Basic Exchange Rate Theories

The Monetary Approach to Exchange Rates

The Monetary Approach to the Exchange Rate remedies the fixed exchange rate limitation of MABOP. Instead of monetary disequilibrium being adjusted by international money flows, as in a world with fixed exchange rates like exist under a gold standard, the MAER has flexible exchange rates leading to monetary equilibrium, as money demand and money supply, controlled by central banks, is equilibrated through exchange rate changes. A country with a managed float requires for its analysis both MABOP and MAER.

Unlike the MABOP approach, where exchange rate changes equal zero, the MAER assumes currency reserve flows are zero (with no central bank intervention) and exchange rates move instead. The relationship can be written

E’ = D’ – P'(foreign) – Y’,

which means that the change in the exchange rate equals the change in domestic credit minus the change in the foreign price level minus the change in domestic income. An increase in domestic credit by the central bank, with constant demand for money, will lead to a higher exchange rate with domestic currency in terms of foreign currency. In other words, the domestic currency is losing value relative to the foreign currency. An increase in domestic income will lead to a stronger domestic currency and a lower exchange rate, which is why Y’ and E’ are of opposite sign. An increase in the foreign price level leads to fewer imports and a stronger currency.

The Portfolio Balance Approach to Exchange Rates

The MAER assumes that domestic and foreign bonds are perfect substitutes, meaning that investors are indifferent to the currency that a bond is denominated in and care only about the return. In other words, uncovered interest rate parity holds between bonds in different currencies.

The Portfolio Balance Approach allows for imperfect substitutability, where investors do perceive currency risk and balance their portfolios accordingly. PB models contain a risk premium in forward exchange rates, and uncovered interest rate parity does not hold. As a country’s supply of bonds on the market increases, the currency’s risk premium increases, and the domestic currency depreciates. The equation describing the MAER above is modified to be

E’ = D’ + (B’ – B'(foreign)) – P'(foreign) – Y’

The additional term added to the MAER equation above, (B’ – B'(foreign)), shows that an increase in domestic bond supplies greater than a corresponding increase in foreign bond supplies will lead to a weaker domestic currency and a higher exchange rate.

Sterilization

The central bank, in a fixed exchange rate system, can attempt to maintain a money supply greater or less than money demand, which would lead to money flows out of or into the country, through increasing or decreasing the supply of domestic credit. If the central bank wants to increase the supply of money, but demand for money also increases, causing an inflow of reserves, then the central bank can sterilize the reserve inflow by increasing the supply of domestic credit by the amount of the inflow.

Under flexible exchange rates, a central bank can buy foreign bonds and sell domestic bonds, which would lead to higher exchange rates, or a depreciated domestic currency.

Source: Husted and Melvin, International Economics

Balance of Payments Theories

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National Income Accounting

A country’s current account measures the value of its trade in goods, services, investment income (not buy/sell of financial assets), and unilateral transfers. The current account indicates whether a country is a net borrower or lender to the rest of the world. The current account must be matched by a financial account, which measures foreign investment in domestic financial assets, of opposite sign. The national income accounting identity is

Y = C + I + G + X

where Y is GDP, C is consumption spending, I is investment, G is government spending, and X is the current account. This identity can be rearranged to show many things, including the fact that when savings is greater than investment there is a current account surplus, where savings includes both the private and government sectors. In other words, X = S – I. A negative X means that a country must borrow from the world to finance its imports. The current account deficit will fall when domestic spending, private or government, falls relative to domestic income.

In the absence of decreased government spending, the exchange rate and interest rate markets will cause a reduction in the current account. As the current account is financed by selling domestic securities to the world, the domestic currency is pressured downward, causing interest rates to rise, making domestic securities even more attractive. But the higher interest rates, and hence greater borrowing costs, cause a decrease in domestic spending. Domestic income increases due to the weaker currency leading to greater exports. The reduced domestic spending and higher income cause a reduction in the current account deficit.

The Elasticities Approach to the Balance of Trade

The change in the quantity demanded of foreign goods due to a change in the exchange rate of the two currencies is measured by the elasticity of demand, or the percent change in demand due to percent change in price. Elastic means the absolute value of the ratio is greater than one. Similarly, the change in amount supplied due to changes in price is measured by the elasticity of supply.

