Standard economic theory claims that millions of rational individuals simultaneously acting on their self interest produces results that are in society's collective best interests. The utter absurdity of this mantra has been proven time and time again, especially in periods of endemic crisis such as the current one. Are key decision makers irrational? Not at all! Economics professor Ingo Schmidt made this observation on the precipice of the 2008 financial crisis; "...we can see that individual capitalists are behaving more or less rationally within an irrational system." Schmidt's statement clarifies much about short term behavior under capitalism; economic agents behave rationally, that is in an adaptive manner within the confines created by the imperatives of an essentially anarchic capitalist system, regardless of the long term disasters to which this collective behavior may lead.
Prof. Schmidt was attempting to examine the "limits to bourgeois economics" in explaining the key trends leading up to the 2008 crash/crisis that seemed to defy the predictions of both orthodox and "New Keynesian" thinking at the time. Schmidt wanted to explained what he (and more and more analysts) call "dollar hegemony"; the seeming defiance of the US dollar to the debilitating effects of certain trends as generally predicted by neo-classical and some heterodox economic thought. In short, the collapse of the US dollar after the 2001 recession didn't reduce or even halt the rise in the US trade deficit. Foreign demand for dollars by US trade partners in US capital markets, which was expected to decline due to growing deficits, a weakening dollar and inflation expectations that were proven wrong, actually increased eventually pulling the US Dollar up in the process. US corporations made billions through global investment, trade and supply chains as the US trade deficit worsened, jobs were offshored, household debt grew and US middle class income stagnated all leading to greater financial instability, collapse and crisis.
Neither capital markets nor those for goods and services worked in the predictable ways during this time and along with widening US trade deficits, budget deficits and rising consumer debt was increased foreign demand for a seemingly "weak" US Dollar to keep the whole cycle going. It seemed that American consumers could go endlessly into debt to finance imports as the US trade partners (and the US Fed after the 2008 crisis) propped up US and global demand as the lender of last resort. "Market forces" (whatever that means) were not at work here. It was the global US business model of investment that make fundamentals work in a manner that is rational only in terms of the internal logic of that model itself (Schmidt's "rational behavior" within an "irrational system."). When considered this way, it makes much more sense to talk about global business models (and globalization in general) rather than resort to the old public policy debates that no longer fit the current reality. This is why all the banter about "returning to gold standards" and "reigning in the Fed" make no sense. The old policy debates won't give us the answer to the current crisis. Globalization isn't a policy; it's a stage of capitalism's long history!
Economist Anwar Shaikh made this remark about the relationship between "surplus" and "deficit" countries in the epoch of globalization and the manner in which this observed pattern renders traditional economic theories of international trade untenable. Shaikh's critique of neo-liberal orthodoxy and its assessment of seemingly persistent "global structural imbalances" goes as follows;
In a country that enjoys an initial trade surplus, the resulting inflow of funds would enhance the availability of credit, which would lower interest rates. Conversely, in the country with the initial trade deficit, the fund outflow would tighten the credit market, and raise interest rates. With interest rates lower in the surplus country and higher in the deficit country, profit-seeking capital would flow from the former to the latter. Thus the surplus country would become a net lender on the world market, and the deficit country a net borrower. Instead of eliminating the trade imbalances, this would end up offsetting them with capital flows. Trade imbalances would be persistent, and deficit countries in particular would become international debtors. This is an exceedingly familiar historical picture.
