The Big-Picture Economy, Part 1: Labor, Imports and the Dollar   (September 23, 2013)

It is impossible for the U.S. to maintain the reserve currency and run trade surpluses.

Many well-meaning commentators look back on the era of strong private-sector unions and robust U.S. trade surpluses with longing. The Progressive consensus (articulated by Robert Reich, among others) is that unions gave the working and middle classes bargaining power that has been lost in the decline of unions.

Other commentators look back with similar nostalgia on the large trade surpluses (i.e. current account surplus) of the same era--the 1950s and 1960s.

The two trends are connected. Unions had bargaining power because the corporations on the other side of the table were generally cartels (autos, steel, etc.) that were largely domestic, meaning that they were captive to domestic markets and politics.

All these conditions have changed. Present-day U.S. corporations are global, not domestic; up to 75% of their sales and/or profits are generated in overseas markets, and a similar percentage of their workforces are also overseas, not just for cost reasons but to stay close to the markets generating their profits.

Free-trade agreements restrict attempts to protect domestic markets from overseas competition, and as a result domestic unions have essentially zero bargaining power with either nominally American firms or their global competitors in most markets. The only sectors open to union bargaining power are domestic monopolies or cartels with no overseas competition, i.e. the government, which is why the union movement is now dominated by public unions.

The trade surpluses vanished for two reasons: global competition and to protect the dollar as the world's reserve currency. This is a difficult issue to grasp, so let's do it in parts:

1. When the global exporting nations recovered after World War II, their costs of labor and production were cheaper than American industry, which was hobbled by the strong dollar. For example, $1 bought 250 yen as recently as the early 1970s. Today, it barely buys 100 yen.

2. As a result, cheap imports took market share from domestic producers (believe it or not, BMWs were once relatively cheap), and the U.S. trade balance went negative, i.e. the U.S. ran trade deficits. To settle the deficits, the U.S. had to ship gold to the creditor nations.

3. As the trade deficits expanded, America's gold holdings shrank. The writing was on the wall: continued deficits would eventually shrink the U.S. gold holdings to zero, at which point deficits would be impossible to sustain.

4. As a result, President Nixon closed the gold window and the U.S. dollar floated in a market of supply and demand.

The second half of the story is Triffin's Paradox, an issue I have covered in depth:

What Will Benefit from Global Recession? The U.S. Dollar (October 9, 2012)

Understanding the "Exorbitant Privilege" of the U.S. Dollar (November 19, 2012)

Prior to 1971, the dollar was backed by gold, which acted as a supra-national anchor to the dollar's reserve status. The gold standard inhibited both massive trade deficits and money creation, so it was jettisoned.

The Triffin paradox is a theory that when a national currency also serves as an international reserve currency, there could be conflicts of interest between short-term domestic and long-term international economic objectives. This dilemma was first identified by Belgian-American economist Robert Triffin in the 1960s, who pointed out that the country whose currency foreign nations wish to hold (the global reserve currency) must be willing to supply the world with an extra supply of its currency to fulfill world demand for this 'reserve' currency (foreign exchange reserves) and thus cause a trade deficit. (emphasis added)

The use of a national currency (i.e. the U.S. dollar) as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: some goals require an overall flow of dollars out of the United States, while others require an overall flow of dollars in to the United States. Net currency inflows and outflows cannot both happen at once.

In other words, the U.S. must "export" U.S. dollars by running a trade deficit to supply the world with dollars to hold as reserves and to use to pay debt denominated in dollars. Other nations need U.S. dollars in reserve to back their own credit creation.

It is impossible for the U.S. to maintain the reserve currency and run trade surpluses. It's Hobson's Choice: if you run trade surpluses, you cannot supply the global economy with the currency flows it needs for trade, reserves, payment of debt denominated in the reserve currency and credit expansion.

If you don't possess the reserve currency, you can't print money and have it accepted as payment. (The euro and yen are quasi-reserve currencies based on the size of the European Union and Japanese economies, but neither acts as the primary reserve and as a result both are vulnerable to currency crises, despite the conventional wisdom that both are on the same footing as the U.S. dollar.)

Unions have little bargaining power in a global economy with surplus labor and mobile capital, and trade surpluses are impossible for the nation possessing the reserve currency. Some view this as a liability, but any currency that is not the reserve currency is vulnerable to a currency/credit crisis and collapse, for currency and credit are tied at the hip through reserves.

Those who disbelieve that the yuan, yen and euro are vulnerable to currency/credit crises--please check in around September 2015.

My new book The Nearly Free University and The Emerging Economy (Kindle eBook) is available at a 20% discount ($7.95, list $9.95) this week.

The Nearly Free University and The Emerging Economy:
The Revolution in Higher Education

Reconnecting higher education, livelihoods and the economy

With the soaring cost of higher education, has the value a college degree been turned upside down? College tuition and fees are up 1000% since 1980. Half of all recent college graduates are jobless or underemployed, revealing a deep disconnect between higher education and the job market.

It is no surprise everyone is asking: Where is the return on investment? Is the assumption that higher education returns greater prosperity no longer true? And if this is the case, how does this impact you, your children and grandchildren?

go to Kindle edition
We must thoroughly understand the twin revolutions now fundamentally changing our world: The true cost of higher education and an economy that seems to re-shape itself minute to minute.

The Nearly Free University and the Emerging Economy clearly describes the underlying dynamics at work - and, more importantly, lays out a new low-cost model for higher education: how digital technology is enabling a revolution in higher education that dramatically lowers costs while expanding the opportunities for students of all ages.

The Nearly Free University and the Emerging Economy provides clarity and optimism in a period of the greatest change our educational systems and society have seen, and offers everyone the tools needed to prosper in the Emerging Economy.

Read the Foreword, first section and the Table of Contents.

print edition (list $20, now $18)

Kindle edition: list $9.95, for one week only, $7.95 (20% discount)

Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify. We will cover the five core reasons why things are falling apart:

go to print edition 1. Debt and financialization
2. Crony capitalism
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Once we accept responsibility, we become powerful.
Kindle: $9.95       print: $24

NOTE: gifts/contributions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

  Thank you, James B. ($50), for your outstandingly generous contribution to this site-- I am greatly honored by your support and readership.  

"This guy is THE leading visionary on reality. He routinely discusses things which no one else has talked about, yet, turn out to be quite relevant months later."
--Walt Howard, commenting about CHS on another blog.

Or send him coins, stamps or quatloos via mail--please request P.O. Box address.

Subscribers ($5/mo) and contributors of $50 or more this year will receive a weekly email of exclusive (though not necessarily coherent) musings and amusings.

At readers' request, there is also a $10/month option.

What subscribers are saying about the Musings (Musings samples here):

The "unsubscribe" link is for when you find the usual drivel here insufferable.

Your readership is greatly appreciated with or without a donation.

All content, HTML coding, format design, design elements and images copyright © 2013 Charles Hugh Smith, All rights reserved in all media, unless otherwise credited or noted.

I am honored if you link to this essay, or print a copy for your own use.

Terms of Service:
All content on this blog is provided by Trewe LLC for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information. These terms and conditions of use are subject to change at anytime and without notice.

blog     My Books     Archives     Books/Films     home


Making your Amazon purchases
through this Search Box helps
at no cost to you:

to your reader:

Free Page Rank Tool #7 in CNBC's
top alternative financial sites

#25 in the top 100 finance blogs