A currency devaluation should normally cause an increase in the balance of trade, but this is not always so if there are low short run elasticities. This causes what is called the J Curve in the balance of trade, where the balance actually decreases after currency devaluation before beginning to improve. This could be due to the currency contract period, when contracts enacted before the devaluation must be fulfilled. Inelastic demand for imports would also cause a J Curve. The change in domestic and foreign prices is measured by the pass through effect. The difference in profit margins between countries, and the greater pricing flexibility among higher profit margin countries, lessens the effect of a devaluation.

The Absorption Approach to the Balance of Trade

Here, the balance of trade is defined as an economy’s production less its “absorption”, or total domestic spending. Absorption has to decrease in an economy with full resource utilization for the current account balance to increase, which would allow domestic prices to fall and exports to rise. A devaluation here will produce domestic inflation as foreigners bid up the price of domestic goods. A currency devaluation could improve output and GDP, and increase the current account, while absorption remained unchanged in an economy not employing all its resources.

The Monetary Approach to the Balance of Payments

The Elasticities and Absorption Approaches have the limitation that they do not consider the financial account and instead focus on the trade in goods and services, which worked well in a world of limited capital mobility. MABOP emphasizes monetary disequilibrium in explaining balance of payments disequilibria, where monetary disequilibrium is the difference between the fiat currency supplied and the currency demanded. Excess money demand will lead to increased exports. This analysis assumes fixed exchange rates and high capital mobility.

The exports are paid for with foreign currency, which the commercial bank will exchange for dollars with the Federal Reserve. These dollars are created by the Fed and lead to an increase in the supply of base money and hence domestic credit. The demand for money can be written as

L = kPY

with L the demand for money, k a constant, P the domestic price level, and Y is real income. The demand to hold money increases with P or Y. MABOP assumes a stable demand for money. MABOP states that the percentage change in the balance of payments minus the percentage change in the exchange rate equals the inflation rate of the foreign currency plus the percentage growth of real income (Y) minus the percentage change in domestic credit (due to the increase or decrease in base money). This can be written as

R’ – E’ = P'(foreign) + Y’ – D’

The Monetary Approach assumes fixed exchange rates, so E’ = 0. With a fixed exchange rate, like a gold standard system, an increase of domestic credit by the central bank, assuming prices, income, and money demand are constant, will cause a decrease in foreign reserves. An increase in domestic credit leads to a weaker BOP as spending goes up to decrease excess cash reserves, and vice versa.

BOP problems are monetary phenomena in this world, and countries could not run perpetual deficits since they could not inflate a gold backed currency. Instead, the deficit running country would eventually run out of reserves. Domestic prices would become cheap and foreigners would buy domestic goods, and the exports would bring in currency until the system reached equilibrium again.

A domestic credit adjustment by the central bank would be used to equilibrate the BOP. Barring this, an increase in domestic income, which would strengthen the currency, would improve the BOP with domestic credit unchanged.

Regardless of the forces acting on the BOP, Gresham’s Law is always at work under fixed exchange rates and a currency managed by a central bank. People will always seek to unload overvalued currency and buy undervalued currency.

According to the MABOP analysis of currency crises, budget deficits contribute to inflation since it is known they will eventually be monetized. Devaluations of a currency do not keep pace with inflation, leading to overvalued exchange rates. Exports fall while imports rise, leading to a trade deficit and capital flight. Governments must borrow to finance the balance of payments deficit, which leads to high interest payments. Each step of the cycle makes the next step worse and the cycle is perpetuated until the government capitulates.

It can be seen that in an international commodity money system, such as the gold standard, governments would not have to worry about the supply of money, or conversely they would not be able to manipulate the supply of money. In this case each individual’s money holdings is based on his marginal utility of money and flows between countries are no more important than flows between cities or individuals. Under fiat systems too the analysis must begin with the individual’s demand for money (methodological individualism versus aggregate analysis) to avoid the problems associated with the abstraction of the country.

