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Buoyant Economies

Letters on Economics

 

 

 

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Sent: 14 April 2016 

Read (in part) 17 April 2016

 

Dear Ian

Last week you were discussing the loss of Australian manufacturing businesses and how Americans are raging against the loss of their industries.  Also, you questioned the merit of “free trade” agreements.

Economics is a very political subject.  Therefore, economists and politicians often use words and phrases designed to mislead or deceive us about what is really going on.  A pact to regulate trade between two or more countries is what politically sensitive economists call a “free trade agreement”.  But that should not stop you and me from calling it a “trade pact”. 

Economics is full of deceptive phrases.  One of the most blatant is the “oil crisis”.

US statics show that the recession called the “oil crisis” started in the third quarter of 1973.  The OPEC meeting that raised oil prices was held later, in October of that year.  It was politically convenient for politicians to call the recession the “oil crisis” and blame OPEC for it, even though oil prices could not have had anything to do with it.  It would have been more accurate to call that recession the “floating exchange rate” crisis because it followed the floating of the US currency in March 1973.     

Even the term “floating exchange rate” is deceptive.  The so-called “floating exchange rate system” is a mechanism designed to isolate an economy’s money supply from international transactions.   Money is a system for recording things like our income.  By preventing money from international transactions from entering our economy, the floating exchange rate system deprives us of additional income from international trade.  

If we increase our exports, under the floating exchange rate system, the exchange rate rises to reduce our export incomes.  Also, by making imports cheaper, the higher exchange rate drives consumers to shift their spending away from domestic products and towards imports.  That lowers the income of local businesses.  It is that shift from local products to imports that has undermined our manufacturing industries.  Instead of calling it the “floating exchange rate” system, we should be calling it the “industrial suicide” system.  

US political economists have been telling their citizens that they are reaping the benefits of a market driven floating exchange rate system.  But many US voters no longer believe them.  They are feeling the loss of income arising from the collapse of their manufacturing industries: a direct consequence of President Nixon’s industrial suicide system.  It is no wonder that voters are enraged by the rhetoric of political economists and are supporting any politician that identifies with their pain.

Yours sincerely

 

Leigh Harkness

 

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Sent: 22 August 2015 

 

Dear Ian

Over the last few weeks you have been lamenting the downfall of our manufacturing industries.

The structure of our economy has changed since the days when manufacturing industries were growing and prospering.

In the past, we had a balanced monetary system: that is, we could earn additional money from increased exports and we could create additional money from bank credit.  The money earned from exports was spent mainly on domestic products.  Those additional domestic sales stimulated our manufacturing industries, enabling them to prosper.  Bank credit also helped finance investment in those industries.   

We now have a one-sided monetary system in which the only source of additional money is bank credit, or debt. If we increase our exports, we no longer earn any extra money.  Instead the exchange rate rises and makes imports cheaper so that we reduce the amount of domestic products we buy and buy imports instead.  It is this decline in domestic sales that has been eradicating our local manufacturing industries. 

Bank lending now finances housing rather than industrial investment.       

If we are to prosper from Australia’s vast resources and skilled workforce, we need to return to a more balanced economic system: one that not only allows us to borrow money from the banks but also permits us to earn more money from exports.

Regards

Leigh

 

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Sent: 11 July 2015 

Read: 12 July 2015

 

Dear Ian,

A few weeks ago, you took a call from a fellow promoting a trade show in China.  He invited Australian businesses to participate in the exhibition, and to take advantage of the Government’s subsidies to promote trade. 

However, Australia no longer prospers from trade.  

In the past, Australian business could earn additional income from exports. The exporters would spend their extra income mostly on Australian products. Consequently, we all prospered from their good fortune.    

The economic principle of the time was that, while exports were greater than imports, the economy was in a state of disequilibrium.   The additional money it earned from exports, above what it spent on imports, would cause it to grow.  As it grew, it would spend more and more money on imports.  Eventually, it would reach the equilibrium level of income, when spending on imports was equal to its income from exports. 

Since then, monetary “reforms” have employed the exchange rate as the instrument to achieve that equilibrium.  The exchange rate is required to rise, or fall, to ensure that our international receipts and payments are equal.  In other words, it makes sure that any additional income we earn from exports is spent immediately on imports.  

There is no longer any need for the economy to grow to achieve equilibrium.   Also, any increase in the income of exporters is offset by a reduction in the income of other Australian producers.  Their incomes fall because the monetary system requires us to buy fewer Australian products so that we have the money to spend on the extra imports.  

Now, if we want our economy to grow, we must synthesize the old effect of additional exports, by raising bank credit.  However, bank credit is a poor substitute for export income: it raises our debts faster than it raises our incomes.  Also, it make us spend more than we have earned, and buy more than we have produced.

 The only way we can buy more than we have produced is to import more than we exported.  To offset that imbalance, we are required to sell off the farm, or raise foreign debt.   

Like many other countries, we cannot afford to go deeper and deeper into debt so that we can grow.  Nor do we want to continue selling off the farm.  If we are to “advance Australia”, we must have a “fair” system: a system that delivers “wealth for toil”; not toil to pay off our debts.

We need a new monetary system; one that allows us to prosper from trade with other countries, such as China.

Regards

Leigh Harkness

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Sent: 23 May 2015  

Read: 31 May 2015

Dear Ian

You have been urging us to buy Australian.  But it is very difficult.  The problem is that we are exporting too much of our mineral wealth.  That forces our exchange rate up, making imports cheaper, so that we buy them rather than Australian products. 

Imagine what would happen to farmers and manufacturers if we found large oil reserves in Australia, or struck a gold nugget the size of Uluru.  The export of that oil, or gold, would drive the exchange rate through the roof, and Australian products would be too expensive to buy compared to imports.

If that were to happen, it is likely that buying Australian would not be our problem: we would not have a job to earn any money to spend.  As now, we would be told it was our fault; that we were too inefficient and unproductive and we should lift our game.

The problem we really have is that there is a barrier in our economy.  That barrier stops us earning more money from exports.  Like many things in economics, that barrier is given a name to hide what it really is.  Sometimes it is called an open market.  At other times it is called the floating exchange rate system.

Whatever we call it, it has a perverse effect on our economy: it stops us prospering from the wealth of our resources and it forces us to buy imports rather than local products.  For that reason, we may as well leave our minerals in the ground.  That way, the exchange rate would fall making Australian products more competitive.  Then we would all buy Australian and prosper.

