On Outsourcing, the Economy and the United States
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If you’ve missed the economic disaster that’s gripped the world over the last few months, you’re probably capable of forgetting to breathe. Then again, if you’ve been following the free fall of the US stock market you’ve probably stopped breathing all together. The economy is on everyone’s mind and a popular blogging subject. As such, I was a little hesitant to write on it. However, I’ve yet to see anyone discuss the big picture and very few American news outlets are taking a realistic look at what’s really going on.
The Global Environment
Simply put, you can’t understand the economy until you understand recent world history. The collapse of the USSR in 1990 set off a series of dramatic changes. With the death of the Soviet Union the US lost its major competitor and the world saw one of its largest and most powerful economies vanish. This provided a fantastic opportunity for the US to solidify its presence on the global stage.
In 1993 the European Union was formed and began to fill the void that the USSR’s collapse had created. By 1999 the Euro was introduced and by 2002 most of the member countries had switched to it as their exclusive currency. As intended, the EU and its currency created a new world economic superpower able to face off with and stand side-by-side with the US dollar. Meanwhile, the widespread adoption of the internet, and decreases in the cost of shipping/phone communication and the like made it economically beneficial to outsource to places like India and China.
Russia’s collapse offered a valuable opportunity for China. By devaluing their currency China was able to establish and maintain itself as one of the world’s greatest exporters - fueling an industrial revolution unlike any the world had seen for over 40 years. With a wealth of natural resources, nearly endless population, and government able to undertake massive/risky projects, China catapulted itself onto the world stage. By the late ’90s China had truly come into its own as an economic power.
A fourth historical factor essential to an understanding of the current economic crisis is the concept of world currency. In 1945 international currencies were pegged to the US dollar which helped secure US dominance and established the dollar as the world currency. With the collapse of the gold standard in 1971 most of the world currencies were un-pegged from the dollar. Despite this, most international transactions were still carried out in dollars due to our position as the world’s economic superpower.
The Power of Currency
As the dollar has been the world’s unofficial currency, the United States has been able to operate as the central economic node through which most international business is carried out. This poured money into the US and helped fuel our economy. The difficult trade off is that it also provided for a strong dollar which slowly made a lot of our industry unprofitable. As a result, our exports began to drop and our imports began to rise. A brutal and difficult transition. These decreases were, however, balanced by the thriving tech industry in the US. Our creativity, drive and forward-reaching thought provided the internet and new technologies which we were able to export and sell while re-tooling our economy to the early stages of the next wave: The digital revolution which replaced the industrial revolution.
As our exports continued to diminish, outsourcing thrived and the debate - which had picked up steam in the early 2000s - eventually came to a head around the time of the last presidential election. Outsourcing became a dirty word, unpatriotic and an affront to the American public. The administration decided something needed to be done to bring American manufacturing jobs back to the US and by George they did it. They began a series of actions which resulted in the gradual suppression of the US dollar. A practice which is similar to what China has done to keep the value of their currency low and exports high. The idea was to de-value the dollar to increase the price of imported goods while creating incentives to fuel American industry. Ironically, this has worked. Companies like Toyota, BMW and others have opened a number of plants in the US over the last year and a half, and industry has poured back into the US. Unfortunately, not as fast as necessary. There are a few catches.
- Our standard of life has been based on living in a post-industrial nation. Our consumption rates, wages, etc. are all vastly different than those of the factory worker who fueled America’s 2nd industrial revolution and exponentially different than those of the Indian and Chinese workers fueling their country’s current industrial revolutions.
- Technology and automation have drastically changed the way manufacturing and assembly jobs are executed, streamlining the process and reducing the demand for manpower.
Unhappily, both of these factors pale in comparison to the real catch. Our role in the global economy. Unlike China, Japan, India, Mexico or any other foreign nation, the US is not truly an independent currency. As the de-facto world currency, the US dollar is the central quay to which all of the world’s other currencies are tied. When we began artificially deflating our currency we began destabilizing the world economy. Instead of offering a quay that the world economies could tie to, we quickly became a lead weight pulling them down. We can’t have it both ways. We can’t be the world’s economic super power/global currency of choice AND at the same time be de-valuing our dollar to drive up exports. This process began destabilizing the world economies and has, in my opinion, resulted in a lot of the credit and economic issues we’re currently facing. It also helps explain why the US is suffering, but stock markets around the world are in equally - if not worse - shape.