Familiar indeed! The remarkable thing about Shaikh's critique of traditional trade theory is that he notes how various deficit countries can be effected in radically different ways depending on their structural positions within the world economy. Shaikh is probably thinking mostly of third world deficit countries who invoice their imports in a foreign currency and need to maintain high domestic interest rates to attract foreign investment capital to pay their debts. These high interest rates suppress domestic consumption and local business investment causing chronic unemployment and low wages. This makes these economies heavily dependent on consumer goods imports creating a constant spiral of debt leading to even greater net capital outflows, higher interest rates and deeper debt. The US is similarly a deficit country but one that controls the world's main reserve currency. It can borrow in dollars so deficits don't ultimately force a currency devaluation and in fact, US trade deficits are met with greater capital inflows which keep interest rates down as part of the strategy to boost consumption for trade partner exports. Thus, chronic balance of trade deficits have the polar opposite effects in the US economy as they do in some poorer economies. Many third world countries have deficits that are the direct result of chronic poverty from dependence on primary commodity exports whose prices are volatile forcing endless borrowing to meet import and other needs. US deficits support consumption that sustains foreign trade partner export markets thus swelling the nearly risk free US bond market and strengthens the Dollar. This expansion of loanable capital keeps interest rates low despite rising US debt and balance of payments deficit levels. Foreign holdings of US treasury debt is now about $5.5 trillion giving US trade partners an abiding interest in sustaining the strength of the US Dollar. US borrowings are thus a key driver of global demand due mostly to the massive levels of consumption they support. The dollar thus becomes the world's safest asset so that world financial instability, even due to crises that originate in the US, result in even greater dollar inflows to the US bond market rather than to capital flight. The US is still the safest port in a storm!
What Shaikh seems to point out is that structural imbalances aren't policy failures or even "market" failures at all; they're the inevitable consequences of the current global corporate business model and they're more a function of investment than trade itself! The very structural deficit position that links debt to poverty in the third world actually strengthens the US and the dollar's hegemonic position! This is due chiefly to the export led development strategies of the America's main trade partners who depend on America's domestic consumer goods market. China's trade surpluses need a risk free investment outlet. A strong dollar not only props up the US consumer goods market but secures growing foreign investment in dollar denominated financial assets like US treasury bonds. The strength of the dollar further means that dollar reserves in foreign banks will be borrowed to be used for investment, consumption or debt repayment meaning that increases in these foreign held reserves of dollars can never in and of itself depress the dollar's exchange rate.. Most importantly, all this is driven by US and other transnational corporate investment in Chinese and other foreign manufacturing!
Progressives have long understood this but they need to more aggressively make the point in the discourse on globalization and the manner in which its failed all but the rich. Doing so would stifle a lot of the silliness about "currency wars" and the absurd call for tariffs as a "solution" to the problem as if this sort of modern day Luddism could eventually save the middle classes of the capitalist west any more than Bill Ludd's smashing of large scale, labor saving factory machinery ultimately saved the jobs of unemployed workers in early 19th century England. It would thus raise the discussion to a level that would place the real issues before us, namely income inequality and stagnating real wages.
Talk about currency valuation, tariffs and other red herrings are a distraction from the real issues. Progressives have always known that globalization isn't about trade, its about investment. US tariffs came down to accommodate US corporations that increasingly invested in manufacturing in places like China and Mexico to benefit from cheaper labor not to boost international trade. The persistent imbalances are not the result of policy failures or interference with the market; the imbalances are meant to function as part of the globalization model of capital accumulation. Cheap labor zones become centers of western capital investment that eventually recycle their trade surpluses through the capital markets of the western importing countries in order to keep interest rates low enough to support their export markets for manufactured consumer goods while also earning profits on their financial investment. We saw the beginnings of this as a regular global patter in the 1970s with the recycling of "petrodollars" after the massive OPEC price hikes. It currently involves nearly all forms of international trade. This is how the model functions. Its not the "new merchantilism" but corporate globalization.
