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American Monetary Policy Will Ruin the European Union's Economy

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The Fed has been engineering the continuance of a strong dollar and the EU has been forced to follow suit although both countries are facing an incipient recession. This article will explain why this policy will fail with the ultimate effect of impoverishing the working classes in both the US and the EU. In the interest of keeping the rich in the US happy, the FED has pursued policies designed to keep them rich but will ruin the working classes and ultimately ruin the rich as well. The foreign trade deficits which are the result of this policy will, within a short period, cause a catastrophic fall in the value of the dollar resulting in a worldwide financial implosion and worldwide recession. First it is necessary to explain the history of the economic policies which caused these deficits. 

When the Second World War ended the US was producing seventy percent of the manufactured goods in the western world. The manufacturing capability of the countries comprising the current EU and Japan had been ruined by the war these countries and needed low exchange rates in order to maintain their money supply they competed with the US. As these countries recovered their manufacturing capabilities their exchange rates should have been adjusted to reflect their increased competitiveness with the US. Absent an appropriate adjustment in exchange rates, manufacturing shifted to the EU and Southeast Asia and the US began experiencing ever-increasing trade deficits. Until 1970 the US was on the gold exchange standard which meant that current account balances were to be resolved by an exchange of gold between central banks when these balances were not offset by the net foreign investment. This mechanism was designed to correct trade/current account balances by a decrease in the money supply of a deficit country resulting in lower prices and wage levels. In practice, because of wage inflexibility, a decrease in the money supply caused a corresponding decrease in production/employment causing a recession instead. 

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So President Nixon took the US off the gold exchange standard by refusing to transfer gold to resolve the current account deficit, and implemented a "dirty" (controlled) float of the dollar. Under this system the dollar was unfortunately allowed to float by only a small amount, which in effect allowed ever-increasing trade deficits to continue. Foreign dollar holders were forced to buy other US assets such as real estate and stocks and bonds, including the purchase of US government securities. Because the mechanism to prevent/alleviate large trade deficits was insufficiently adjusted, the trade deficits actually increased as foreign manufacturers increased in sophistication. To make matters worse, the western governments and the IMF sat mutely by as western hedge funds ruined the money supplies of the developing countries of Southeast Asia, resulting in even lower and unjustified wage levels for workers in these countries and making western worker's wage levels even less competitive. The result was that no one wanted to hire western workers and white collar as well as blue collar manufacturing jobs began moving to Southeast Asia.  

So US and EU workers have little chance of finding work, and wages in these countries will have to fall perhaps as much as eighty percent before they again become competitive. Given the costs of living in the US it is unlikely that US workers will agree to a wage decrease of this amount. Because the western governments have chosen "free" capital and labor flows, their worker are competing against similarly trained workers whose average wages are about seventy cents per hour. In this "free trade" environment the only way for western workers to compete will be for their governments to allow their exchange rates to fall to a level where they are competitive with worker's ages worldwide Under these conditions, the trade deficit would disappear or reverse as US made goods again became competitive.

   Many policy-makers as well as economists believe that the US can continue these trade deficits by means of offsetting investment flows into the US by foreign dollar holders. If US citizens had unlimited assets perhaps this would be a valid option. But investment flows simply amount to the transfer of US assets such as stocks, bonds, and real estate from US citizens to foreigners. No country/population has unlimited assets. Most people want to hold onto their assets (which are a source of their income). When foreign dollar holders have finally purchased from American citizens all assets which are offered for sale, what will foreign dollar holders do with their profits? They will have to be resolved by a draining of assets from the American banking system by dumping  these dollars on the foreign currency exchanges. When this happens the dollar will fall to a level in which US worker's wage level will become competitive in worldwide manufacturing.

   This will have the same outcome as a voluntary decrease in the dollar's exchange rate, but will occur when foreigners have finally gained control of most of the wealth in the US. With the current account balance approaching one trillion dollars(plus) and US investors purchasing foreign assets of about the same amount , there is currently a transfer of US assets to foreign ownership of about 2 trillion dollars annually. With profitable and purchasable US assets available for sale of about twenty trillion dollars, a fall in the dollar will occur within the next seven years to ten years.