Mexican Fiscal and Monetary History

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Mexico maintained a fixed exchange rate of 12.50 pesos to the dollar until 1976. To accomplish this, the Banco de Mexico actively intervened in the currency market to keep the peso at the desired exchange rate. The central bank would use its foreign currency reserves, usually dollars, to buy pesos. This decreases the supply of pesos on the market and increases the supply of dollars, making pesos more valuable relative to the dollar. A main reason for this is to maintain the purchasing power of the peso in order to keep imports affordable.

On the other hand, if the peso is perceived to be overvalued, the bank will sell pesos in exchange for dollars, driving the value of the peso down. Mexican exports will be more attractive with a weaker peso.

Despite continued economic growth in Mexico in the 1970s, budget deficits and inflation were rising, and deficits were financed through foreign debt. A precursor of problems to come, the peso was devalued by 56% in 1976 and taken off its fixed exchange rate in favor of a managed floating rate. In the managed floating rate system, the peso would be allowed to move within a band which would be enforced with central bank intervention.

The Mexican government, expecting increasing oil revenues from high world prices, increased borrowing in dollars. However, oil prices plummeted in the early 1980s, greatly reducing revenues and dollar inflows. Declining international economic conditions decreased demand for Mexico’s primary exports. Foreign capital, made nervous by the growing debt, began to leave Mexico, putting downward pressure on the now overvalued peso. These dollars had been used to service the growing Mexican debt, and in their absence the government announced in 1982 that it could not service its debt on billions of dollars of loans.

Neoclassical economists developed the Monetary Approach to the Balance of Payments (MABOP) theory to explain the cycle indebted Latin American countries found themselves in during the 1970s and 1980s. According to MABOP, budget deficits contribute to inflation since it is known they will eventually be monetized. Devaluations of a currency do not keep pace with inflation, leading to overvalued exchange rates. Exports fall while imports rise, leading to a trade deficit and capital flight. Governments must borrow to finance the balance of payments deficit, which leads to high interest payments. Each step of the cycle makes the next step worse and the cycle is perpetuated until the government must capitulate and devalue the currency.

Miguel de la Madrid came into office in 1982, inheriting an economy in crisis and in serious need of reform after years of government intervention. The first order of business was to tackle the near 100% inflation rate. The government was able to slow inflation to around 65% by 1985 through spending cuts and tighter monetary policy, but at the cost of a 13% decrease in GDP over the same period. Another top priority was government debt reduction, which resulted in net transfers through debt payments to foreign creditors of 6% of GDP between 1982 and 1985.

Despite publicly claiming to control inflation, the government was incentivized to inflate the money supply through the existence of an “inflation tax”, which is the wealth transfer from holders of cash to the spender of newly created money, in this case the government. Money creation was such that this course of action equated to up to 8% of GDP between 1983 and 1985. By 1986, inflation had returned to its 1982 level of near 100%.

The Mexican government was still heavily involved in the economy, controlling the banking sector and limiting foreigners’ ability to invest in Mexican businesses. Government debt and controls had smothered the economy, causing a drop in per capita income in the 1980s almost as large as that seen in the Depression. Clearly, a freeing of the economy through free market policies was in order.

In 1987 and 1988, the Mexican government signed two agreements with the business, labor, and agriculture sectors popularly called the Pacto, which through its various incarnations has attempted to curb expansionary monetary and fiscal policies, control prices and wages, renegotiate debt, deregulate markets, and privatize state-owned businesses.

The Mexican public sector owned 1,155 businesses in 1982, and by 1994 940 of those were divested. The tax system was simplified, rates were decreased, tax collection and tax revenue increased, and government spending and fiscal deficits fell. The government also implemented financial and trade liberalization. The elimination of bank reserve requirements and mandatory financing of public sector businesses removed a heavy burden from private finance and allowed capital to flow to more productive areas in the economy. Banks were privatized, capital controls were lifted, and foreign capital was allowed greater access to Mexican investment. Trade liberalization came in the form of reduced import licensing and tariffs, and was codified with the passage of the North American Free Trade Agreement (NAFTA) in 1993 (Gould, 1995).

