Wednesday, September 3, 2008


(Week 6 - Wednesday, Sept. 3)

In yesterday's column we noted that into the late 1970's the city of Flint, Michigan was the home of one of the largest automotive production complexes in the world, but after a concerted program by the management of General Motors to relocate these factories to other areas (like, for instance, the desert in Mexico) that in a physical and human sense had virtually no natural advantages over Flint (in fact were hugely disadvantaged), the workforce shrunk to only ten percent of its previous size in less that three decades.

The economic reason widely attributed in the media and claimed by the GM management to have compelled such a drastic move was that the Flint plants and workforce were somehow no longer "competitive" in the "global marketplace." By constructing a mental checklist of the relative physical and human advantages of the Flint-vs.-Mexico siting I attempted to demonstrate that this could not have possibly been the reason in actual physical or human terms. The only factor that did seemingly make the move economically compelling was the relative disequilibrium in the exchange ratio between the dollar (which currency American workers get paid in) and the peso (by which Mexican workers are paid).

If the value of the dollar remains high enough for long enough, this effectively becomes the reason that American workers cannot "compete," supposedly, with their foreign counterparts. That has evidently been the case for the last few decades, as the U.S. has run up enormous and mounting "balance of trade deficits." The perception that this "imbalance" was in effect, and would be for some decades at least, must, it would seem, have been a factor in the mindset of GM management (though perhaps not consciously in these terms) when they decided that they just had to move those plants to save the company.

The question then becomes, what has caused the value of the dollar to remain so consistently high with respect to the rest of the world that the American worker, even with every physical advantage, is no longer "competitive" (i.e. can no longer sell his goods at a competitive price on the international market)?

The answer is that the American dollar is the "reserve currency" of the world. That is, it is effectively the backing for every other currency. This status was established officially at the Bretton Woods Monetary Conference in 1944 which set the basis for the post-WWII monetary order. The dollar was unofficially dubbed "liquid gold," and it has since evolved in a way that is consistent with that nickname due to many factors.

These include that the U.S. economy for several decades after WWII was by far the largest, most materially productive and most stable in the world. It is only natural that the currency which was backed by the economic (not to mention military and cultural) might of this "superpower" would become the most sought after in global trade. If one had a dollar, one could be confident of being able to spend it freely almost anywhere in the world. If a nation had an ample supply of dollars in its central bank, that signified in the eyes of the world that it was "solvent" (much as gold used to indicate the same),which bolstered the value of that nation's own currency as well. World trade in oil was conducted (and still is) only in dollars. The list goes on.

The demand for the dollar has been, and remains, huge; so much so that well over half of American money circulates outside the U.S. (which is not to say that confidence is not wavering). As we have talked about since the start of this series of columns, the dollar is a "debt"-based currency that is created and borrowed into existence through private banks. It is out of the combination of these two factors that the potential for the American government to sell trillions of dollars worth of bonds "backing the dollar" arises. The process manifests in a cycle that basically unfolds as follows.

Participants in the U.S. economy borrow hundreds of billions of dollars into circulation through the private banking system every year. This money injects tremendous buying power into the American domestic market (which is complemented by American's huge appetite for goods). Americans could use the money to buy the output of their own factories, but it is often less expensive to purchase what they want from foreign nations, partly because these nations are willing to sell their goods more cheaply in order to obtain in the exchange the dollars that they need. They must, for example, have dollars to buy oil on the international market.

So, the U.S. runs up a huge "balance of trade deficit", and our dollars flow to foreign countries; but, they can't stay there. They have to flow back. Otherwise they will cause inflation in their own domestic market such that they will lose their "competitive" trading advantage and the flow of dollars will stop, or reverse.

Generally, foreign central banks, to support the value of their own currencies, buy up the "debt" paper (i.e. Federal bonds and other "debt" contracts) by which U.S. currency comes into being. They become the recipients of the "interest" payments that are made to service the "debt" on the U.S. money supply, and the American people abandon their "uncompetitive" industries, and borrow more money in an attempt to keep up lifestyles.

What I have described above is, in very simplified terms, the cycle that the American productive sector has been caught up in and driven out of business by, as exemplified by the fate of the auto industry in Flint.

The ways this play out are vastly more complex that what could be covered in this short article. The key to not getting lost amidst all the bewildering intricacies is to keep in focus that this all starts with the fact that the entire world is slipping into "debt" because it borrows its money into circulation from an international banking oligarchy, and these complexities arise out of the incredible manipulations that all parties feel obliged to participate in simply to survive.

Richard Kotlarz

The complete set of columns from this series is posted at the following websites:

No comments: