Saturday, 23 May 2009

The Curse of being a Creditor Export Nation

"Germany was one of the leading borrowers on the American market during the boom. Germany was undoubtedly short of capital, bereft as she was by the war and then by her ruinous inflation, culminating in late 1923. However, the German bonds floated in the United States did not, as most people thought, rebuild German capital. For these loans were largely extended to German local and state governments, and not to private German business. The loans made capital even scarcer in Germany, for the local governments were now able to compete even more strongly with private business for factors of production."
Murray Rothbard, Americas Great Depression

The recent GDP figures in relation to the German economy were dreadful. The economy was reported to have shrunk 3.8% in the first quarter. Later in the week Japans figures came out, again the numbers were once again nauseating. This time a contraction of 3.5% for the quarter along with a collapse in exports. Meanwhile millions in China are being made redundant. Despite the massaged figures that the Communist party reports, China is heading for a hard landing. Many commentators have begun warning the Asian bloc of nations that their export based economic model is flawed, signaling they need to buy our bonds to avert a further collapse in their own economies. Ambrose Evans Pritchard has stated that Asia will author its own destruction if they stop buying US governments bonds, meanwhile Anatole Kaletsky claims that Germans need to abandon their rigid monetary stance and deploy a looser fiscal policy in order to save itself and the Eurozone. Why is it that prudent nations, who saved, lived within their means, who were running trade surpluses during the boom are having a harder time of late than nations such as the UK or US, who did the exact opposite? I mentioned that this should occur back in February, and it is perfectly logical. It is always the prudent that face a worse punishment than the reckless, this is the way it always works.

Think of a hypothetical situation in which Person A works, saves, lives within his means and always seeks to improve his working skills. Person B on the other hand, works as little as he can, doesn't save, borrows as much money as he can and has no interest in bettering himself. Person A has so much saving that he doesn't know what to do with it all, therefore lends it to Person B to fund his lifestyle. It seems like a good idea, as both benefit, one gets interest on his loans, the other is able to live beyond his means. Person B comes to a point where he has simply borrowed too much, but insists that Person A must continue to lend him money just until he gets back on his feet, otherwise he would default on his loans. Person A initially agrees, but as time goes on Person B has still not changed his ways, still threatening that he needs more money as both would be in real trouble if the current agreement stopped. At some point, Person A decides enough is enough and decides to cut his loses. Person B realises he can no longer pay back the money so defaults.

In the above Person A has to go through a lot more pain, as he has essentially just worked and saved for no reason, as Person B defaulted on his loans. He has lost all his capital and doesn't know what to with his future earnings. Person B however has had a pleasant lifestyle and at this point has gained greatly. He hasn't taken the short term hit. Yet despite this, over the long term Person B needs to develop his skill set to pay for his lifestyle he was previously used to and needs to learn once more how to live within his means. Person A meanwhile has the above already and has a head start on person B. Over the long term he is in far more beneficial position as he re saves his money, continues working and has learnt a lesson not to take excessive risk by lending to individuals such as Person B.

The above is an extreme and simplified situation but illustrates the global issues we are now seeing. Despite all the empty threats Hilary Clinton sends to China to continue buying US government debt, as soon as creditor nations decide to cut their losses the better they will be in the long term. This is the decoupling commentators such as Peter Schiff mention. The initial stages will be very painful for the creditor export based nations, but over time they will write off these losses and move forward consuming more of what they produce, rather than shipping it to others who can't pay.

The globe was at a similar junction during the Great Depression. Back then America was the creditor export nation of the world, making loans to Europe and assisting with the inflationary program Britain was pursuing as she tried (and failed) to keep the pound artificially high. During the 1920's Europe was a economic fiasco. Germany witnessed the collapse of the Mark, Austria nearly had a similar fate, France was weak, Britain was struggling with her empire and Russia had cut itself off as it succumbed to Communism, embarking on the road towards impoverishing her people. When the phrase 'roaring twenties' is used, it never applied to Europe, America was the creditor of the world producing and exporting some of the most innovative products of its day. With this surplus she helped nations in Europe, even into the depression;

"The New York Federal Reserve loaned, in 1931, $125 million to the Bank of England, $25 million to the German Reichsbank, and smaller amounts to Hungary and Austria. As a result, much frozen assets were shifted, to become burdens to the United States. The Federal Reserve also renewed foreign loans when borrowers failed to pay at maturity."
Murray Rothbard, Americas Great Depression

Economists always like to mention the fact that European nations never had as bad depression as America, such as the BBC's commentator Stephanie Flanders, however comments like this miss the whole economic perspective and analysis. Europe never had a boom, therefore it didn't have as hard a time as the US, instead during the 1920's many of the continents nations experienced high inflation to erode the value of debts obtained during the First World War. Over the long term America, as history showed, bounced back and became the economic superpower. During the 1950's and 1960's American products were practically unbeatable and she also assisted with Europe's Reconstruction after WW2 with the Marshall Plan.