Mexico’s economic liberalization programs and successful foreign debt renegotiation in 1990 attracted capital inflows, which were made more attractive by the low interest rates seen at the time in the U.S. The financial sector’s unburdening resulted in rapid credit expansion, made possible by a large reduction in public debt and a rise in the Mexican stock market and real estate prices. Expectations of economic growth and an abundance of foreign and domestic capital led to decreased lending standards which, when faced with an economic slowdown in 1993, resulted in a rapidly increasing number of non-performing loans on the books of Mexican banks.

Local Mexican commercial banks increased credit to the private sector by an average of 25% per year from 1988 to 1994. During this same period, credit card debt rose 31% per year and mortgage loans rose 47% per year (Gil-Diaz, 1998). This local credit expansion combined with large foreign capital inflows led to rising aggregate demand within Mexico and a strengthening peso which could only lead to a current account deficit. Unfortunately, the Pacto contained within it a commitment to keep the exchange rate within a narrow band that was not in harmony with the current heated economic conditions.

With foreign money spurning low U.S. interest rates in favor of higher Mexican rates, largely in the form of short term capital, money flowed into Mexican markets. The Banco de Mexico acquired an increasing supply of dollar reserves and was able to provide the needed pesos to the market.

Predictably in an environment inundated with foreign capital and easy credit, leveraged investment began to flow to less productive projects chasing returns, increasing the fragility of the economy and leaving it vulnerable to changing international investment conditions, which occurred when U.S. interest rates rose, decreasing the demand for peso denominated investments and exposing the multitude of bad loans on the books of Mexican banks (Kaplan, 1998). As investors began to demand dollars in exchange for pesos at the managed exchange rate, Mexico’s foreign reserves began to shrink to the point that peso devaluation became necessary. The peso/dollar exchange rate went first from 3 to 3.5 pesos to the dollar, with the managed currency band still in effect. This move did not end speculative pressure on the peso, and the government increased the peso’s band. With pressure mounting, the government was forced to capitulate totally on December 22, 1994 by removing the peso’s managed float and allowing the currency to move freely against the dollar. This effectively devalued the peso from four pesos to the dollar to 7.2 pesos to the dollar in one week’s time. The U.S. government began buying pesos in an attempt to stop a collapse, and then put forth $50 billion in loan guarantees to Mexico, which were accepted and repaid ahead of schedule by 1997.

Paul Kennedy’s “The Rise and Fall of the Great Powers”

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Chapter 4 of the book talks about Western industrialization and what it meant for the rest of the world in the 18th and 19th centuries, especially after Napoleon’s defeat in 1815, which is worth study because the opposite process seems to be going on today. Several characteristics of this time are described.

First, a transoceanic and transcontinental trading system developed, rapidly after 1840, with western Europe and especially Great Britain as its trading and finance center. The process was helped along by advances in transportation and communications and by the removal of the tariff-based mercantilist system, and allowed for Europe to pass from its Great Power politics and war period to a time of economic harmonization and cooperation.

The European powers and the United States did not stop aggressive military action, but instead focused it on the conquest of the less developed but resource rich world. The technological superiority of the west over the rest of the world was also clear in military technology, making resistance difficult.

Before the Industrial Revolution, Indian or Chinese laborers were not too far behind Europeans in productivity, but after European industrialization the absolute level of Chinese and Indian production decreased as cheaper and better European products entered their markets. The developing world sometimes de-industrialized. Regulations, high wages, and Wall Street, helped by inflation, are reversing this process.

The Makeup of the Polis and Financial Speculation

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Plato described the makeup of the ideal polis, with its division of labor broadly into rulers, protectors, and workers, and said it could never exist on the earth, but was instead a study of the individual. Regardless of the form of government, the nation would only be as good as its citizens. No form of government, contrary to today’s believers in the religion of democracy, will lead a corrupt people to a just society and prosperity.

What does this type of analysis tell us about modern America? Our earlier rulers have been displaced to a large extent by a new ruling caste with a different world view. Noblesse oblige, once common among American elites who considered themselves custodians of something larger than themselves, is less common today. This may also have something to do with the change in the occupations of the elite; largely in manufacturing in the past, and hence connected more closely with the people of all social classes through contact with their managers and workers, the old elite were actual custodians and guardians of large numbers of people, abuses notwithstanding.

