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WAITING FOR THE J-CURVE – US dollar devaluation and Free Trade Not a few observers have already come to the inevitable conclusion, that Obama's recovery plan, exactly like its forerunner Henry Paulson plan, can only weaken the US dollar and will not at all surely stop the rout in the bank and finance sector. As Obama has already said, the worst is likely in front of us, not behind us. To a certain but limited extent, 'benign neglect' of falls in the US dollar's world value can help trim some of the bank and finance sector losses on certain types of bad debt. But the real goal of devaluation, as classic as Keynesian free spending of public borrowed money, now that private borrowers are unable or unwilling to borrow more, is trade-related. One of Keynes' one-liners to FDR was that getting rid of any linkage between the dollar and gold, and letting the US dollar decline, should lever up exports. Just like other Keynesian asides and a basic part of his theories was that obsession with Strong Money, that is gold-based or gold-linked, is part and parcel of the process that led the world economy into recession, and the spiral into depression that followed. At the time, in the 1920s and 1930s, inflation was not the main problem, but trade deficits were. The goal of engineering a trade surplus was set as an almost surefire way to turn the economy round. Today, we have exactly the same, classic Keynesian strategy from the Obama team. Not Exactly Experience shows the US trade deficit is a miracle of unmanageability, growing like Topsy, whatever happens to the USD's world value. The 1985 Plaza accord, a quite-heroic devaluation of around 40%, was soon explained away as 'not working' because of the J-curve. That is US exports increased in volume, but not in value. Imports, even if falling in volume, rose in unit price. During slump, which was not the situation in 1985, we could or might imagine that imports would fall so much in volume, that a hefty USD devaluation would beat the J-curve, and sharply trim the gargantuan trade deficit. Obama may shortly decide he has to take that bet. The 70% fall in oil prices since their peak in midyear 2008 is certainly bringing down 'constant structure' US trade deficit numbers, but during recession or slump the economic structure changes. Any chance of US high-value, high-tech exports rapidly increasing is cancelled by the recession, leaving the agro-commodities, minerals, metals and other recession-hit goods, whose unit price has spiraled down over 12 months, to take the strain. In simpler terms, these are products with relatively inelastic global demand, unlike high-price goods and services. The problem is these basic exports are oil price-indexed, applying their own J-curve wipeout to any hopes for a quick rise in export revenues for the USA. Another really simple credibility problem for engineering a fall in the US trade deficit is its sheer size. If the US exported all its manufacturing output, consuming none of it at home, this would not cover the present trade deficit ! As the Obama team already knows well, US monthly trade deficits are showing little if any 'oil benefit', exactly like trade deficits of nearly every other OECD country – even whole regions like the European Union 27, whose global trade deficit goes on rising. The reasons are simple, but do not make good reading. Decades of delocalization and de-industrialization has stacked up unbeatable competition in almost any industrial activity, and increasingly in services from China, and quite soon Brazil, India and other big countries. Continued or increasing dependence on imported oil and other raw materials for the throughput, one-trip consumer society, even its 'postindustrial' culture crisis and desires for a green-clean future add to the Obama wisdom that the worst is still to come. Shrinking the world value of the dollar will do little to change these harsh real world facts – and would surely raise inflation. Return to the Deep Past Few if any Obama economic advisers could say yes they know who Malynes and Mun were, and even less say how they influenced less-unknown economic icons like Ricardo, Marx or Keynes. But a study of gold and trade throws up key insights on why the Obama plan or program is doomed, as well as its choice of pressure points to throw money at. Mun and Malynes date from the 1560s and these advisers to Elizabeth 1 of England had a crisis agenda not at all unlike Obama's advisory. Their solution is what we call mercantilism, more precisely gold-based mercantilism. The objective is to lever 'structural', or at least long-lasting trade surpluses, build or maintain the nation's stock of gold, keep the national money strong and domestic inflation low, and beat down any competitor trying to grab a share of markets dominated by the nation. Perhaps useful for the Obama team to know, this early mercantilism with contradictory objectives did not work. Trade deficits soared and the money crashed - and Elizabeth 1 was followed by England's answer to Saddam Hussein, that is Oliver Cromwell. Some historians claim she was assassinated. Not so far back in the future, the Japanese economic miracle can be closely dated to 1955-1990. This miracle was built on 'structural' trade surpluses, strong money, and large national gold reserves. The premonition signal for the end of this miracle, was the 1985 Plaza accord, which firstly and mostly targeted the Japanese Yen for revaluation. By 1990, Japan was set for a long-term future of economic decline, with a bizarre mix-and-match of hyper Keynesian deficit spending inside Japan, and a remaining, mercantilist trade surplus with the rest of the world. The JPY is now a plaything of FX traders, but its true value is a black box ! Not a few observers claim this is the near-term future for the USA, but at present the trade surplus does not exist and US gold reserves, relative to economy size or population, are far behind Japan's gold hoard. A little further back in the future, Keynes was surely blackballed by orthodox economists applying what today we call 'Austrian' or von Hayek nostrums and one-liners to the economic debate, but Keynes was ultra classic in targeting trade surplus as a way out of economic slump. His favored ways to get a trade surplus were also in part classic: cut income and corporate taxes. Where Keynes fell out with 'classicists' was to also argue that government borrowing and make-work programs can jumpstart the general recovery process, with his now-you-see-it (and now you dont) multiplier principle. Today, its hard to not see the Obama plan as almost 100% pure Keynes, right down to the tax cuts 'to stimulate exports'. Jump to the Near Future No J-curve is needed to guess, and forecast that income tax cuts will not increase US imports but will deepen the trade deficit a lot faster and more radically than they raise investment in export industries and export-oriented economic activities. Devaluing the USD, bringing Obama remedies even further into classic Keynes territory, could easily ensue within 6 months. However, given the basic, internal weakness of the 'committee money' called the Euro, it will be hard to find a money against which to devalue the US dollar! Absolutely off the Keynesian radar, reflecting the real world 21st C, Petro Keynesian recovery of the global economy is available and possible – and can be accelerated by Russia's daily devaluation rout and outflow of its gold and FX holdings, in an attempt to shore up the ruble. Since October 2008 Russia has lost around 50% of its early 2008, record FX hoard or war chest, as inflation and job losses mount and Hero Putin loses his aura. The simple remedy, for Putin, is a doubling of oil prices restoring petrodollar and petroeuro inflows to his US-style, 'neoclassic' de-industrialized and import-dependent economy, also based on commodity exports whose value can slump, or explode, in a few months. The difference is the USD is a reserve currency, the ruble is not. When or if Putin applies oil export cuts, or even talks about doing it, the oil price will start recovering. To be sure, there are more than a few 'ideological differences' between the Saudi rulers, and the Putin-Medvedev duo, but the N°1 and N°2 world oil exporters can both use an oil price hike to around 75 USD/bbl ! The potential for cooperation and collusion between Russia and Saudi Arabia only increases as oil prices fall. Whether a controlled oil price hike jumpstarts economic growth, or not, the massive and classic Keynesian deficit spending decided by almost all OECD governments, and by some Emerging Economies will surely lead to inflation, and possibly to trade war. Without waiting for an 'oil price signal', gold prices have continued to grow, as public deficits and borrowing deepen. Under these real world conditions, it is hard or impossible to see any quick, or medium-term recovery arising from the ashes of the US bank and finance sector – but the global economy still might, or could play locomotive. The Obama plan, in this outlook, has an almost zero percent chance of success.
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