which Greeks are protesting so vigorously, will still leave the government spending more this year than last year. That's fiscal austerity?)

A reminder. This is just a very long question. I'm hoping that those who know more than I do can explain what's right and what's wrong about the various steps, most of which I've gleaned from the book.

Thx in advance!

In reply to an earlier post on Mar 6, 2012 1:47:29 PM PST
Omer Belsky says:
Dear Mr. Ledbetter

Well, maybe the time will arrive when the US has to fear inflation, but we're not there yet. Currently, world demand for US government debt is huge. The inflation mongers have to read the story of the boy who cried wolf.

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Initial post:  Oct 28, 2011
Latest post:  Mar 6, 2012

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How an Economy Grows and Why It Crashes
How an Economy Grows and Why It Crashes by Peter D. Schiff (Hardcover - May 3, 2010)
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