Today’s elites are often to be found in finance, a field which is conducive to short term profit making and allows its participants to be disconnected and aloof from the population at large. One does not feel oneself a custodian of something larger than oneself when structuring an interest rate hedge for a client or engaging in statistical arbitrage between the yen and euro.

The dominance of finance has led to a government designed to cater to its needs, and in so doing has looted the middle class, the class necessary for its ability to put checks on the power of government, of much of its wealth and earning power through currency debasement regulation. Ideally, from the government’s point of view, the middle class would be transformed into a middle management technocracy wholly employed by large corporations and thus politically neutered, their work siphoned off by their employers into political donations to favored politicians.

The military, the guardians of American liberty, now largely consist of semi-employable enlisted men, and now women, drawn to the military because it’s a steady job, led by a fairly talented officer class, with a large number of Southern men whose ancestors were the victims of the organization they now so proudly serve and who visit upon the current political enemies of their politicians or the possessors of resources coveted by their oligarchs and “geostrategists” the crimes which were once visited upon their forebears. They are economic hit men to a degree that even Smedley Butler would not believe. The nationalistic symbols, slogans, and myths have replaced the old patriotism to an extent that debate can no longer take place in the mainstream.

The ruling class, disdainful of a self-sufficient middle class, is using the poor, both working and not working, and both native born and imported, against them, a tactic as old as societies and an inversion of the principles of the Magna Carta.

The political and economic system is now more fragile than ever as the partnership of finance, industry, and government bails each other out with looted money. This leads to an unsustainable and volatile situation both dangerous and potentially profitable to those who understand the game as the debt incurred in the name of the people, to give the people undeliverable promises, cannot be paid and leads to a reordering of society.

The Fed and Stock Prices

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This study shows that as much as half of stock market gains since 1994 are the result of Fed actions or expected Fed actions. Despite the danger in being long the stock market when the Fed’s ability to manipulate stock prices runs out, what other manifestations of this misallocation will arise?

Eric Voegelin’s “Order and History, Volume III” and Plato’s View of the Correct Government

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The popular reading of The Republic is that it describes the best form of government that man can attain. Voegelin considers this to be a vulgar reading of the book which completely misses the point, which he explains in Order and History, Volume III in the section called “The Foundation Play”, where Voegelin describes the paradigm of the good polis (city-state) and its politeia (government).

Instead of involving himself with the hands-on business of running a government, as most have interpreted, Plato instead tells of how the just polis cannot be formed on earth. Instead, the philosopher must remain clear of the impious acts inherent in politics (Plato often uses such words as pious in the world of politics since he considers the polis to be merely an extension of the souls of its inhabitants, and participation in an unjust politeia will corrupt a just soul). Unfortunately for the philosopher, his true fullness can only be reached in participation in a just politeia, which leads to the paradox that human public stature decreases as the soul’s justice increases.

It can now be understood that Plato is not describing the correct order of an earthly polis, but the correct order of a soul, and without that all attempts at reforming earthly politics is pointless. Education should establish a “politeia within oneself”, of which the individual’s best elements will be the ruler. This internal politeia will be preserved by following a middle way between extremes of wealth and poverty and public honors and insignificance. The existence of an earthly politeia of such form is unimportant now for the philosopher, since he is concerned only with his soul and its link to the paradigmatic heavenly politeia, as Plato has Socrates describe it. Plato has now gone from apparently describing the formation of the perfect earthly polis to denying its possibility while attesting to the truth of the philosopher’s very real journey (zetema) toward the transcendent source of order. The earthly polis is the metaphor, and the individual’s soul and its connection with the transcendent and the just internal politeia which result from this connection is the reality.

The dichotomy between Apollonian and Dionysian souls is apparent in the distinction between the political metaphor and the transcendent reality. The paradox of the earthly diminishment of the philosopher, who cannot take part in politics without risking his soul, is now solved through the individual polis and its ruler’s connection with the universe’s until now hidden order. The paradox remains for those who cannot see that political life is lower than eternal life.