The Stock Market & Housing
The common perception and discussion within the US paints the current stock market turmoil and economic trouble as being largely limited to/caused by the US. While it’s obviously hitting us hard and in many ways started with US, it’s not only a US problem. Further, the political dialogue has attempted to imply that the difficulties essentially stem from legislation established to put poor people in houses. Poor people who are now defaulting on their loans and going into foreclosure. While this is, in part, true, it’s a small portion/side effect of the real issue. It’s not the somewhat limited cross section of lower income Americans who were able to realize the American dream by purchasing a home that created the housing bubble.
In reality it is the fault of middle and upper class Americans who took out home equity loans and ARM loans to purchase 2nd and 3rd properties. Properties which were purchased as investments in the rush to cash-in on the soaring real estate market. These were properties purchased with the expectation that they could be re-sold for profit in months or at the most a few years - all this to be done before the ARM’s interest rate kicked in and the price skyrocketed. These are the individuals who threw the dice and took a gamble every bit as risky as any stock market investment … and lost. These are the individuals, many of whom are now faced with paying 2 or 3 mortgages in this bad economy who stand to lose both their speculative investment and their primary home. Many in the the middle class made the mistake. They jumped on the bandwagon and now we’re paying the price.
Back to Currency
I talked earlier about how suppressing the dollar doesn’t make sense/work. Consider that since July the Dollar has turned around its downward march and rebounded forcefully. To illustrate this point, consider the gains made by the dollar against the following international currencies:
- July: 1.04 October: 1.44 - Australian dollars 28%
- July: .63 October: .73 - Euros 16%
- July: .50 October: .57 - British Pound 14%
- July: 1048 October: 1390 - South Korea Won 33%
- July: 79 October: 110 - Icelandic Krona 39%
- July: 1.49 October: 1.79 - Fijian Dollar 20%
- July: 10 October: 12 - Mexican Peso 20%
- July: 1.59 October: 2.36 - Brazilian Real 48%
- July: 1.01 October: 1.12 - Canadian Dollar 11%
- July: 516 October: 611 - Chilean Peso 18%
- July: 1924 October: 2281 - Colombian Peso 19%
- July: 149 October: 187 - Hungarian Florin 26%
- July: 1.31 October: 1.67 - New Zealand Dollar 27%
- July: 5.07 October: 6.12 - Norwegian Kroner 21%
*Credit goes to Cody Paris for pulling this data/doing the calculations.
So, the question begs - what’s the macro message we should take away from this? In the modern global economy nothing is quite what it seams. For my part, I’ll be watching the international markets every bit as closely as I watch the markets here in the states.
As always, I value your thoughts and feedback! Please, keep in mind that these thoughts are a summary of my observations and nothing more. I’m not an economist - only a curious mind trying to make sense of things.
Posted in 2008 Election, Backpacking, Business, Impressions, Online, Politics, Uncategorized
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October 11th, 2008 at 1:57 pm
You don’t go far enough in analyzing WHY the US$ has risen against world currencies. I have a theory. Capital Destruction. The world currencies you mention have better regulated financial systems. The pool of $US is DESTROYED through deflationary affects. At its root is the spectacular fall of US real estate. UK, Germany, Canada & Australia have yet to get up steam in their real property declines.
People talk of hyperinflation hitting the US. This will not happen, unless the $US currency is debased via the printing press. This is not happening either. US T-Bills are “Safe” for world finance at the moment. Its only when gold values start to skyrocket, along with commodities, that I’ll get worried about the $US.
October 11th, 2008 at 6:19 pm
An interesting perspective indeed, and certainly worth a more in depth study. If you look at the value of the dollar in 1913, when the Federal Reserve was created, and compare it to todays dollar, you’ll find 2000% inflation. A dollar today is worth 4 cents of a dollar in 1913, when the US ended it’s commodity-based currency and switch to a credit-based currency. The prices have gone up because the value of the dollar has gone down. Please, I urge to read about the Austrian Business Cycle Theory, if you aren’t familiar with it.
October 11th, 2008 at 6:37 pm
Excellent information and thoughts. Thank you both.
Glenn - I’ll definitely have to check that out, I’m not familiar with that one.
