Thurow and Euro

Henry C.K. Liu hliu at
Thu Dec 31 03:35:42 PST 1998


Within a capitalist system, workers always get hurt, because they are the only ones paying the bill. When bankers profit, workers get hurt; when bankers suffer loss, workers get hurt more.

The domestic economic impact of a falling dollar is not much a mystery, baecause there is enough recent history data to illustrate it.

In 1985, the G7 governments agreed in the Plaza Accord to force the overvalued US dollar to fall, raising the undervalued Japanese yen, thus slowing Japanese export. As the US dollar fell in value, Asian economies that were pegged to the US dollar experienced long periods of low or negative local interest rates because their currencies devalued along with the dollar. The Japanese Ministry of Finance responded to the G7 attack on the yen by lowering Japanese interest rates to keep the economy afloat and to slow the fall of the US dollar. By 1988, despite an overheated economy, Japan yielded to heavy U.S. political pressure to continue to keep Japanese interest rates low, in order to slow the contraction of the U.S. economy and the drastic fall of the US dollar. Low Japanese interest rates and an overvalued yen fueled financial bubbles throughout Asia that translated into systemic currency risks for the region, including Hong Kong which acted as an unregulated center for low-cost, easy Japanese loans. Even Japanese borrowers came to Hong Kong for yen loans at low interst that were not legal in Japan.

To increase competitiveness and growth, both the Japanese and other Asian governments emphasized capital intensive physical infrastructure investments at the expense of social infrastructure, with distorted and inefficient stimulative impacts on their economies. Starting in 1993, Japan spent in four years US$480 billion (70 trillion yen at prevailing exchange rates) worth of stimulative packages, with another US$115 billion package announced in April 1998. For growth, both Japan and other Asian economies rely heavily on external conditions that are beyond their control, depending heavily on the US consumer market and placing high hopes on China as a future market, as well as the emerging markets in Southeast Asia. The Japanese economy is managed by entrenched bureaucracies that jealously guard their prerogatives.

Japan has a serious bad debt burden (US$600 billion and growing as more disclosure is released), carried over by banks in a binge of reckless lending during the bubble economy of the 1980s. The Nikkei 225 stock index rose six fold in a decade (from 6,550 in 1980 to 38,916 by the end of 1989), not dissimilar to the U.S. stock market of the 90s. Deflated in the early 1990s, investor reckoning dragged down the Japanese stock market by over 60% from its peak in 1989 and property prices by 80%. Japanese banks never made proper provisions for the consequences of bad debt, keeping them on their balance sheets, hoping the economy would recover in time to allow the debts to be repaid in full or a resurgence of asset inflation to lessen the pressure. Typically, the managers of the Japanese economy engaged in denial, wishfully thinking that masking the symptoms would cure the fatal cancer. As the GDP contracts, the bad debt problem looms greater. To date, the government has spent 30 trillion yen (US$235 billion) to prevent the banking system from collapse. As a painless solution, it opted for the "convoy system", the practice of forcing healthy banks to rescue ailing banks by merging. The festering economic malaise has gone on for over eight years domestically and brought to a head by the Asian financial crises that began in July, 1997, the underlying conditions for which Japanese banks kelp created. The resultant credit squeeze caused bankruptcies losses to reach 14 trillion yen (US$115 billion) in 1997. Corporate failures in May, 1998 rose 37.5% from a year ago (to 1,791 filings, highest in 14 years, since 1984). Industrial production in April dropped 6% from the previous year, causing corporate profits to drop 25%. The precipitous collapse of the yen in the second quarter of 1998, (falling 15%, or 50% from its peak in 1995) rattled an Asia already in financial crisis, by threatening to trigger a new round of currency devaluation, including relatively insulated China. A falling yen threatens the stability of the banking system as it erodes its capital base. Many Japanese banks book their outstanding loans in dollars, some up to one third of their lending total. As the yen falls against the dollar, the yen value of dollar loans increases, pushing the yen capital of most banks towards falling below the 8% capital to loan ratio required by sound banking standards set by Bank of International Settlement. This causes Japanese banks to cut new lending or to roll over outstanding loans. As a major creditor nation, such actions by Japanese banks create new stress in the world economy that has yet to play itself out completely.

Japan's banking crises greatly reduced the impact of any macroeconomics policy to stimulate demand. Regardless of demand in the economy, Japan is structurally condemned to no growth for the foreseeable future. Even if Japan does all that Washington wants it to: spurring demand with monetary and fiscal policy, cleaning up the banking system and vigorously pursuing systemic reform, its estimated contribution to stability in the global economy is overstated. U.S. export to Japan is a mere 1% of its GDP, to all Asia 2.4%. Rising European economies are filling in the Asian gap in world demand. Asian crises are keeping the Fed from raising U.S. interest rate which otherwise should be rising. Japan needs looser monetary policy while America needs tighter, either movement would further weaken the yen. The Fed cannot postpone hiking US interest for long, and must by more if it acts later.

What had to Japan and the yen may hapen to the dollar and to the U.S. economy and the prospect of its being trggered by a run on the dollar created by the introduction of the euro is very real. Some time in the near future, a fall in the dollar of 20% would not surprise too many people, but the impact to all the economies whose currencies are peg to the dollar will be hard to predict. The stock market might fall by 40% and unemployment will rise in certain sectors. American exports may be cheaper, but there will be very few people overseas who can afford to buy even at reduced prices. Domestic interest rate will rise to stamp the dollar's fall, thus slowing down the economy. American consumer power will decline, causing problem for America's trading partners who will default on their dollar loans depite the lower dollar. A downward spiral may hit the U.S. economy and quickly spread worldwide. Unlike Japan, the U.S. government does not have the tradtional nor the political will or the budgetary surplus to absorb the pain from its lower classes, thus exposing American society to more social instability.

The dissolution of the Soviet Union marked the transition of a bipolar world into a multipolar world. In the bipolar political world, trade was primarily a Western regime. The world was a sphere of contention between the two super powers that did not trade and aid was the exclusive tool of ideological competition and economic

development . In a multipolar world, trade has become global, replacing aid as the recognized tool of economic development. American planners see world trade and globalization as a vehicle to a new world order under U.S. tutelage in which market capitalism and Western democratic principles rule. Other emerging economies sees foreign trade as means to achieving world power status along mercantilist paths. The european Union and the creation of the euro are concrete steps in this direction. These two separate and different objects will inevitably clash. The U.S. see bilateral trade as a privilege to be granted to countries which subscribe to American values and in concert with American national interests. Europe sees foreign trade as its re-entry into global power status. Emerging economies see bilateral trade with richer nations as a moral obligation of rich nations to equalize historical economic injustice. It does not add up to a pretty picture for global capitalism.

Henry C.K. Liu

J Cullen wrote:

> If there is a run on the dollar, causing it to fall in value versus the
> euro, could that be a good thing for American producers, since American
> products would be more competitive on the world market? In other words, who
> gets burned if the dollar falls, bankers or workers?
> -- Jim Cullen
> >Tom:
> >
> >Have not read it, but if the message is that the euro will provide global
> >funds another safe haven alternative to the dollar, causing a run on it and
> >forcing it to fall, Thurow has been saying that for almost a year.
> >The prospect is real and imminent. Most central banks and institutions are
> >fully set up to move on January 1, 1999. Much dollar assets are already
> >hedged.
> >
> >Henry
> >Tom Lehman wrote:
> >
> >> Dear Doug and the LBOers,
> >>
> >> Anyone read Lester Thurow on the Euro in the January 11th edition of the
> >> Nation. Anything tu-it.
> >>
> >> Your email pal,
> >> Tom L.

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