U.S Manufacturing Productivity and Employment

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Pat Buchanan makes an interesting point in this article about how bailouts of banks who have foolishly lent to foreign governments has affected U.S. manufacturing. He says that the countries which have borrowed money and could not repay were encouraged to lower their exchange rates in order to make their exports more attractive, which has made American made products less attractive.

This seems plausible, but does not seem powerful enough to warrant all the hand wringing we so often hear in the media. Usually, the loss of American manufacturing jobs is blamed on greedy corporations who move their factories overseas in search of cheap labor. The question of why overseas labor is so much cheaper is rarely addressed other than the fact that there exist teeming masses of exploitable human fodder.

This article shows that U.S. manufacturing has in fact not gone down, but has stayed at around 21% of world output. What has decreased is U.S. manufacturing employment. This is indeed due to higher labor costs, but those higher labor costs come from government regulation. This causes manufacturers to invest in labor saving technology to increase productivity per worker, which is simply the efficient use of available factors. In countries with cheaper labor relative to technology, more workers are used. So what should be decried is not a nonexistent decline in manufacturing, but the government/labor union-engineered decline in manufacturing employment.

“The Austrian Theory of the Trade Cycle”

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The Austrian business cycle theory (ABCT) was swept away by the Keynesian revolution in macroeconomics. There were several reasons for this: Keynesianism did away with the mathematically intractable and complicated Austrian capital theory, opening up macroeconomic analysis to systems of equations and graphs which were easily solved and understood. Much of the economy was reduced to incomes and expenditures and the psychological factors which have a hand in driving them. Such ease of exposition led to perhaps the most important reason for the Keynesian system’s success: it told politicians that what was needed of them was what they already desired to do, which is lead the economy through spending, easy credit, and manipulation of the money supply.

An understanding of Keynesianism is necessary to understand the government’s actions in the economy, but it is not sufficient to understand the results of these actions. For this we need a richer theory which does not shy away from the difficulties of capital theory and intertemporal economic coordination. What is lost in mathematical precision will be more than gained in an understanding of the distortions caused by economic intervention.

“The Austrian Theory of the Trade Cycle” provides an overview of Austrian business cycle theory with essays from Ludwig von Mises, Gottfried Haberler, Friedrich Hayek, and Murray Rothbard, and an introduction and a final summary by Roger Garrison, a leading Austrian macroeconomic theorist today.

Ludwig von Mises’ “The Austrian Theory of the Trade Cycle” (1936)

Mises starts his essay with a description of the English Currency School’s (ECS) theory of trade cycles. The ECS’s theory focuses on unbacked credit expansion through bank notes, but neglects the similar problems caused by the existence of bank current accounts which can be drawn on at any time. The ECS favored legislation restricting unbacked bank notes, which they got with Peel’s Bank Act of 1844. This law, which left unbacked current accounts unhindered, failed to stem future crises and wrongly led to a discrediting of monetary theories of trade cycles.

The ECS also analyzed the effects of credit expansion in one country only, where its trading partners maintained tight credit policies. While useful, this needlessly restricts the theory to foreign trade effects, leaving the situation of simultaneous credit expansion among many countries out of the analysis. The theory goes like this: easy credit leads to rising domestic prices, causing imports to rise and exports to fall. Metallic money flows out of the country, domestic banks must repay the unbacked notes they have issued, causing them to restrict credit, which together with the outflow of metallic money causes domestic prices to fall.

Mises now proposes a theory with some similarity to the ECS, but without its limitations. Here, unbacked bank notes and current accounts, known as fiduciary media, allow banks to extend credit far beyond their assets and deposits. This lowers the money rate of interest below the natural rate, so the “hurdle rate” for business projects falls and more activity begins, with an increase in the demand for and price of capital goods and labor. Consumer goods prices then rise, signalling businesses to start more projects, which must also be financed with unbacked bank credit.

Capital goods and labor have, however not increased in quantity, so the increased activity must divert these resources away from activities which would have otherwise gone on in the absence of credit expansion. This means that consumer demand and business production have diverged during this credit induced boom.

