Sunday, May 10, 2009

Learn From History, or Repeat the Mistakes

The following is from a thread discussion at ... Freepers are very well educated and very smart people. Enjoy the truth as posted by Freeper 'sanchmo' ...

"The big risk for the US during this (current economic)crisis is that it follows the path of Britain’s pound.

In 1900, Britain was the world’s lone superpower, based on its position as the leading industrial economy, as a net exporter and a net lender. Its empire controlled massive swaths of land in Africa, North America, Australia and Asia. London was the world’s financial center, and the system of global trade was centered on the pound sterling - giving British subjects the most desired currency in the world and the most favorable position for access to strategic natural resources. But there were vulnerabilities - the cost of militarily protecting its position was growing while dozens of small threats ganged up strategically against the giant.

Up and coming competitors and recent entrants into the industrial revolution seemed poised to take Britain's position - most notably Germany and the US. Then came WW1 and the Great Depression. The world expected the impossible - that Britain’s industrial power and its pound sterling would be able to save the world. But it couldn’t - the policy required to maintain the global system of London-based, Pound-focused trade and finance (strong pound, low debt burden) was the exact opposite of that required to keep up the rate of British production and unemployment (cheap British exports) and the burden of war and fiscal stimulus (monetary inflation).

Britain became a net importer from the US during the wars, and a net borrower to pay for its war and economic recovery efforts. The global London/Pound based system collapsed in the 1930s, currency crises reduced the value of the pound, the empire began to unwind, and Britain was saved only by the discovery of oil in the North Sea, and by the power of the US, which emerged from WW2 and finally from the cold war at the top of the power pyramid.

From the 1920’s until today, the pound has declined by over 50% against world currencies, and by over 85% against the dollar, and during times of crisis it dives even deeper into the hole.

On to Washington and New York

With the destruction in Europe in WW2 and the loss of London and the Pound in the 1930s as the anchor of international finance & trade, the US and the Dollar took their place. Economists at first proposed that reserves be denominated in a pseudo-currency based on either a basket of international currencies (the SDR) or based on a wide basket of commodities (the bancor).

At Bretton Woods in 1944, the US negotiated an alternative where the US promised convertibility to gold in exchange for the world agreeing to use the Dollar as the global reserve. But the cost of the Marshall Plan, the Cold War, and the Great Society cost the US too much gold to maintain convertibility.

By the early 1970’s, Nixon cancelled gold convertability, and Nixon & Kissinger protected the dollar’s supreme position with a promise of US trade deficits (to provide foreigners a way to earn dollars and grow their economies), US budget deficits (to provide foreigners a safe place to invest those dollars), and growing imports of foreign energy (to increase demand by making the Dollar the currency used to buy oil).

In 1973, the US was still a net lender and exporter, but the unsustainability of the bargain was clear by Nixon economist’s comment to objectors that “if it can’t go on forever, it will stop.”

Since 1973 - for 35 years - the US has gone from a net exporter and net lender to a net importer & net borrower. Its future liabilities are unsustainable with current policy/guidelines.

US debt held by the public now exceeds 40% of GDP, and generally accepted guidelines of currency vulnerability say that when debt held by the public exceeds 50%-60% of GDP, the country is unable to spend its way out of a recession; and that debt held by the public of 65%-70% makes a country unable to defend itself against speculative attacks on its currency. Crisis-date estimates for those codition sare typically believed to be in the 2025-2050 range, although the combination or reduced tax revenue & increased social spending & bailouts in the current economic crisis threatens to bring the crisis date to the 2012-2020 range.

Today, the dollar is still the global standard and is in high demand around the world. But that is based on several vulnerable supports:

--the position of US treasury bonds as both a safe and profitable investment;
--the ability of the US economy to maintain its levels of net importing and net borrowing;
--its position as the medium of international trade for oil;
--the percention that the Fed can maintain its independence from US politicians, so that Fed policy does not hurt foreign dollar-holders.