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The IMF may alleviate the situation but not avoid it by the issuance of mammoth tranches of special drawing rights. They will quickly tire of this when they will have to do this annually and at a level which will cause inflation problems in the other hard currency countries of the world. All that will be necessary to start a run on the dollar is for any one of the players holding large dollar denominated assets to panic, realizing that to continue supporting an overvalued dollar will only result in greater loses down the pike. These include the petrodollar crowd, foreign central banks, foreign corporations, foreigners holding large balances in US banks, and Eurodollar account holders, among others. There is no longer a question of "if" but "when" this will occur and how far the dollar will fall. The British pound experienced a drop in value relative to the dollar of about seventy percent over a fifty year period, and it's deficits were miniscule compared to those of the US today. 

Having explained the history of what has compromised the US economy and the future of the workingman in the US, I can now get around to explaining how current monetary policy in the US will ruin the EU. To begin with, US policymakers are claiming the dollar to be undervalued based upon its purchasing power. The purchasing power of the dollar is undervalued only because of infrastructure and marketing advantages available in the US. These are augmented by a high level of market competition resulting in lower prices generally on foreign tradable goods at the retail level. Any halfway competent economist looking at the trade deficit knows that the dollar is tremendously overvalued on the basis of the wage levels of US workers which determine the employment and production of a country. The IMF, the worldwide "expert" in foreign currency values is well aware of the "structural" problem in the value of the dollar and the fact that it is seriously overvalued.
   The bogus claim of an undervalued dollar gives the policymakers an excuse to hold the dollar at an unsuitable level, and is causing the ruination of the manufacturing workers in the US. Jobs of white collar and tech workers will soon be affected as well. 

Now for the real folly. The Fed has been raising interest rates for the past year or so claiming that it is "fighting inflation". The inflation that the public thinks that the FED is referring to is one of increased prices/labor rates of consumer goods sold in the US. But this kind of inflation is not present and is unlikely to reappear again soon because of some very fundamental changes in the US economy such as tariff reductions, transportation cost reductions, and a fundamental shift away from union membership. As long as 200 million skilled workers in Southeast Asia are unemployed, an 
increasing number of competitive foreign goods for sale in the US will inhibit stateside price increases indefinitely.

  Inflation simply doesn't exist in the US. The federal reserve people are using the word "inflation" as an excuse to do what the rich want them to do, namely to hold the dollar's value high even while it is ruining the American workingman. The rich call a decrease in the value of the dollar "inflation" because it increases the prices of imported goods. But a decrease in the value of the dollar won't necessarily increase the prices of local-made goods, and therefore needn't cause the inflation which the Fed is pretending to be so concerned about. Based upon this pretence (lie) the FED has been raising the interest rate not in order to control inflation but solely to keep the dollar from falling in value. This increase in interest rates will allow foreign dollar holders to "invest" in the US money markets thereby keeping their money in American banks. This "investment" will decrease pressure on US bank reserves by avoiding a resort of dollar holders to the currency exchange markets. They are effecting this by increasing short term interest rates which  decreases bank reserves. A decrease in the money supply normally drives any economy into recession. In a very short period this will be the fate of the US.

The EU is in even worse shape employment-wise. At a time when it is facing an ongoing recession, EU policymakers likewise are compelled to raise interest rates in order to avoid losing their own money supply. In other words, the US interest rate policy forces the EU to do the same, ensuring a drop in production and employment there as well. If the FED continues to raise interest rates, the EU will simply do the same going further and further into recession. They will continue to lose jobs to Southeast Asia, unemployment will continue to increase, and their high standard of living will slowly disappear. Until the US decides to support its working classes, the EU will be unable to support theirs as well.

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Richard Backus is a journalist specializing in economics and politics.He has degrees in physics and engineering, and considerable experience in computer systems development. He is single, a good bridge player, and an enthusiastic tennis player.

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