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Most American
economists are singing "Happy days are here again." The stock
market is up, business profits are rising, and commodity prices are going
through the roof. They are convinced that stock prices will continue to rise,
the economy will boom, and business spending and industrial employment, which
presently are trailing other indicators, will soon follow suit. Government
politicians and officials happily are joining the tune – after all,
it's a Presidential election year.
A few economists are marching to a different drummer. They are certain that
stocks are greatly overvalued and prices are bound to fall soon, and that we
must brace for deflation leading to recession and even depression. They are
the deflationists who envision and observe a gradual reduction in the stock
of money or substantial declines in spending, which will depress the economy.
They fault several economic and political forces that will cause a deflation
despite the apparent present expansion and recovery of stock prices.
During the 1990s, they contend, the American economy enjoyed an unprecedented
boom that generated a huge bubble of excess capacity; it is bound to deflate
soon and depress economic production for years to come. Moreover, the new
computer technology has been contributing to this excess capacity, as has an
entirely new factor, the globalization of trade and commerce. Relentless
competition by industrial newcomers, such as China and India, together with the new technology and the old bubble, are bound to leave their
painful mark. The official guardian of progress and prosperity, the Federal
Reserve System, will be unable to bail out failing banks and businesses
because the deflation will affect the entire world economy and render failure
systemic. Surely, the Fed will load the banks with money, but they will
prefer to invest their funds in U.S. Treasuries rather than lend them to
failing businesses. The stock market, according to the deflationists, will be
the key and gauge of the deflation and depression to come.
Deflationists do not tire likening present economic and financial conditions
to those of the 1920s that led to the Great Depression of the 1930s. They may
point to a precarious real estate market based on exaggerated real estate
prices; it crashed in 1931 and 1932 and spread its gloom throughout the
economy. Or they may frighten their readers with horror tales about the stock
market crash of October 24, 1929, which signaled the beginning of a new era. The
stock market rallied thereafter, just as it has after the 2002 decline. Early
in 1930, most investors believed that they were on the way of recovery and
turned bullish again, as they have now. Actually, the worst was yet to come,
as it is now.
Deflationists also seek to prove their case pointing to the decade-long
recession in Japan. During the 1980s the Japanese economy was the envy of the
world, reporting expansion rates that exceeded all others. Actually, it was
blowing bubbles that were bound to burst. When they began to deflate in 1990,
the Japanese government chose to fight the needed readjustment. Yet, no
matter what the authorities would attempt and undertake, deflation and
recession have kept the people in their grip ever since.
This writer readily concurs with the deflationists' analysis of economic
bubbles. In contrast to mainstream economists, they correctly perceive the
gross overvaluation of corporate stock, the economic maladjustments which
they call "excess capacity," and the market pressures of
readjustment. They observe the changes in technology and international
competition but draw conclusions that differ radically from those of this
writer. They plan the future by the past, by the Great Depression and the
Japanese recession. This writer braces for more inflation and stringent
government controls to come. In his judgment, the future will be different
from the past.
In just two years the U.S. dollar has fallen some 30 percent of its value in
money markets of the world. Federal Reserve inflation, credit expansion, and
government deficits have caused the U.S. dollar index to plunge from 120 to
85. Many foreign holders of dollars, Treasury securities, agency paper,
corporate stocks and bonds, etc. have lost equivalent amounts. As U.S.
authorities are determined to continue their easy-money policies, and even
accelerate them as they deem fit, U.S. deficits on trade or current account
are bound to grow; ever more dollars will flow to the rest of the world and
swell the debt.
If it were not for Asian central banks, mainly in Japan and China, which are absorbing the rapid outflow of dollars and investing them in U.S. Treasury
securities, the U.S. dollar would plunge even deeper. But how long can they
keep up their valiant support sending their goods in exchange for American
paper? Sooner or later, they may tire boosting American levels of living at
their own expense. Or, they may decide to retaliate for new trade
restrictions which all Democratic contenders for the U.S. Presidency so
ardently advocate and President Bush may finally impose; they may cease to
support the dollar, or even dump it. The dollar would fall precipitously,
interest rates would soar, and financial markets would crash. It would
present the Fed with two possibilities of courses of action. The Fed could choose
to continue its policies, even accelerate its accommodations, increase its
open-market purchases, and lower its one-percent discount rate even further. Or
it could step aside and allow the economy to readjust to the calls of the
market. No matter what it should choose, allowing interest to rise to market
levels or embarking upon super expansion, the American people would be dazed
and stunned by the sudden upheaval. Many would be frightened and prompted to
forsake their easy-spending ways, even to reduce their debts, and increase
their savings. They would reinforce the very forces of deflation foreseen by
the deflationists.
