Wednesday, December 3, 2008

This Sounds Eerily Familiar...

From America's Great Depression, by Murray Rothbard, which I am reading as part of Voxiversity on Vox Day's site:
Instead of repealing unemployment insurance, contracting credit, and/or going back to gold at a more realistic parity, Great Britain inflated her money supply to offset the loss of gold and turned to the United States for help. For if the United States government were to inflate American money, Great Britain would no longer lose gold to the United States. In short, the American public was nominated to suffer the burdens of inflation and subsequent collapse in order to maintain the British government and the British trade union movement in the style to which they insisted on becoming accustomed.
A lot of people want to draw parallels between today's economic circumstances and the circumstances surrounding the Great Depression (including myself). There certainly are parallels, but one thing people tend to screw up is just what exactly that situation is. The United States will likely not experience the same thing it experienced in the last go round precisely because it is not in the same situation. China is! The US is now playing the role of Great Britain, who didn't want to cramp her lifestyle so she inflated her money and tried to get the US to shoulder the "pain" of the contraction. The US is now about to do the same thing to China, or you might just say "Asia" in general, as this is the principle location of the exporters financing our bloated consumption habits, if Bernanke follows through with his threat to have the FED buy US Treasuries. The US under Hoover did the same thing way back when, lending money to Europe to buy American exports. We'll see if China is as willing to "help us out" as we were towards Britain. If we want to see what will happen to the US, we should stop looking at our own history books and look at Britain's. I'll save you most of the effort: the British empire collapsed, and she was knocked out of her role as world superpower in the wake of that little war that followed a few years later. So, be prepared. ----Update---- Um, yeah, OK so I really botched that one. Once again, chalk it up to being an amateur. I'm thinking of the wrong time period (how can inflation cause a contraction, at least in the short term?). This occurred before the crisis, during the inflationary boom stage. Britain wanted to revalue it's currency upward against gold WITHOUT disrupting the comfy status quo, so it asked the US to inflate along with it so that the trade relationship would not be distorted. Back then, exchange rates were fixed against a gold standard, so if Britain valued its currency improperly versus gold (and therefore foreign currencies), it would've resulted in a large flow of gold out of the country as Britain's export industry would've become uncompetitive, being priced in an overvalued currency. So it inflated its currency (devaluing it) to remain competitive, and asked the US to do the same (I know that doesn't make sense. How does devaluing currency change the gold stock? The exchange rate should've had to change to reflect the increased number of British pounds versus gold for things to "balance out." Sadly, the economics of the twenties and thirties weren't much more rational than today.) Basically, both countries agreed to lie to the public together, increasing their money supplies but claiming that they still had the same exchange rate with gold as before the inflation, trusting the public not to call the bluff and rush in and demand gold in exchange for paper currency supposedly backed by said gold all at once. So the analogy actually holds very true today: actually, China did "help us out" over the ~30 year build up to this crisis, inflating its own currency along with ours, so that the trade relationship was maintained as well as America's comfy lifestyle of excessive consumption. That's why inflation in China was running 15% until recently and their government is sitting on ~$1 trillion of American debt. So what will the magnitude of the contraction be like? And will the relationship stay the same? Probably not. We no longer have to worry about gold inflows and outflows, as we no longer have a gold standard. One of the exacerbating factors that made the Great Depression so bad was that the Fed actually contracted the money supply for fear of a disruption in US holdings of gold. Today, there is no such threat, and the Fed has made it clear it has no intention of shrinking the money supply, at least to that degree. As a result, there will likely not be anywhere near the depressive pressure coming from balance sheets this time as prices probably won't fall nearly so far below the costs of production. That tends to be a pretty severe disincentive to production. And employment. There is, however, a lot more debt to unwind, and far greater excesses and imbalances built into the production structure that need to be liquidated and straightened out. National economies of 1930 were far less specialized than ours are today. So, it remains to be seen exactly how bad it will get. At any rate, sorry for the confusion, folks. I'm still learning here. But that's what the blog is all about...

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