As people begin to accept that money inflation and rising prices will continue, they quickly begin to exchange their money for goods as an inflation hedge. Commodity prices rise as the currency’s exchange value falls, and the boom accelerates. Even though nominal interest rates are rising at this time, due to inflation, real rates are not high enough to slow the boom phase.

If at this point the banks decrease the availability of credit in order to avert a currency collapse and to stop the boom, then the bad investments undertaken in the easy credit environment will be exposed and will be halted or liquidated, causing prices to crash and a depression to follow. As credit is restricted, interest rates rise as the economy is braked, then fall during the depression, but are ineffective in stimulating the economy. Cash reserves held by fearful banks, businesses, and individuals grow as the depression continues.

Wages rose rapidly during the boom phase and should fall now with the prices of the other factors of production in nominal and real terms. The trade unions, however, prevent this natural equilibrating process, extending unemployment by pricing labor out of the current market and preventing a natural fall in goods prices in accordance with the new, smaller money supply.

The banks face a decision of when to restrict credit to end the unsustainable boom. The longer it continues, the more bad investments take place, and the longer the period of adjustment and depression will be that follows. It is often suggested that the economy should be “stimulated” at this time by lowering interest rates, which can only temporarily relieve the current conditions but will cause worse problems in the future. The pain during the readjustment period cannot be avoided.

Ron Unz’s “China’s Rise, America’s Fall”

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The American Conservative recently ran an article by Ron Unz which is a response to Acemoglu and Robinson’s “Why Nations Fail”, which argues that China’s growth will falter and America’s will resume because of the corrupt, “extractive”, one party rule in China versus the open, democratic rule of the benign American bureaucratic State.

Criticism of the American system of government-big business-bank partnership, in other times and places called fascism, has for too long been the exclusive domain of leftists, with soi disant conservative publications mocking any criticism of the corrupt symbiosis of government and the corporate world, especially “conservative” corporate sectors like weapons manufacturers and private prison operators. Defense. Law and order. Those are conservative values, right? Who other than a liberal would be against them? So it is good to see a magazine with the word “conservative” in its title actually criticize our corporate welfare state.

Unz documents the rapid growth of the Chinese economy against the stagnant American median incomes of the last 40 years, and lists several areas where the Chinese have surpassed American business. Despite this, China’s rise does not need to be seen as a threat since the global standard of living is increased by Chinese production.

Of course, China has its share of corruption and social problems with such a quick ascent, but this is a lot easier to take when real per capita income has risen by over 1,300 percent in 30 years. The stagnant American worker seems much more resentful of his elites.

While China’s masses are benefiting from this progress, the United States is becoming more unequal, with the top one percent controlling about as much wealth as the bottom 95 percent. The Chinese and American Gini coefficients are about equal now, and moving in opposite directions. Thirty five percent of the last few years’ economic recovery in America has gone to the top .01 percent. The government-corporate partnership funnels money upward.

The central message of the article is this:

“…although American micro-corruption is rare, we seem to suffer from appalling levels of macro-corruption, situations in which our various ruling elites squander or misappropriate tens or even hundreds of billions of dollars of our national wealth, sometimes doing so just barely on one side of technical legality and sometimes on the other.

Sweden is among the cleanest societies in Europe, while Sicily is perhaps the most corrupt. But suppose a large clan of ruthless Sicilian Mafiosi moved to Sweden and somehow managed to gain control of its government. On a day-to-day basis, little would change, with Swedish traffic policemen and building inspectors performing their duties with the same sort of incorruptible efficiency as before, and I suspect that Sweden’s Transparency International rankings would scarcely decline. But meanwhile, a large fraction of Sweden’s accumulated national wealth might gradually be stolen and transferred to secret Cayman Islands bank accounts, or invested in Latin American drug cartels, and eventually the entire plundered economy would collapse.

Ordinary Americans who work hard and seek to earn an honest living for themselves and their families appear to be suffering the ill effects of exactly this same sort of elite-driven economic pillage. The roots of our national decline will be found at the very top of our society, among the One Percent, or more likely the 0.1 percent.”