No matter how the American people would react, the inflation forces would
reign supreme in international money markets and beseige the dollar. They
soon would follow it to American shores and overwhelm the deflationary
tendencies in the end. Rising prices of essential foreign energy and many
imported consumers goods as well as newly protected domestic products would
determine the outcome. However, if the Federal Government should decide to
follow the pattern of the Hoover and Roosevelt New Deals or the Japanese deal
of the 1990s, it would constrain and retard economic activity and give rise
to an admixture of inflation and stagnation, commonly called
"stagflation."
Most American economists misjudge the very causes of the Great Depression,
which may mislead them in their analysis of the present situation. Many fault
the Federal Reserve for not expanding its credits in the fall of 1931 and the
winter of 1932. Others lay the blame for the Depression on the credit bubble
of the 1920s and the 1929 crash which finally burst it. Actually, the credit
expansion merely called for a year or two of readjustment with some
redirection of capital and labor, similar to the 12-month recession of
1920-1921. It did not give rise to the Great Depression, which was the tragic
handiwork of the Hoover-Roosevelt New Deals. In June 1930 the Republican
Congress passed the Smoot-Hawley Tariff Act which practically closed U.S. borders to foreign goods and led to foreign borders being closed to American goods. Rapidly
growing trade restrictions, including tariffs, quotas, foreign trade
controls, and other devices, soon generated a world-wide depression. Moreover,
in the dark hours of 1932, the Hoover administration struck another blow
– it doubled the income tax. The Revenue Act ordered the
sharpest increase in American history. When state and local governments faced
shrinking tax collections, they, too, joined the Hoover team and imposed new
levies and raised the rates of old.
Marching in President Hoover's footsteps, President Roosevelt's exactions and
demands on business were unrelenting. Revenue legislators in 1933, 1934, and
1935 again raised tax rates on higher incomes. Estate taxes were raised to
the highest levels in the world. The Farm Relief and Inflation Act of 1933
sought to raise farm income by reducing output. Crops were burned in the
fields, livestock destroyed, and the expenses were covered by a new "processing
tax." In 1935, Congress passed the Wagner Act, taking labor out
of the courts of law and lodging it in a newly created federal agency, the National
Labor Relations Board. Soon, labor unions engaged in numerous boycotts,
strikes, seizures of plants, and outright violence which depressed business
even further. With unemployment above the 10 million mark, the American
economy just would not rise from the depths of depression into which it was
cast by the Hoover and Roosevelt Deals.
Japanese governments during the 1990s were marching in the footsteps of the
American New Deals. When Japanese financial markets began to break after many
years of unrestrained credit expansion, the government decided to support and
sustain high-cost unprofitable banks and businesses. It ran budget deficits
amounting to one-fourth to one-half of its annual budgets which, in time,
boosted the national debt to more than one and a half year's gross domestic
production. The Bank of Japan even lowered its rates below the yen inflation
rate, offering its credits without cost. In short, the Japanese government
labored strenuously to prevent a needed readjustment to true market
conditions; it succeeded in protecting the maladjustments and prolonging the
recession.
Deflationists observing booms and depressions correctly recognize and analyze
the harmful policies of national treasuries and central banks. They perceive
the cyclical instability of a hampered market order but blithely overlook and
ignore all other forms of government intervention that impede, thwart,
shackle, and curb economic activity and lead to deep depressions. And they
pass over the peerless position of the U.S. dollar as the world's primary
reserve currency, which allows the Federal Reserve System to inundate the
world with U.S. dollars – until the principal creditors, China and Japan, call a halt to the delusion. At that time, the U.S. government may contrive a Bush
or Kerry Deal, similar to the Hoover-Roosevelt Deals. We are bracing for
fervent controls and dreary stagflation to come.
Robert Blumen
Robert Blumen is an independent
software developer based in San Francisco, California
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