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Sent: 21 March 2014 

Ian,

Despite all the doom and gloom about Australian industries, there is one industry that is currently doing very well: our banks.

Banks owe their prosperity to the government’s decision to deregulate them, and to the policy of “shutting the gate” on money entering and leaving the Australia economy.  

To explain the significance of “shutting the gate”, I need to tell you about my experience managing banking in a small island economy.

Before that small country had a bank, the government would convert foreign currency, entering the economy, into local currency.  When the local currency was spent on imports, the government would convert it back into foreign currency to pay for those imports.  This was a simple but effective policy.

When the country established a bank, it started lending money.  That money was spent on imports, also, and needed to be converted into foreign currency.   

The Treasury came to realise that the bank’s lending was causing the country to spend more on imports than it was earning in foreign exchange.  That is, bank lending was depleting the country’s foreign reserves.  

In Australia, in the early 1980’s, banks increased their lending.  The additional money caused us to spend more on imports than we were earning in foreign exchange.  Therefore, bank lending depleted our foreign reserves. 

To balance the international payments of the small island economy, the government regulated bank lending to ensure that it did not deplete foreign reserves.  This allowed the small economy to leave the “gate open” for local industries to earn additional money from exports and tourism, and for that additional money to stimulate the whole economy. 

But in Australia, our government “shut the gate” on money entering and leaving the economy, and deregulated bank lending.

The “shut the gate” policy is commonly called the “floating exchange rate system” because it requires the exchange rate to fluctuate to ensure that foreign receipts and payments are equal.   The system uses all the foreign currency that we earn from exports, and foreign investment, to pay foreigners for our imports.  Then it uses all the local currency we spend on imports to pay our exporters and foreign investors.  The “shut the gate policy” prevents exports from contributing any additional money to our economy to raise our incomes.  

During the current mining boom, our “shut the gate” policy has been inflating our exchange rate to balance our international receipts and payments.   The higher exchange rate affects us in 4 ways:

1.      It reduces our exports by making many of them more expensive to foreigners.  This particularly hurts our manufacturing export industries.

2.      It increases our imports.  Imports remain the same price in terms of foreign currency, but our inflated exchange rate makes them appear cheaper to us (in terms of Australian dollars); so that we buy more of them. 

3.      It reduces the value of our exports in terms of Australian dollars.  Therefore, it reduces the incomes of our mineral exporters and farmers.

4.      It reduces our spending on Australian products.  The cheaper imports make Australian products less competitive, so that we buy less of them.  This reduces the incomes of Australian industries supplying the domestic market.

However, the “shut the gate” policy has been good for the banks.  It has ensured that nothing, not even bank lending, can deplete our foreign reserves.  This has allowed the government to deregulate bank lending, and consequently, our banking industry has grown and prospered.

It all goes to show, that if you want to look after the banks (and you don’t care about anybody else), as far as international payments are concerned, “you’ve got to shut the gate, mate.”

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Sent 15 December 2012 

Read;   16 December 2012 (in two parts);

            19 May 2013 (first half); 26 May 2013 (second half).

Economics without analogies

Ian

A couple of weeks ago, you questioned my use of analogies to explain what is happening in the economy.  The following is a straight forward explanation of what is going on. 

Our economy is a system of trade.  The simplest form of trade is barter in which people exchange goods with one another.

Money is a recording system that should make that trade easier.  That is, the money we earn from selling products should entitle us to buy products of an equivalent value.  The money, or recording system, that we use for this trade need to be very secure.  If it were not, someone could create their own money and use that to buy products without having to reciprocate.  They would be stealing from people who had produced products.  It is for this reason that counterfeiting money is a serious crime.

If the government were to print money to finance its expenditure, that would defraud the economy. That is why governments apply taxes.  Taxes reduce our spending enabling the government to spend without defrauding the economy and undermining the monetary system.

Most money we hold is recorded by banks as deposits.  If bankers were to write additional deposits into their personal bank accounts, they would be entitling themselves to products that they had not earned.  We would consider such action as criminal and a serious breach of security and trust.

If banks write deposits into other people’s accounts and call it a loan, it has the same effect on the economy as if the bankers had given themselves the money.  This is what currently happens in our banking system and the deregulation of this practice is the main source of our economic problems.

Of course the banks would say that the borrowers from the banks would eventually repay the loan.  Therefore, they eventually reciprocate.  But by then the banks would have lent even more money so the loan repayments only partly offset the effect.   It is the growth of total bank lending (that is, new loans less loan repayments) that is the source of our economic problems. 

If people who had earned money lend their money, that is not a problem.  They are reducing their spending to allow someone to buy the goods to which they were entitled.  But when banks increase their lending, they are not reducing anyone else’s spending.  They are taking advantage of the trust we have put in them to swindle the economy: they are giving money to people who have no entitlement to the products of the economy. 

It is this growth in bank lending that causes the economy to buy more than it produces.  The only way we can buy more than we produce is to import more than we export.  The only way we can import more than we export is to raise our foreign debt, or sell off the farm.  That is what is happening to our economy: our foreign debts are rising and we are literally selling off the farm.

In the days of fixed exchange rates, if the banks lent too much money, the economy’s foreign reserves would decline.  That would prompt the central bank to restrict bank lending.  Floating exchange rates protect the central bank’s foreign reserves.  This is why central banks are keen on the floating exchange rate system.  Commercial banks adore the floating exchange rate system because it allows bank lending to be deregulated.

Also, in the days of fixed exchange rates, the economy could earn more money by exporting more than it imported.  That is why we use to say that the economy rides on the sheep’s back.  Now, with floating exchange rates, the economy cannot earn any more money by exporting more than it imports.  The only way we can inject more money into the economy is to borrow from the banks.  Therefore, we have become dependant upon the very thing that is destroying our economy.

The floating exchange rate system may be wonderful for the central bank and the banking system, but as we have seen, it has been disastrous for the rest of the economy.  When we increase our exports, we do not earn any more money.  Instead, we drive up our exchange rate to reduce our export incomes and make imports cheaper.  We then buy the cheaper imports and our own industries suffer, together with the wider economy. 