In order to further understand how this sort of model is utterly beyond policy as a stage of late capitalism we have to also examine the role of the US Dollar as what has been called a "hegemonic currency" or simply a hegemon in international trade. Much to the surprise of those sounding the alarm about the allegedly "falling dollar", the dollar has defied all traditional expectations by remaining, as one analyst recently remarked, "strong as an ox!" The reason is simple; the dollar is the main currency for invoicing all international trade. In addition, the expansion and "deepening" of global financial markets as part of the global investment model's functioning, has actually strengthened global demand for the US Dollar. According to one scholarly paper, there is a now a global "duopoly" for reserve currency usage with the US far exceeding use of the EURO. US trade deficits and other imbalances have not led to depreciation or inflation and in fact the dollar has only strengthened. One source explains why;
"...since 1980 the US current account has been balanced only once during the recession of 1990-1991. Since this recession, the US current account deficit has actually increased for 15 years, reaching 6% of the GDP in 2006. Since the 2008-09 financial crisis, a recovery of the US savings rates has allowed a reduction of the current account deficit by almost half. At the same time, the US economy has been offering sufficiently strong returns on US dollar assets and monetary stability (low inflation…) to attract investment to finance the current account. Besides, current account deficits did not translate necessarily in a deterioration of US investment position. This is explained by the fact that U.S. assets overseas have gained in value relative to the domestic assets held by foreign investors. This, in itself, helped reinforce the international role of the US dollar. US net foreign assets have not been deteriorating in line with the current account deficits, except since the recent financial crisis, due to the relative under-performance of domestic ownership of foreign assets (foreign equities) in comparison to foreign ownership of domestic assets (mainly US treasuries and bonds). As a result, US dollar holdings by non-residents continue to irrigate the international financial and trading system, and constitute, for all uses, the largest pool of currency in the world."
The above analysis shows that financial demand for the US dollar is propped by strong returns on dollar denominated financial and real assets. Though the Net International Investment Position (NIIP) has been negative since the late 1980s, the US has also had, as one analyst points out, "...consistently had a positive net investment income position. In other words, interest and profits resulting from holding foreign assets has exceeded the payments of income to owners of US assets." This has been the case for a long time. Thus, the negative nominal position over the past three decades is misleading and a resulting run on the US dollar is not likely. Furthermore, many globally traded commodities such as oil are invoiced in dollars further boosting "dollar hegemony."
This could easily explain why, as experts like Jeffery Frankel point out, the 2008 financial crisis resulted in a situation where global investors actually, "...flooded into dollar assets, even though the crisis originated in the United States." The safety of US treasury assets is partly due to the impossibility of a dollar default, low inflation and a closing of the current account gap as a share of GDP over the course of the current economic recovery. The dollar thus remains as strong as ever! Thus, international demand for the US Dollar is strong for both trade and financial reasons. The US dollar still comprises over 60% of all central bank reserves (down from a peak of 70% in the 1990s) while the Euro is barely one third. Foreign exchange reserves around the world have steadily increased their dollar holdings even if the relative share of dollar holding has declining slightly since its peak.
But the US dollar has become the global hegemon mostly because of its special characteristics making it the strongest reserve currency not likely to be rivaled in the near future. According to a 2011 working paper by two economists with the Levy Institute, David Fields and Matías Vernengo, US Dollar hegemony is predicated on two important functions no other major currency now performs. First, the US Dollar is a default risk free asset for the global system because, unlike the Eurozone, the US government can borrow in its own currency and secondly, it serves as the main prop for global demand by monetizing its debt and keeping interest rates low and liquidity high. The authors explain;
"...the hegemon must be able to borrow in its own currency and provide a secure asset free of default risk to the system. The dollar is the key currency because the United States can impose that key commodities are traded in its own currency, and agents must trade in dollars to settle transactions with American corporations. The role of the dollar in international markets, and the advantages that come with it, are the spoils of hegemonic power. The provision of this asset allows the hegemonic country to become the source of global demand and insulate itself from fluctuations and contradictions of perilous cumulative disequilibria that may arise in the world economy. In other words, the secure asset enables the hegemonic country to set the global social, political, and economic conditions, within which the transmission of misery (contagion) between countries, and between global and national levels, is essentially regulated."
