I've been sitting on Stephen Diamond's November 6 essay, The Income Statement v. the Balance Sheet: Will the Economic Crisis Unravel the Long Peace? because I planned to write a book in reply but before the days turn into months here are my thoughts about his concern.
My problem with his discussion is that he's not factoring in the real story behind the economic collapse. In this he's not alone; only a virtual handful of Americans, most of whom relocated to Canada or Switzerland when Nixon shut the gold window, are aware that since the 1970s the major industry in the United States has been U.S. dollar sales to central banks around the world.
The industry is untaxed and run by people who are not elected and thus, are immune to the wrath of voters. This has led to great abuse of the U.S. dollar. Yet the ability of the industry to magically generate billions of dollars without generating runaway inflation insulated the American economy from the worst effects of the onslaught by Japan, Inc. and later from China, Inc. The downside is that the U.S. government's heavy reliance on the industry led to the horribly destructive policy that perpetual debt was highly profitable.
It was only a matter of time, however, before U.S. dollar hegemony would be challenged, which led to the joke that Saddam Hussein signed his death warrant when he conspired to accept euros in payment for Iraqi oil.
The worst downside of the U.S. dollar industry was that it came to substitute for the innovation that drives the kind of technological revolutions that Steve mentions in his essay, and which allows capitalism to function in a healthy fashion. "King Dollar," as Larry Kudlow likes to call it, became a king with feet of clay. The dollar ceased representing the hard work, ingenuity, and freedom of the American people. It became a symbol for a kind of extortion deal, in which countries that could ill afford it had to keep a large amount of their hard currency reserves in U.S. dollars if they wanted to buy OPEC oil and virtually all other key commodities.
The deal began to collapse under the weight of its unfairness, with many oil producers accepting barter or non-dollar payments from the poorest nations by the 1990s, and when a resurgent Russian energy industry challenged OPEC's power.
Yet the more the USD industry came under pressure, the more other nations were expected to carry an ever-leapfrogging amount of U.S. debt. There was no way the situation could continue indefinitely and it finally crashed with the bursting of the last financial-markets bubble.
I mentioned the key role of the USD industry in some of the earliest posts on this blog and warned that hard economic times were ahead for Americans as the industry ran into more and more obstacles. Yet I also noted that once America had gone through a painful readjustment the society would regain its health -- a true health.
The other side of the picture is that some carrying of U.S. debt by other nations is not an unfair burden because it's a de facto tax. Being the world's policeman is an expensive enterprise. That long peace Steve talks about has been mostly courtesy of Uncle Sam the Supercop.
If some readers shriek, 'Supercop? What about Darfur?' -- yes, what about Darfur? The USA wasn't going to lead the charge into Sudan because it was already under fire from almost the entire world for the Iraq invasion. But when we asked the African Union to take the lead with Darfur, then came the rattling of the begging bowl, hemming and hawing because no African leader wanted to a invade a Muslim nation, etc. etc. They wanted the USA to play the fool again, so they could blame all the downsides of an invasion on Uncle Sam.
The downside to weaning the world from American military protection is the specter of mushrooming small wars that could touch off the kind of situation that worries Steve. There is no easy reply to his worry. But the developing world and 'emerging' economies, in particular BRIC nations, are relatively untouched by the economic crises that spun out from the collapse of financial markets in September 2008. Russia has big economic problems, as does China, but so far these are unrelated to the collapse. That situation would change if the crisis continues to drag out.
Again, I think the underlying factor in the economic crisis is a currency crisis. I suspect the latter is the real reason for the hesitation of so many U.S. banks and corporations to part with their big cash positions. If I'm right, then quantitative easing measures won't work. Neither will nationalization of the banks.
Bottom line is that there's nothing spookier, as far as banks and big corporations are concerned, than a looming seismic shift in the international currency regime.
If you ask, 'What seismic shift? -- ah, that's just it! There is no shift, just a lot of shifting from foot to foot and everyone asking everyone else, 'So, any news about the seismic shift in the currency regime?'
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