The problem that we now have is that bank lending has been growing faster than the rest of the economy.  That is, our debt has been growing faster than our capacity to repay that debt.  We are now approaching the point that we cannot afford any more debt.  If we cannot afford more debt, then our economy will not have any additional money to stimulate it.  That would cause a recession.  If we have a recession, many of us with debts may not be able to repay those debts.  That would cause the banks to collapse, as they have in the USA, UK and Europe.

Another facet of our economic problems is the government’s fiscal deficit.  One of the symptoms of a weak economy is low tax revenues and increased government expenditure on social security.   This leads to fiscal deficits.  To distract the government from the real issues in the monetary system, the financial sector blames the government deficit for our economic problems. 

Making the victim the scapegoat is a particularly common response of proponents of our failing economic policies.  This is particularly evident in Europe where countries that have been devastated by the monetary system have been told to adopt sever austerity measures to balance their budgets. 

That is where we find ourselves at the end of 2012.  It will be interesting to see what happens in 2013.

Leigh

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Sent 9 November 2012 

Read 2 December 2012

Winds of Trade

Ian

Last Sunday you questioned why our manufacturing industry was declining in Australia. 

To understand why, think of the economy as being like a sailing ship.  Sailing ships need wind to fill their sails to drive them along.  Likewise, our economy needs international trade to drive it along.   

If a ship points to high into the wind, the wind will not fill its sails and it will just drift. Likewise, if our economy’s exchange rate goes too high, our economy will just drift.     

In Australia, we have had good trade winds.  But our ship is being steered too high into the wind; our exchange rate is too high.  Therefore, our industries cannot prosper from that trade.   

The strong export trade is in the sails of the mining industry.  But the high exchange rate produces a back-draft of imports that push our economy in the other direction, so that we go nowhere. 

The more we increase our exports and catch the trade winds in one part of our economy, the more the back-draft blows to increased imports and undermine our other industries, such as manufacturing.

It would be easy to steer the ship so that the whole economy prospers from the winds of international trade.  But, it suits the finance industry for us to buy paddles from them in the form of increased debt to push the economy along.   

As in the USA, UK and Europe, our exchange rate is being controlled to suit the finance industry.  While this continues, we can expect the ship to continue to point too high for our industries to prosper from trade.

China steers its economy so that its industries prosper from international trade.  We hope to be towed along by their good seamanship.  However, we could choose to be good seamen, too, and steer our own ship in a direction that ensures that our manufacturing industries prosper from international trade, as well as our mining industries.

Last Sunday you questioned why our manufacturing industry was declining in Australia.

To understand why, we can think of the economy as being like a sailing ship.  This ship needs the winds of trade to fill its industrial sails.  

We have the trade winds.  They have been blowing hard.  But our ship is being steered high into the wind so that our industries cannot prosper from that trade.

The strong trade winds are caught as exports in the sails of the mining industry are offset by a back-draft of trade lost to the manufacturing industries, because of increased imports.

The more we increase our exports and catch the trade winds in one part of our economy; the more the back-draft blows to increased imports and undermine our other industries.

It would be easy to steer the ship so that the whole economy prospers from the trade winds.  But, it suits the finance industry if we have to buy paddles from them in the form of increased debt to push the economy along. 

Therefore, while-ever the exchange rate is being controlled to suit the finance industry, we can expect our ship to continue pointing too high for industry to prosper from the winds of trade.

China steers its economy so that its industries prosper from trade. 

We may hope to be towed along by China's good seamanship.  However, I would prefer that we are able to steer our own course, and so ensure that we all prosper from trade.

Leigh

 

 

 

Letter to the Australian Financial Review

Sent 27 June 2012

A global economic shift

Dear Sir

Warwick McKibbin (A global economic shift, AFR June 27) uses a plethora of economic clichés to tell us that the global economy is changing. 

He says Australia is lucky because it sells mining output to China.

He calls for flexibility, and for labour and capital to flow into Australia.

Australia may be lucky. But if Australia is to be as lucky as China, it must be as flexible as China and allow money to flow into Australia from international trade.

Currently, government policy places an embargo on additional money flowing into Australia from international trade.  The money entering Australia from exports and foreign capital is required to equal the money leaving the country to pay for imports. 

It is this embargo that causes our booming exports to inflate our exchange rate, reducing import prices and export revenues, and ruining our comparative advantage.  

China prospers from its export led growth.  But government policy in Australia has turned export growth into a curse that turns prosperous industries into “declining industries” that McKibbib calls to be put out of their misery.

McKibbin is correct in concluding that the government has chosen to “consume the boom”.  The government has forced us to spend the proceeds of the mining boom consuming cheap imports rather than allowing the mining boom to stimulate the whole economy.

Your sincerely

 

Leigh Harkness

 

Letter to the Australian Financial Review

Sent 24 June 2012

Published 26 June 2012

Conservatism may hurt growth

Dear Sir

The RBA has good reason to be concerned about productivity (Conservatism may hurt growth, AFR, June 22), particularly the productivity of its own industry.  The debt generated by the banks is growing faster than GDP. That means that our debt is rising faster than our capacity to service that debt.  Eventually, when debt servicing costs exceed our capacity to repay, we will join the USA and Europe in a financial crisis.

It is possible to raise GDP and the money supply through increased savings rather than debt.  That would improve the productivity of debt.  But to balance the sources of money in this way would be contrary to the RBA’s policy of monetary independence, or monetary isolationism. 

Therefore, the RBA blames the victims of its flawed policies, the “unproductive” sectors, for its own failure and dooms Australia to follow the mistakes of the USA and Europe.

Your sincerely

 

Leigh Harkness

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Sent 8 June 2012 

Read 10 June 2012  Click here to listen 

Ian

Last week a caller from Europe described the economic prosperity of Germany.

Germany has prospered while other Euro countries have collapsed into debt and poverty.

The big difference with Germany is that it can stimulate its economy with money earned from international trade.   

Because Germany shares the Euro with many other countries, its exchange rate is much lower than it otherwise would be.  That lower exchange rate allows it to prosper by exporting more than it imports.  Although the exchange rate is low for Germany, it is high for the other European countries and forces them to import more than they export.

We have a similar situation in Australia.  Mineral exports in some parts of the country allow those parts to prosper while other parts of Australia are made poorer because they must balance those receipts by shifting their spending from local products to imports.  If the mineral regions had their own currency, their exports would drive up their exchange rate to put the less efficient miners out of business.  It is the single Australian dollar that applies to all of Australia that allows the mineral exporters to be prosperous.

The important point we can learn from Germany is that the money it earns from international trade allows it not only to prosper, but to prosper with lower inflation.  It is the poorer countries of Europe that rely on bank credit to stimulate their economies that have the debt problems and the higher rates of inflation.

Therefore, if countries lowered their exchange rate to allow money to flow in from international trade, they too could be prosperous like Germany, with low inflation and less debt.

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Sent 23 October 2011

Ian

This morning you were discussion the possibility of protecting Australian manufacturing industries.

Australia already protects one of its industries: the banking industry.  All Australian money is now made by the Australian banking industry.

In the past, other industries could make additional money for Australia.  For example, when the wool prices were high, Australian farmers would make more money for Australia.  The additional money they earned from wool exports would pour into Australia and circulate through the whole economy.  In that way the whole country prospered from the wool industry and exports generally.

Now, the only way we can make additional money is by borrowing it from the banks.  That makes sure that the banks very profitable.  It protects our banks.

It does have some side effects such as rising domestic and foreign debt.  But the government does not consider that a problem.

Possibly the most damaging side effect is that if we do try to earn more money by increasing exports of wool or minerals, the exchange rate rises to reduce our export income and increase our imports.  If we increase our imports, that means we must switch from buying Australian products and buy imports instead.  That destroys our local manufacturing industries.

However, that seems to be acceptable to the government because it ensures that the banking system is profitable. 

The only problem for the banks is that those of us who are not protected may not be able earn enough to repay our bank debts.  That could create a financial crisis such as in the US and Europe. Our government hopes that problem can wait for another day and another government.

Regards

Leigh

 

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Sent 28 May 2011

Dear Ian

The recent Federal Budget acknowledged that Australia does not earn any additional income from the growth of its mineral exports.  The boom to which it refers is an “investment” boom.  That is, the only additional income we receive is when mining companies borrow funds to invest in mining.  The more they borrow, the greater the boom. 

The banks may proposer by lending to finance that boom, but that hardly benefits the rest of us.  The growth in lending for mining has led to cuts in government spending and threats of higher interest rates. 

The Budget recognises that “for some, talk of an investment boom seems divorced from reality.”   This is because the growth of exports has inflated our exchange rate, further tilting the playing field against our domestic industries.  The high dollar makes imports cheaper than Australian products thereby eroding away Australian industries and jobs.  Also, the higher exchange rate undermines the incomes of traditional exporters, such as farmers.  

Why should we continue to suffer because of our mineral prosperity?  China prospers from its exports.  Why shouldn’t we?  What is the point of exporting our mineral wealth if we are not going to prosper from doing so?

We have the skilled people and resources to prosper.  But our monetary system prevents us from doing so.  The government is aware that there is something wrong with our system.  The first recommendation of the Senate inquiry into bank competition was for an independent broad ranging inquiry into our financial system.   

But many of us can’t afford to wait for yet another inquiry.  Other high exporting countries, such as Norway and Singapore, have already modified their exchange rate systems to allow them to prosper.  We, too, need to change our system.   We should prosper, rather than suffer, from our mineral wealth.

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Sent 16 April 2011.

Read 17 April 2011

A story about exchange rates  - Listen Here

Dear Ian

Did you know that our economy is managed a bit like a football club?  It has a salary cap on the players.  If one group of players gets a pay increase, the other players have to suffer a pay cut.

Our Australian industries are the players and the exchange rate system enforces the cap. 

The way it works is that if we have a minerals export boom, our dollar becomes stronger.  This higher exchange rate reduces the incomes of all exporters, including the other exporters that don’t have a boom, such as farmers.  They all suffer a pay cut because they are receiving less for their foreign currency income. 

In turn, with the stronger dollar, imported products become cheaper and we import more of them and buy less Australian products.  These lost domestic sales reduce the incomes of local industries that cannot compete. 

So, for every extra dollar we earn from exports, the exchange rate system makes sure that someone else in our economy suffers a pay cut, just as one highly paid player in a football club reduces the money available for the others. 

Those of us on fixed incomes may benefit from cheaper imports, but for every dollar saved, someone else loses a dollar off their export income or local sales. 

The backroom boys that manage our club finances tell us that this is a wonderful system.  They say that when things go bad, the system ensures that we keep earning the same pay.  But it also means that when things get better, the system ensures that we still earn the same pay.   

It is a common misconception that our strong Australian dollar is a sign of a strong economy.  In reality our mineral wealth is killing our other industries rather than contributing to our prosperity. Clearly we have a flawed system that is in desperate need of change.

Best wishes

Leigh

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Economic Growth

Sent 19 February 2011.

 

Dear Ian

You have been concerned about why so many of our domestic industries are becoming extinct.

Some time ago, I was the economist for a small South Pacific Island country. 

Until 1974, that country did not have a bank.  Even so, the country issued its own currency.    When foreign currency came in, the government would exchange that money for domestic currency and add the foreign money to the country’s foreign reserves.  When people spent money on imports, the government converted their domestic currency back to foreign currency to pay for the imports.  In that way the country always had sufficient foreign reserves to pay for its imports.

However, when the country established a bank, the bank started creating additional money by lending money. Money from bank lending did not add to foreign reserves.  Yet, when that money was spent on imports, it still needed to be converted into foreign currency.  Therefore, increasing bank lending depleted the country’s foreign reserves. 

To ensure that there were adequate foreign reserves to meet requirements, the government advised the bank to regulate its lending according to the level of foreign reserves.  If there were plenty of foreign reserves, it could lend without restraint.  But if foreign reserves were low, it had to slow down or stop lending.  That system worked well.

The US had a similar problem. American banks increased their lending significantly in the late 1960’s and early 1970’s.  That lending depleted foreign reserves, in the same was as in the islands.

But when faced with falling gold and foreign reserves, the Federal Reserve Board did not restrict bank lending. 

Instead, in 1973, the US President declared that the Federal Reserve would no longer convert US dollars into foreign exchange. Instead, people who wanted to exchange their US dollars into foreign currency were required to swap them with those people that wanted do the reverse.  Foreign exchange dealers could swap their US dollars for foreign currency at whatever exchange rate they agreed.  This was called floating the dollar and it was hailed as a great economic reform.