This is not entirely unprecedented in history and the British Pound Sterling seems to have played just this role in the international economy prior to the end of WWI when it was the world's most powerful financial center despite its gradual decline as a world manufacturing power. The fatal flaw was that the Pound's tie to gold prevented it from becoming the lender of last resort and guarantor of global effective demand because, as the Fields and Vergnengo point out, "...[UK] debt was ultimately redeemable in an asset that was not directly controlled by the monetary authority." The US is a more stable hegemon for the international system since it is has no "balance of payments constraint" and can act as a prop of global demand because it is free of having to "maintain a fixed ratio of currency to an external asset" like gold. This is what monetarists and Metalists don't get about the system, policy adjustment can't succeed but only cause unmitigated disaster for the world economy. This is because the entire corporate global business model is locked into the ability of the US and the dollar to provide liquidity and stability as the system's hegemon!
The Euro cannot eclipse the Dollar as the systemic hegemon. This is not only because of the crisis now plaguing the Eurozone and the risk of default by many of the countries there but what the crisis indicates; the Eurozone is too weak and constrained by austerity and monetary tightening to play the role the dollar plays. Only the US Dollar can play the stable role in international markets. The Federal Reserve's quantitative easing program whereby $85 billion in treasury bonds/month were purchased, provided both low interest rates and stable bond prices by assuring the risk free security of US public debt and easy liquidity to the system. Thus, growing deficits are no threat to US financial stability. The ECB cannot act as lender of last resort to EU commercial banks. It is for this reason that concerns about the decline of the US dollar is baseless; such predictions don't understand the role of the currency hegemon in stabilizing and sustaining global capitalism and providing liquidity and sufficient effective demand to sustain the current business model. This model of US led corporate globalization is based on political power and policy flexibility, not currency credibility in the classic sense.
Regarding the dollar itself, the authors point out that, "The reason the dollar remains and will remain the key currency is not that its value is stable, as Metallists would argue is necessary for fiat money, but because the United States does not incur debt in other currencies and the institutions that manage macroeconomic policy guarantee that a default in dollars cannot take place." This is only one reason that unlimited US foreign debt is possible. The other, of course, is that the US market is so large-about one quarter of the entire global economy-that it serves as the engine of export led growth for the rest of the world even if it is based largely on private consumer debt. Current EU austerity precludes the Eurozone from playing this role.
But the corporate global model is itself unstable. This is not due to state "merchantilist" interference with the market or any such rubbish but the contradictory nature of capitalism as a global system itself. The Fed provides liquidity to a system racked with income inequality, economic concentration, chronic stagnation and growing debt because this has been the ultimate cost of profitability without middle class income growth and GDP expansion. In other words, tea party Republicans that continually threaten default while screaming for debt ceilings in lieu of a gold standard don't understand that it is only the current system of merchantilism that allows continued corporate profitability on a global scale despite low and declining middle class income growth at home (and elsewhere). Allowing the "free market" to reign would only bring about a global collapse of the system much sooner since all the stop gaps against the most destabilizing aspects of laissez faire capitalism would be removed (such as fiscal stimulus providing a floor below which demand cannot sink as well as financial guarantees that prevent a run on the system and total collapse).
The modern global corporate business model that outsources jobs and depresses middle class income while concentrating wealth, income and output is supported less by the old 18th century merchantilist features than the stabilizing intervention of the modern capitalist state. A return to the old system of tariff and currency adjustments that allowed the US to become a global power won't work but only create greater global over capacity and unemployment. The old tariff system is like an old dog that can no longer hunt! It is time for progressives to demand real reforms like massive public investment to create full employment and meet human needs, taxation on the rich to finance such programs, a restoration of union rights and a strong minimum wage that matches cost of living increases and the growth of public sector investment in education, health care, infrastructure and renewable energy that meet long term human needs. Such demands and their implementation will either reform and restructure US capitalism along lines commensurate with the restoration of a growing and thriving middle class society or plunge the contending classes into a mutually destructive war with no survivors. I don't believe that the latter outcome is necessary. But that depends more upon the willingness of the capitalist class to temper their own greed than what happens on the other side of the class conflict. On this score, I suspect that the ball is still in the court of the rich.