October 11th, 2008 at 7:52 pm
Would love to hear the authors opinions on this video.
http://video.google.com/videoplay?docid=-9050474362583451279
October 11th, 2008 at 9:06 pm
“They began a series of actions which resulted in the gradual suppression of the US dollar.”
Can you explain what these actions were? Also, do you know the percentage of foreclosures that were “2nd or 3rd properties”? I am trying to follow your reasoning.
October 11th, 2008 at 9:06 pm
An excellent post about our current economic situation.
Excellent because of the factual references devoid of political opinion.
Thanks Alex!
October 11th, 2008 at 9:21 pm
The US dollar is bouncing back because the Federal Reserve stopped cutting interest rates and thus lessened the creation of more US dollars.
While you mention the US not being competitive with other countries in some industries, this a good thing and not a bad thing. Specialization in industries where you have a competitive advantage creates more for everyone.
The main source of the current crisis is that too much credit was created and that risk was mispriced. Lenders thought that mortgages could not systematically all fail at the same time, so they packaged the loans together to reduce the risk by diversifying. Turns out their assumption was wrong and after the epic drop in housing prices, the loans became bad.
The government has equal (if not more) responsibility for this crisis as the banks. The Federal Reserve manipulating interest rates is almost like socialist central planners trying to fix prices: it doesn’t work. As a result, we get all sorts of bubbles. Hopefully this one will finally serve as a wakeup call to the flawed global economic system.
October 11th, 2008 at 9:25 pm
I would still argue that it is the fault of the banks themselves, and the greed of banking executives. Really, what is the function of a loan officer if not to determine whether a loan is a good risk, and deny the loan if it is not? Loans were made in the last ten years that a 14-year-old with good math skills and a basic understanding of finance would have told you were a bad bet. Enough excuses. The Banks were scamming, the pyramid is now collapsing, and the American taxpayer is being handed the bill. NO.
October 11th, 2008 at 9:44 pm
It’s not correct to say that the Soviet economy vanished. It’s more accurate to say that the eastern and central european economy was released from the deadweight of central planning.
Similarly, the Chinese economy benefitted tremendously from the sharp reduction of central control, in the wake of the 1989 uprisings. The gerontocracy of the Red Dynasty realized that unless they did something to allow the people to get on with making a living, they would end up like Ceaucescu, and deservedly so.
October 11th, 2008 at 9:49 pm
What a wonderfully fresh and insightful analysis of the crisis! I’m amazed that you are not an economist as a matter of fact. You should give it some consideration, might have a knack for it. Definitely look into what glenn is talking about. Inflation of currency (which is what devalues currency) is a horrid thing not only for the economic regression you point out, but because it is stealing wealth from anyone who holds assets valued in that currency, and it steals much more from the poor than the rich.
The reason the bad investments of the banks and the middle class people who you blame occurred was because of this inflation. The federal reserve used the inflationary printing press to artificially lower the interest rate. This led to bad investments because it distorted the market indicators and made credit appear much cheaper than it should have.
Anyway, sorry for the long comment, but if you look into that it might add to your theory. Your theory definitely extended mine. Thanks!
October 11th, 2008 at 10:11 pm
Interesting read, but c’mon, it’s not big bad government making evil inflationary plans.
2 wars and tax-cuts at the same time?
That won’t work. Unless you solve it by printing. And indeed, some of the effects of this were thought to be good, and some bad but in the end bush admin. did what they thought was best for the country.
About deflation. Nice theory. Show me a single person who honestly can say, damn, everything is so cheap since a year ago when the crisis began. Gas, food, mortages. Don’t think so pal.
October 11th, 2008 at 11:30 pm
As JP notes, the root is the spectacular fall of the US real estate market. To say that the UK, German, Canadian & Australian markets still have to experience similar declines is naïve without analyzing the banking systems in each of these countries. E.g. in Canada the banking system is under much stricter control, with lending rules that make such speculation as we’ve seen in the US much harder, resulting in property prices that are much more stable.
I am somewhat worried about the UK housing market since the UK has a tendency to mimic the US in policy decisions; somewhat unsure about the German market as it depends very much on how the industry fares, but the Germans themselves are cautiously optimistic; and don’t know anything about the Australian market. However, each of these markets have different rules governing real estate and lending, so the effects of the financial crisis will be different too.
October 12th, 2008 at 1:14 am
Best article I’ve read in a long while, looks at the bigger picture.
The one important factor I think you have left out is the inability of supply to keep up with demand for primary resources such as oil and food and how this pulled the trigger.
October 12th, 2008 at 6:49 am
This article looks at the bigger picture.
However a few key factors ignored here:
1) Can financial analyst/economist put a exact $value on the current and future losses.Can anyone put a value on the losses that we have incurred and might incur because of the derivative trading.Some of these contracts are over 10 years
The problem has always been and will be this practice of trading where deals are based on prediction of future values and are marred with uncertainity
October 12th, 2008 at 8:41 am
I am so glad that someone finally has the balls to to actually point out the fallibility of our current economic system of government.
Thank you.
October 12th, 2008 at 5:53 pm
Credit Derivatives and Swaps… The most complex instrument ever used to destabilize and destroy economic markets. A financial time-bomb.
Chaos is not beholden for a single element in its creation, no a plethora of events have unfolded - some cascading from others, some unintended, some deliberate. The deregulation of financial markets has destabilized these markets. At the same time the practice of letting the banks acquire each other until they reach behemoth status - a relatively new system - until recently banks weren’t allowed to cross state lines - means when a large bank collapses the crater is much larger and the financial fallout larger and more toxic.
Leveraging of assets by banks was increased until now it is something like 30:1 - meaning for every one dollar they have, they can bet thirty on transactions - great profits on the upside, great losses on the downside - amplifying every swing in the market, every twitch. The whole thing was allowed to get out of hand, was not sufficently regulated, and when regulated, the regulations were either poorly or non-existently enforced. Its a wonder it didn’t collapse sooner, is been apparent that behind the scenes manipulations have been occurring for some time now, I’d say at least 10 years if not longer.
The bubbles grew too large, and time ran out.
October 14th, 2008 at 10:23 am
In my opinion the de-valuation was done to finance the war. 1st Gulf war was financed by all the allies, this time around they didn’t join. So, the U.S. said fine, we will finance the war ourselves and started devaluing the dollar (although claiming the belief in strong dollar). Unfortunately this current financial crisis is a result of the devaluation, which you commented on so aptly.
October 28th, 2008 at 5:29 am
I am curious to know how this will affect the price of minerals and metals worldwide.
I live in Botswana, fast becoming the diamond capital of the world in every sense, and the feeling here is that, with the global markets in freefall all metal and mineral commodity prices will drop? Will they? and When can we expect things to get back to normal?
October 28th, 2008 at 8:28 am
Thank you all for your contributions, insights and feedback.
Sue - that’s a fantastic question and actually ties into a revelation I had earlier this week.
From what I’ve seen - and keep in mind i’m not an economist - they will be effected. Depending on the strength of world currencies gold and diamonds may, however, behave differently than the rest of the commodity market. I’m just not familiar enough with them to say. In general however, I suspect that decrease in demand corresponding with the massive, global, economic slowdown will have a pretty serious impact. It’s hard to say how long and drawn out that will be.
Several recent articles I’ve read talk about a second impending credit crisis hitting/about to hit Europe tied to investments in emerging markets/economies. My personal hunch is we’re looking at about 6 months-1 and a half years before things start to really turn around on an international scale.
On a separate note however, it recently occurred to me that with China and India’s economies industrializing even an artificially deflated currency will not be sufficient to keep their goods low enough. As they transition to middle economies another region will need to move in to take their place. While that may be South America, I’m beginning to think that central/southern Africa may be ideal.
With extreme poverty, issues with government stability, a lack of strict economic, environmental, and humanitarian laws and an abundance of natural resources it’s very possible that the world returns to Africa in a very big way - especially the west coast.
Map of natural resources:
http://static.howstuffworks.com/gif/maps/swf/AFR_THEM_LandUse.swf
The distance between the west coast of Africa and Europe, the Eastern Seaboard and India/China is less than the distance between China and the US’s western seaboard/the complex rail trip to Europe, etc.
What are your thoughts as someone in the heart of it all?
November 5th, 2008 at 6:22 pm
[...] on this one as I’ve outlined a fair share of my basic world view above, as well as previously here and in my posts on the Technological Revolution. However, in summary I honestly believe that [...]