It was a great outcome for the banks. They could continue to lend without restriction.  Actually, the economy now needed the banks to increase their lending because the banks were now the only source of additional money and the economy needed additional money to enable it to grow.    

But for the rest of the economy, floating the dollar proved a disaster.  It meant that the only way the country could increase exports was to simultaneously increase imports. That required the exchange rate to rise to make imports cheaper.

If people were to buy more imports, they had to buy less domestic products.  Consequently, domestic industries lost business and the regions that were once the powerhouse of American industry became known as the “rust belt”.

When Australia deregulated its banks and floated its currency, we suffered a similar fate.

So, while we continue to float our currency, we will continue to sink our industries.

Regards

Leigh Harkness

 

 

The Economist Magazine

An extreme necessity                                                         Apr 24th 2010

The Greek problem is not Greece’s problem alone. The Euro was formed when a number of large European countries could not make their monetary systems sustainable.

But the Euro did not fix the problem. It only allowed the problem to continue and shared it among a larger community.

Not even the richest country on earth can make the current monetary system work. The USA is heavily in debt, both domestically and internationally, has low economic growth and high unemployment.

China is the only country that appears to be prospering and it uses the monetary system which Europe and the US abandoned in the early 1970s. That system had brought prosperity to Europe and the US while they stayed with it.

Our problem is that our economies rely on monetary growth to facilitate economic growth. We create money by creating debt, essentially domestic bank credit. But the growth of bank credit causes us to buy more than we produce and so creates foreign debt. Therefore, for every unit of domestic currency we create, we create a unit of domestic debt and a unit of foreign debt.

If debt grew in proportion with our income, our debts would be sustainable. But as we need to hold more money to repay both our domestic and foreign debts this gives us less money to spend. The money we spend is the money we earn. So our debts grow faster than our income and so become unsustainable.

The finance (or debt creation) industry may be prospering because it must grow faster than the rest of the economy. But it is a house of cards whose growth must eventually cause its own collapse.

Now that financial deregulation has let this financial genie out of the bottle, it is unlikely to return. It has become the powerful master. Rather than the financial system serving the economy, the economy now serves the financial system.

So we can expect the financial crisis to continue until the whole financial system collapses. Greece’s problem is not its own, it is our collective problem.

 

Letter to the Australian Financial Review, Published 15 October 2010 - online edition

Dear Sir
 

Harold James (“Currency interventionists playing with fire”, Opinion, October 5) is to be commended for recognising that the world’s exchange rate system is dysfunctional.  Yet he is critical of those countries attempting to rectify the system.  Such tinkering may have been futile, but the exchange rate system continues to be dysfunctional.

 

This is because the exchange rate is being used to manage the consequences of inappropriate monetary regulation. Those inadequacies have caused imbalances in international trade flows. 

 

Trying to deal with those imbalances through the exchange rate is ineffective. It is like trying to manage what an elephant eats through the market for elephant manure. 

 

We need appropriate rules to manage what the elephant eats.  Once we have a stable and desirable output, a functional market can determine a suitable price.

 

Yours sincerely

 

Leigh Harkness

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Economic Growth

Sent 14 August 2010.

Dear Ian,

Last week you were spurning economic growth.  I am also repulsed by some aspects of economic growth.   Economic growth that is generated by deliberately pushing people into debt is disgusting.  Yet to raise our economic growth, we subsidized people into debt with the first home buyers scheme.

Economic growth that is generated by trading our finite resources for imported products, including food, that we are capable of producing ourselves is also distasteful. It is even more abhorrent when one realizes that the export of those resources is destroying our manufacturing industries and raising unemployment.

As Dick Smith explained, growth that comes just from bringing in more people so that we can be kept busy building houses for them can erode our own welfare.   It causes urban congestion and leaves us with inadequate education, health and transport infrastructure and services.

 But not all growth is bad.  Growth that uses our resources more effectively and efficiently to meet our needs is welcome.  For example, economic growth from advances in medicine that enable us to return from hospital in days rather than weeks, is superb.  Also, growth that provides us with more efficient transport is excellent.

 Economic growth that employs people who are unemployed, or under employed, is also welcome.  It raises our self esteem and enables us all to contribute more to our society as well as to our own welfare.

 Furthermore, economic growth that raises our wealth and welfare, rather than raising our debt, is marvellous. 

 So don’t reject all economic growth.  Some economic growth is constructive.

 Regards

 Leigh

 

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Floating exchange rate, debt and economic growth

Sent 14 May 2010.

Ian

Following your comments last Sunday, it would be wise to distinguish between the two major forces in the economy: those that create debt and those that create growth and prosperity.

 Money constrains expenditure to income (production)

When we sell our goods and services to the economy, the money we earn enables us to buy the equivalent of what we have produced, or contributed to the economy.  That is, money constrains our expenditure to our income; what we buy to what we sell; our demand to our supply (Says law).

 Creating extra money causes expenditure to exceed income

You would be aware that a forger is a person who steals from the economy by creating money.  They use the forged money to buy goods without selling any goods or services to the economy.  If they were to create a large amount of forged money they would cause the country to buy more than it produced. 

 Foreign debt is created when expenditure exceeds income

If a country buys more than it has produced, then it is either going to:

  • run down stocks; or
  • import more than it exports. 

There is a limit to the amount that stocks can be run down and if it does happen, it causes hyper-inflation.  Usually, the extra spending causes imports to exceed exports and leads to a current account deficit.  This is likely to reduce foreign reserves if the country has fixed exchange rates.  It is likely to increase foreign debt if the country uses the floating exchange rate system.

 Bank credit the source of extra money

Of course forgeries are not responsible for our foreign debt.  Bank credit is the main means that we create additional money in our economy.  The government does create some money and uses it to finance expenditure.  But that is less than 5 per cent of the total. More than 95 per cent of the growth in the money supply in our economy is from bank credit.  So it is not high exchange rates (as generally believed) that causes us to buy more than we produce; it is the creation of additional money through the growth of bank credit.      

 Creating money creates domestic debt and foreign debt

The banks create money when we borrow and this raises total domestic debt.  When we spend that money, we are spending more than we have earned and that creates additional foreign debt.  So for every extra dollar of money we create from bank credit, we produce two dollars of extra debt: a dollar of domestic debt and a dollar of foreign debt.  It is no wonder that debt is a major world economic problem.

 Source of economic growth

The second effect to consider is the source of economic growth.  In the days of fixed exchange rates, if we increased our exports by more than our imports, we would earn more money than we spent.  The extra money we earned would enable us to increase our spending on local products and imports.  Our income would continue to grow until our spending on imports increased to equal our income from exports.  When imports were equal to exports again, we would be in equilibrium: the money coming into the country being equal to the money going out and our income would stop growing. 

For example, assume that we spent 10 per cent of our national income on imports.  If exports increased by $100 million, our national income and spending would have to rise by $1,000 million before our additional spending on imports increased $100 million to equal our additional income from exports.  (This is the trade multiplier.)

The important point to note here is that disequilibrium and the process of achieving equilibrium raised our income and made us more prosperous.  When the economy reaches equilibrium, our income stops growing.

In the process, additional money is created.  It is created because we have produced more than we have consumed; because we have saved.  It raises foreign reserves rather than foreign debt.

Floating exchange rate constrains growth

Under the floating exchange rate system, if we increase our exports the exchange rate rises to make imports cheaper so that;

  • imports equal exports and the additional foreign currency earned from the increased exports is used to pay for the additional imports; and
  • we shift our spending from domestic products to buy those imports so that the additional domestic currency spent on imports can be used to pay domestic currency to the exporters for their increased exports.

The shift in spending from domestic products to imports reduces the income of those domestic industries supplying the domestic economy.  The extra income earned by exporters is earned at the expense of those other industries supplying the domestic market.  That is, the increased income from export of minerals and energy is undermining our manufacturing and agricultural industries. 

With floating exchange rates, equilibrium between international payments and receipts is attained daily on the foreign exchange market.  There is no opportunity for additional income from exports to raise our national income and bring prosperity.  Equilibrium between foreign payments and receipts is achieved by changing the relative price of domestic products and imports.  As we increase our exports, the share of our income spent on imports rises and the share spent on domestic products declines.  Equilibrium is not attained by raising income as under the fixed exchange rate system so trade no longer brings economic growth. 

Money and debt

During the days of fixed exchange rates we had two sources of additional money: increased exports, and bank credit.  As mentioned above, money from increased exports came from savings that would raise our foreign reserves.  Increased bank credit increased our spending above our income and would deplete foreign reserves.  So with fixed exchange rates it was important to regulate bank lending so that the additional imports from bank credit did not deplete foreign reserves.

When we floated the exchange rate, we eliminated the source of money that came from increased foreign reserves.  That left us with only one main source of additional money: bank credit.  That money caused us to buy more than we had produced.

Also, because we need additional money for the economy to grow we needed to fill the vacuum left by the termination of money from trade with increased money from bank credit.  That is why the banking system was deregulated.  (The US floated first and then deregulated the banks to get out of a recession; the “oil crisis”.  We in Australia first started to deregulate banking and then had to float our exchange rate as it was not possible to maintain a fixed exchange rate with a deregulated banking system.)

The need for bank credit left us in a terrible dilemma.  If we increase bank credit to increase prosperity, we also raise our foreign debt.  Also, money from bank credit has proved to be more inflationary than money from trade and savings.  Hence we need more money to compensate for inflation.  This has driven us deeper into debt.    

Current economic policy

Now we have convinced ourselves that foreign debt does not matter.  So our Reserve Bank concentrates on managing monetary policy to control inflation. While the growth of bank credit is seen as necessary for prosperity, we consider that bank credit that causes inflation to exceed 3 per cent is excessive and must be constrained.  So bank credit is constrained, not by restricting the amount of money the banks can lend but by raising interest rates to discourage us from borrowing.   

So this where we are with monetary policy: 

  • we have a floating exchange rate system that stops us prospering from the growth of exports;
  • we are dependant on bank credit (or bank debt) to prosper but it causes us to buy more than we produce and raises our foreign debt; and
  • we have an interest rate policy to whip us into line if we dare to borrow too much from the banks and raise inflation.

The solution

The solution to all this is not necessarily to return fixed exchange rates.  Given the right incentives, the finance market can be induced to adjust the exchange rate in such a way that it creates money from trade to achieve full employment with low inflation.  It can do this more effectively than a central bank and do so with more stable exchange rates and interest rates. 

This is an attempt to explain briefly what I have come to understand about the relationship between the exchange rate system, foreign debt and the demise of our manufacturing and agricultural industries. I hope you find it useful.

Regards

Leigh Harkness

 

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

How to Beggar your Economy

Sent 6 May; referred to 9 May 2010.

Dear Ian

 Last Sunday you stated that China was undervaluing its currency and thereby undermining US manufacturing industry.

 As a member of the IMF, China has agreed to avoid manipulating its exchange rate to gain an unfair advantage over other members. This is the “beggar thy neighbour” provision of the membership agreement.   

A country can beggar its neighbour if it sets its exchange rate too low.  The neighbouring country buys cheap imports from the first country instead of buying its own products.  Industries in the exporting country with the low exchange rates prosper, while industries in the importing country collapse.

Your statement implies that China is beggaring the US economy in this way. 

However, the US already had trade problems with Germany, Japan and the Asian Tiger economies before China came onto the scene.  These economies could not be accused of beggaring the US economy.  

Also, prosperity in a low exchange rate country usually causes prices to rise and so neutralise any earlier benefit from a low exchange rate.

Inflation in China should be making the US more competitive.  But it is not.

For a country to do a good job of destroying its manufacturing industries, it really needs to adopt a “beggar thyself” policy.  That is, the government must set up an exchange rate system that stops the country earning any more money from exports.  If the country does increase its exports, the exchange rate must rise to make imports cheaper.  In that way, any additional income earned from increased exports is spent immediately on increased imports. 

The US has the floating exchange rate system which is designed to stop the country earning any more money from exports.   That is, it has a “beggar thyself” policy. 

So it is not China that is beggaring the US economy; the US is beggaring itself.

Regards

Leigh Harkness

 

 Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program.

Underpants and Dutch Disease

Read 7 March 2010

Ian

It appears that the underpants industry has been hit by the Dutch Disease. In the 1960’s, Dutch income from the natural gas fields in the North Sea drove up the value of the Dutch guilder.  That made Dutch products less competitive on domestic and export markets.   As a result, Dutch industries suffered. This effect became known as the Dutch Disease.

In Australia, mineral exports keep the value of the Australian dollar high.  The high value of our dollar makes imported underwear cheaper than local underwear and so we buy imported underwear and the Australian underwear manufacturers go out of business.   

The disease is widespread in Australia.  In the 1960’s and 70’s we spent around one eighth of our income on imports and around seven eighths on local products.  In the last ten years we have been spending around one fifth of our income on imports and so our spending on domestic products has fallen to around 80 per cent of income.  Consequently, Australian industries competing with imports have suffered.

The Philippines once had a bad case of the Dutch Disease.  Filipinos working overseas were remitting so much money back home that the value of the Peso became very high.  By 2003, imports were so cheap that Filipinos were spending more than half their income on imports.  That meant that they were spending less than half their income on domestic products.  This devastated local industry.    

The central bank of the Philippines is required by law to provide monetary policy that is conducive to balanced and sustainable economic growth.  Therefore, it acted to stabilise the exchange rate. As a result, spending on imports has fallen back to nearly one quarter of income and so nearly three quarters of income is spent on domestic products.  With their new and higher incomes, Filipinos are buying more local products and about the same amount of imports as they were in 2003.    

So there is a cure for the Dutch Disease for countries that want to do something about it.

Regards

Leigh Harkness

 

 Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program

Buying Australian

Sent 12 September 2009

Dear Ian 

You may be aware from history that King Richard had trouble financing his crusades.  He decided to print more money to pay his soldiers and suppliers.  That additional money eventually ended up being spent on imports from across the channel. 

 The foreign traders did not want King Richard’s money.  They wanted gold.  As a result, King Richard had to convert the money he printed into gold, and his gold reserves declined rapidly.

 To solve that problem, King Richard established a new trading system.  He told everyone that it was a brilliant system and no-one could disagree with him. 

 Under the new system, traders sold their exports overseas and used the money they earned to buy other goods which they imported and sold on the local market.   

 No money was allowed to leave, or enter, the country.  So the King did not have to exchange his money into gold.  His gold reserves were saved.

 However, it created new problems.  Traders took pots and pans etc. and sold them overseas.  In exchange they bought food and clothing to sell back home.

 This upset the food and clothing manufacturers back home.  In the past, when exporters came back with money, they would spend some of that money buying local food and clothing.  Hence local suppliers prospered from exporters’ success.

 But now the traders were not bringing back money.  Instead they brought back food and clothing.  The exporters were now competing with the domestic suppliers. 

 As exports increased, imports of food and clothing increased, also, and the domestic food and clothing industry declined.  

 Many people realised that they should buy local food and clothing.  But they could not afford them and had to buy the cheaper imports. So the local industries died out.

  Really, this story is not about King Richard but about President Richard Nixon.  His crusade was not in the Holy Land, but in Vietnam.  He created money to finance that war.  As a result, US gold reserves declined rapidly.  He stopped converting US dollars into gold and in 1973 set up a new trading system.  In 1983, Australia adopted the same system.

 Richard Nixon’s system has the same effect in the US and Australia as King Richard’s system in the story. 

 We may want to buy Australian products to support local industries.  But Richard Nixon’s system not only stops money leaving the country, it stops money entering the country.  As we increase our exports, we must spend that money buying more imports.  Those additional imports compete with and destroy local industries supplying the local market.

 That is why it is now difficult to find Australian produce and products in our supermarkets.

 Regards

 Leigh Harkness

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program

Protectionism and free trade

Sent 12 March 2009

Dear Ian

Last Sunday you read a letter from Brian promoting free trade.  This followed a call from Emily urging us to support to Australian industries. We need more free trade if we are to support Australian industries.

In April last year you read my sequel to Jack and the Beanstalk.  Jack’s milking herd produced too much milk for his little village.  His mother allowed him to export his milk to the larger town, provided that he spent all the extra money he earned in the town.  

Jack had free trade, but his spending was restricted.  That distorted trade, forcing Jack to import goods from town to distribute in his village.  Village businesses were ruined because they could not compete with Jack’s imports.  The local businesses would have prospered if Jack were allowed to spend his money in the village. 

Like Jack, we can freely trade products.  And like Jack, we are restricted from bringing extra back money to spend in our country.

Individually, we are free to bring home the money we earn from exports. However, as a nation, we are prevented from bringing in any extra money.   

We have a foreign exchange market that swaps money between people taking money out of the country with people bringing money in.  When we increase our exports and try to bring in more money, the market inflates the value of our dollar to reduce export incomes and to increase imports, by making imports cheaper.  The system distorts trade to prevent any extra money flowing in. 

This system is known as the floating exchange rate system.  It acts as a moat to protect the country’s gold and foreign reserves.  The US, and a few other large economies, adopted the system in 1973 during the Vietnam War because President Nixon wanted protection for US gold and foreign reserves.  Australia adopted the system in 1983 during a period of financial deregulation when Treasurer Paul Keating wanted protection for Australia’s gold and foreign reserves.     

This system is a barrier intended to stop money leaving the country.  But it is also a barrier keeping money out. 

It prevents us bringing into Australia the additional money we earn from increased exports.  Instead we must spend that money on extra imports.  These imports destroy Australian industries, particularly those competing with imports.

Brian is correct when he calls for free trade.  Emily is also correct when she calls on us to support Australian industries.  If we are to support Australian industries, we must have free trade not only for our goods but also for our money.

Best wishes

Leigh Harkness

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program

Read in part 16 November 2008

Financial Crisis

Ian

Last week you said that no-one predicted the current financial crisis.  Yet I thought you and many of your listeners did.  

For many years, you have talked about the need to buy Australian, the current account deficit and the rising foreign debt. 

Those comments reveal an understanding that it was unsustainable for our economy to continue to buy more than it produced and to borrow from the rest of the world.

The official position was that if the banks wanted to lend the country into debt that was their problem.  We were told that the financial system was deregulated and the banks had a right to do whatever they like.  When our industries could not compete with cheap imports, these officials applauded the benefits of globalisation.  They accused our industries of being inefficient and unproductive.  These officials said that the market was always right and eventually the market will sort these things out. 

Now that the market attempts to sorts things out, these same officials call it a financial crisis and spend billions of our dollars to intervene in the market in a vain attempt to force it to continue on its unsustainable course. 