The recent idea that a nation who consumes too much is doing nations that live within their means a favour is absurd. Its much easier for one to consume than to produce. Generally once a nation becomes a debtor for consumption purposes it becomes very hard to break the cycle, as increasing amounts of money is used for further short term consumption or paying interest on the existing debt. Many Eastern European states borrowed heavily from the West for such means while they were still within the unproductive Iron curtain. Nations such as Poland, who in 1970 were 1.1B in debt, increased these overseas debts to 25B ten years later. This money was not used wisely as it was just used to consume goods rather than to increase productive capacity. Many such nations experienced mass inflation with the economies being effectively Dollarised (foreign visitors were quite frequently asked by the locals to pay for goods or services in Dollars rather than the local currencies).

Many commentators justify Americas recent borrowing stating that America borrowed hugely from European countries such as Britain and Germany in Europe during the 19th Century, but again they miss the point. Back then this money was used for production, not consumption. Countries like China recently have borrowed huge amounts of money from the West, however they have used this money for production purposes or investing in human capital. There is nothing wrong with borrowing money - it's what you do with it that matters.

America up until the eighties was a creditor nation, it was during Reaganomics that it chose to become the worlds largest debtor in history. Once travelling along this path it becomes very hard to stop or reverse. Tough choices have to made by politicians and the countries citizens, all of which are avoided until it is too late.

Don't get me wrong, there are issues with many of the worlds creditor nations. The Saudis are ruled under a despotic regime, Russia still suffers from decades of Communist decay, China has too much bureaucracy, Germany has a rigid labor force and Japan has huge amounts of Government debt, increasing as the crisis deepens. In short I think the whole world has issues.

Keynesian economics always tells people what they want to hear, mainly it is an economic framework that provides individuals with the notion of a free lunch. As Milton Friedman said "There is no free lunch", every action has a cost. Consumption, Debtor nations will have to pay more for their situation than the export and creditor nations in the long run. There is no curse for being an export creditor nation. The curse is a Keynesian myth, the economic school that once again gets the wrong end of the stick. The curse lies with debtor consumption nations. It always has and always will.


  1. christian pickett25 May 2009 at 04:12

    nice commentary

    how do you see the debt restructuring working out in the U.S CRE , Finance, and RRE sectors so a recovery can begin......i hear lots of people talk of inflating the debt away or devaluations...but i don't see a viable way to get money into the people's you see a one time devaluation (perhaps co-ordinated amongst debtor nations).....a large amount of bankruptcy's where gov't picks winners and power is consolidated....? i have been searching for a while to figure out how the debt will and can be restructured

  2. Hi Christian,

    Your question regarding how will they put the money in peoples hands is a common question. Quite simply it doesn't have to happen for inflation to occur. The Central Bank is the willing lender of last resort and the Government is the willing borrower of last resort. The Fed can monetize at will and the Government can borrow as much as it wishes. The current drop in the consumer price indexes is part of the natural part of deleveraging after a credit boom. This is a temporary phenomenon. The above agreement can go on forever. This is what has happened in Zimbabwe. There is no fractional reserve lending between individuals, just the government printing huge amounts of money.

    Central Banks always like to make themselves look like inflation fighters, but as current events are showing they are the causes of inflation. Market forces always make goods and services cheaper, yet the Central Banks always try to target positive inflation rates - therefore they have to create inflation.

    So this is how the debt will restructured with disastrous effects. This will crowd out the private sector further. These are parts of the reason I see stagflation over the long term for years to come.

    We are already seeing the devaluations from everyone. Nations with a stronger foundation are also devaluing as they are trying to keep 'competitive'. Over the short term exports can be made more competitive by devaluing but not over the long term. Back in 1900 the £ was worth around $5 and look at its value now. Its capital that make your exports competitive - not a weak currency, otherwise Zimbabwe would be the next China. A while back Zimbabwe justified a devaluation for this reason.

    There are suggestions that a new carry trade could develop similar where Japan went through QE and exported inflation into Western asset markets, however I can't see it happening this time. The trade would go from the US and UK into the BRIC nations, however most nations are printing money and the whole world has issues.

    I hope that answers some of your queries.

  3. christian pickett25 May 2009 at 16:22

    Still does not seem accurate....but i really appreciate your reply and i agree with the other parts (fed inflation "fighter")

    reason the USA Electronic "money" outpaces Green tangible money by 25 to 1. If you look at the Fed website...electronic money is what is being created....

