Monday, January 21, 2013

Where is the greener grass?

Assume that capital is mobile internationally, and it will seek the highest net rate of return. It is evident that consumption has been overweighted in the composition of American aggregate demand, because it was debt-funded. Increasing income and wealth inequality lower the average propensity to consume. Disposable income is being reduced by tax increases. Investment demand is largely derived from the demand for final goods, for which capital goods are used in production. With stable or decreasing final consumption demand, investment demand is largely put on hold. In this essentially deflationary situation, slack appears in labor and industrial markets. Capital sits on the sidelines, waiting to see what happens next, where the greener pastures may lie. Central bankers lower interest rates to the zero bound and sit around wishing and hoping for an inflation to get the debt under control. Sovereign governments, beholden to the banks, refuse to use the issuance of sovereign currency to put slack assets back to work. This is where we find ourselves.

The conventional wisdom, as given on personal finance websites and in corporate boardrooms, is to wait for the turn of the developing economies, and to put the money where the growth is. America is unattractive.

There is much damage being done to the world economy while playing this waiting game. One by one, developed economies are being sent into severe depression, for example, Portugal, Greece, Spain. These poor countries had unfortunately given away the right to manage their own currencies and were crushed by German creditors. The Japanese, under no such constraints, are gearing up to devalue their currency in an aggressive, mercantilist strategy. Can Brazil, Russia, and India be far behind? China is attempting to balance their domestic demand, and we wish them well. The United States has pushed its interest rates to zero but is frustrated by the status of its currency as the "risk-free" asset. The US has shown that it can blow asset bubbles but because it is intent on the continuing crucifixion of its labor class, it cannot get a sustained domestic inflation going. Pity the poor greenback.

The hidden shoals of the international financial system, the derivatives exposures so conveniently not on the banks' balance sheets, guarantee that the chances of international collapse of the deflationary type are still significant. At that point, should it arrive, some new form of money will almost certainly need to be created. The Fed buying up all Treasury issuance will not be enough.


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