If the world was allowed to stop lending us money, we would have to buy Australian products and our industries would be internationally competitive.  We would have a current account surplus and we would start paying off our foreign debt.

The problem is that our financial system is unstable.  Paul Keating admitted as much when he told us last time that “this is was the recession we had to have”.  But  officials deny that there is a problem with our financial system. 

It is possible to change the financial system to make it stable and sustainable.  For example, the Philippines once had current account deficits like ours.  But they made some changes and since 2003 they have had current account surpluses, growing foreign reserves and the rate of economic growth has been rising, reaching 8% last year. 

But while our officials deny there is a problem with the system, our financial instability will persist.

 Regards

 Leigh Harkness

 

 Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program

Read in part 28 June 2008

Inflation

Ian

Last week, when you were discussing inflation with Kerin, he said that demand pull inflation was caused by “too much money chasing not enough goods”.

To really figure out what causes inflation we need to know how we can have too much money and not enough goods.

 We have two sources of money to spend: the money we earn and the money we borrow.

When we sell our time, resources and products to the economy, the money we earn entitles us to buy goods up to the value of what we have sold.  Spending that money is sufficient money chasing ample goods.  It does not cause inflation.

If we borrow money, provided someone had saved the money lent, that money would enable us to buys no more goods than the lender was entitled to.  Spending that money is sufficient money chasing ample goods. It would not cause inflation.

But what if we could borrow from an institution that created its own money to lend, without savings?  In that case, the money we borrowed would allow us to buys goods that other people were entitled to.  This would create too much money chasing too few goods.  Such money would cause inflation. 

Many financial institutions can only lend the money that has been saved with them.  But there is one class of financial institution that can lend when there has been no savings.  It is mainly the lending of that class of financial institution that creates too much money chasing too few goods, and causes inflation.

Regards

Leigh

 

Ian McNamara, 'Australia All Over', ABC radio, Sunday morning program

Read 20 April 2008

Sequel to Jack and the Beanstalk

Globalization and distortions to trade

Ian

Have you heard the story of what happened to Jack, after he cut down the beanstalk?

Using the gold that he had collected, Jack and his mother bought a dairy herd.  Initially, they sold their milk in the village and used the money they earned to buy all they needed. 

But as the heard grew, it produced too much milk for the local village.  So Jack persuaded his mother to let him take the excess milk to the town market and sell it there.

His mother was reluctant about him going to the town market again, but eventually relented.  However, she stipulated that he was not to bring any of the money he earned in the town back to the village.  She did not want to upset the village economy.

So Jack started taking milk to town and the business grew.  He used the money he earned to buy fruit, meat and vegetables from town.  Soon Jack was buying everything he needed in the town and they did not need to buy much from the village.  Jack would come back from town with so much food and things that he would give some to his neighbours. 

While Jack and his neighbours prospered, other people in the village did not.  The village grocer and butcher found there businesses were declining, as did the local market gardener and dress maker.

Jack also noticed that his sales of milk to the village were declining.  He congratulated himself on the wisdom of expanding his business to the town market.  Jack prospered while the village economy continued to decline.   

Ian, the Australian economy is like Jack’s village.  Like Jack, we have a rule that we are not to bring into Australia any additional money we earn overseas from exports.  It might cause inflation.  So we must spend on imports all the money we earn from exports. 

Consequently, when we increase our exports, as we have in mining, we are required to buy more imports.   When we buy more imports, we buy less of the same Australian products and so Australian industries that compete with those imports go out of business.

If Jack were allowed to bring home the money that he earned from his sales at the town market, he would have spent it in the village and the village would have prospered with him.  But he had to live with his mother’s wisdom. 

Similarly, if Australian exporters were allowed to bring in the additional money they earned from exports, they would spend that additional money in Australia and all Australian industries would prosper.  But we have to live with the wisdom of those who mother us.

Best wishes

Leigh

 

 

Letter to the Australian Financial Review, April 2008

Peter Lloyd and Gary Sampson believe that little can, or should, be done to assist car makers (“Car makers don’t deserve aid”, April 14). 

But what if government policy in another area is responsible for making the local industry uncompetitive?  

Australia has a policy of eliminating the effect of international transactions on the domestic money supply.  It adjusts the exchange rate to ensure that foreign receipts equal foreign payments.   

It means that if there is a boom in mining exports, other exporters and import competing industries such as car manufacturers are made less competitive to retain the balance. 

The system was designed to support Milton Friedman’s prescription of monetary targeting.  Monetary targeting has been abandoned, but Friedman’s exchange rate system lives on, well past its used-by date.

The system does not permit national savings in the form of foreign reserves and increases foreign debt.  It provides unstable and distorted exchange rates.  It slows economic growth because it does not allow the proceeds of export growth to stimulate the economy.  Also, it kills import competing industries and exporters with small margins, such as farmers. 

Lloyd and Sampson acknowledge that the exchange rate is causing damage to the car industry but dismiss it because it is just as damaging to other industries.

If, for its own reasons, the government persists with a policy that has damaging effects on industries, should it not compensate those industries for the damage caused by that policy? 

Lloyd and Sampson are correct is saying that “the bottom line is that the difficulties facing the automotive industries can be traced to economic fundamentals.”  It is the macro economic fundamentals that are the problem, and if they are not changed, little can be done to save many Australian industries.

 

Letter to the Australian Financial Review, September 2006 

Robert Shiller claims that there are deep factors that underlie the difference between China’s high saving rate and the US’s low saving rates (China’s virtuous circle, 7 September).  There are deep systemic factors that can explain the differences.  But, they are not the behavioural factors that Shiller stipulates. 

The psychology and behaviour of the passengers is largely irrelevant to the destination that these diverging systems will take them.

China has a fixed exchange rate system.  It requires Chinese exporters to raise foreign reserves when they convert their foreign income into domestic currency.  These additional foreign reserves contribute directly to national savings.  These savings rise regardless of business or consumer feelings and behaviour. 

When US exporters repatriate their foreign income, they must swap their foreign receipts for US dollars from those making foreign payments.  The floating exchange rate system prevents trade income contributing to foreign reserves and national savings.  Savings are quarantined from the exchange process regardless of the feelings and behaviour of US businesses and consumers.

These systemic differences are much more significant in explaining the differences in savings rates than the elusive “shame of the poor” and the feelings of  “collective sacrifice” that Shiller asserts to be the deep factors.