    In Zimbawbwe they just add zero's to the paper currency.....that will not happen here....Paper money is not being hyperinflated in the usa...not close ...impossible to hyperinflate the money supply via paper tangilble "money" when for every 1 paper dollar ..there is 25 elctronic dollars......

    also unlike zimb....US is not some tiny country that world trade does not depend on....and even should U.S dollar lose "market share" will take a long time to make the dollar as unimportant as the zimbawbwe currency......

    So in the absense of creating new $200, $500, $5000 dollar bills and then handing them out... how do you get inflation with the fed basically creating electronic imputs of credit to purchase new treasury debt that grows the supply of money but how in the real world does this translate into higher say that bank lending is not necessary to facilitate this inflation(via the money mulitplier effect of fractional res. lending) but so how does this = inflation........especially in a enviornment where the debt overhang via city...state....individual....CRE...RRE...Corporate is so high......

  4. I only used Zimbabwe because they are a recent example of heavy inflation.

    With Zimbabwe it began with electronic money. Basically they defaulted on overseas loans around 2001 and admitted they couldn't pay. Usually they would have got an IMF loan (similar to Hungary, Latvia, Iceland etc with the current crisis) however Mugabe had started policies such as collectivisation and the IMF took a principled stance and wouldn't lend the regime any money. This is where Mugabe began buying the debt himself. It takes years to get the extreme bills you see on the TV, these have only been made in the past few years - so $5000 dollar bills are perfectly plausible 5-10 years from now. Nowadays of course Mugabe doesn't even buy the debt - he just prints it direct to pay the bills. It begins with QE policies, and they are supposed to sell it back onto the market, but it won't happen, they are running too large deficits.

    Electronic money is even easier to create and even more dangerous. If the Fed wanted they could print $100T in a second and go spend it. They obviously can't do this as people would quite rightly protest, so its a more gradual process.

    Of course the US is a far larger and diverse economy than Zimbabwe, but Zimbabwe was a solid economy by African standards before the inflation took off. The danger with the dollar is there a lot of dollars in overseas destinations. If these individuals begin to loose faith and believe the Euro or Gold is a better store of value then they will begin to send the dollars back to the US, devaluing it very drastically.

    Paper money is the same as electronic money - its all money spent on goods. When the govt spends money it spends it just as any individual would, so people will eventually receive this money. The debt level of individuals may be high at the moment, but its all priced in dollars. The more dollars are printed the less these debts become, so eventually they should be lower debts.

    Hyperinflation is a possibility, however in my view high inflation is the likely outcome as we have democracy so the politicians will have to act eventually.

  5. We are already seeing the devaluations from everyone. Nations with a stronger foundation are also devaluing as they are trying to keep 'competitive'. Over the short term exports can be made more competitive by devaluing but not over the long term. Back in 1900 the £ was worth around $5 and look at its value now. Its capital that make your exports competitive - not a weak currency, otherwise Zimbabwe would be the next China. A while back Zimbabwe justified a devaluation for this reason.

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  6. Interesting to stumble on this.
    Overall Phill gets it correct in my mind.
    One thing he did get wrong is "Germany has a rigid Labor force". The exact opposite in the ways it matters in my mind. Rigid is the wrong word. Disciplined and skilled and flexible are better words. There flexibility again has been proved as Germany powers out of the recession with continually increasing Exports. They had a hick-up.
    I am Australian 5th Generation German descent - very much Australian but I think I do understand the German Culture still. It is not rigid in many ways - just the opposite. Very Fiery and Passionate at times but the disciplined side comes back in quickly. A culture that will face the Facts and right down to the individual everybody says: "how do we get out of this mess" and gets into solving the problem. Not the British Culture - "how is the Government going to fix this"? The USA somewhere in between. Australia still too much like Britain. Not like Greece - why me? Spain - why me? etc.
    Maybe it is a time for a German descent President again in the USA. I certainly would not mind seeing a German descent Prime Minister in Australia or even a Chinese one. Very similar I think. The ones you had in the past were good - realists and pragmatic and people tended to trust them.
    That is not being rigid - just disciplined. Facing the Facts is being flexible. Also German Companies do find it easy to get there employees to tighten the belt and take less pay at times of crisis because when the good times come they do honor there word and share the boom profits. Thats not being rigid - that's acting in an honorable way.
    Unfortunately there is not much honor in Australia now or the USA from what I can see. Not all Economic problems can be solved by Economic theories. People and there attitudes and Culture play a big part. Being responsible and acting with honor is not being rigid.