I have been on the road for the past few (and next ten) days, in part because of Spring Festival, so I haven’t been able to post as much as I normally do, but I was asked to write an article for a Chinese magazine, which I recently finished, on comparisons between today and the beginning of the 1930s. As the recognition grows around the world of the similarities between China in 2008 and the US in 1929, it is worth considering why the Great Depression in the US was so severe and what lessons China should draw from it. I and a few others have discussed one of the similarities so many times and in so many different places that I think by now the whole issue of the trade impact of US overcapacity in the 1920s and 1930s and how it relates to China today is pretty widely recognized.
But there is more. I just finished rereading Barry Eichengreen’s Golden Fetters, a book on monetary conditions in the 1920s and 1930s (and in my opinion one of the great books of financial history). One of the points he makes – in fact it is probably the main point of the book – is the way currency policies (i.e. adherence to the gold standard) sharply constrained the ability of policymakers to deal effectively with the monetary consequences of the 1929-31 crisis. It wasn’t until various affected countries escaped from their monetary handcuffs and rejected gold that monetary policy became flexible enough to permit them to loosen sufficiently to counteract the banking collapse that accompanied the crisis. Eichengreen makes the point often and forcefully that there was a strong positive correlation between the speed with which countries went off the gold standard and the mildness of the subsequent economic crisis.
As an aside I would add my impressionistic sense that countries that ran large balance of payments surpluses (most obviously the US, but there were others too) were in the strongest position to hang on to gold, and so were the last to go off gold. They were also the ones most harmed by the 1930s crisis. I am not sure if this is primarily because of the monetary straitjacket or because most countries with strong balance of payments positions were also countries with large trade surpluses, and so they suffered most from a contraction in global demand and a collapse in international trade, but I suspect that the two are very closely linked.
Let me summarize my view of the key conditions in the 1920s and 1930s that shed light on current conditions. Besides the standard impact of the 1929 crash on consumer confidence, domestic consumption, and the cost of capital, economists generally speak of two factors that compounded the difficulties facing the US economy:
- The first I have discussed many times. Throughout the 1920s, the US created significant industrial overcapacity, which it was able to export even as massive foreign borrowing in the US markets financed those exports. However just when the 1929 crash caused US consumption to decline, it also eliminated foreign financing for the trade deficit countries. As international trade collapsed – especially after the US tried to force the adjustment abroad by the passage of import tariffs – domestic demand was not nearly high enough to absorb everything US factories produced, and the US was forced to resolve its overcapacity problem domestically. It could have done so by increasing domestic government demand, as Keynes advised, but although the US was in a very strong position fiscally, it failed to take advantage of this strength and barely expanded government spending. This ensured that overcapacity would not be resolved by rising government demand but rather by factory closings and rising unemployment. Of course the passage of Smoot-Hawley and other mercantilist acts, by inviting retaliation, made the process much more difficult.
- To make matters worse, excess money expansion caused by the massive accumulation of reserves in the 1920s had led to over-investment and risky lending. The stock market crash set off the process of deleveraging that always signals the end of a liquidity boom, and banks, financing companies and securities firms saw their balance sheets contract. When the Federal Reserve failed to accommodate the sudden collapse in money supply as banks cut lending in response to the crisis, the resulting money contraction in the US converted a sharp economic slowdown into a disaster. According to Milton Friedman (and I think most other economists) this was the biggest policy blunder that ensured that the crisis would be so devastating.
Compared to the US in 1929 China fares better on some measures, but not all. The first and most obvious is the scale of China’s overcapacity problem. China’s trade surplus, the cleanest measure of overcapacity, is of the same magnitude as that of the US in 1929 – roughly 0.5% of global GDP – but its economy is less than one-fifth the relative size of the US in 1929. Resolving the overcapacity problem will be much more difficult for China, especially if the world descends into trade friction and if international trade contracts. For that reason China must be at the forefront of trade liberalization and avoid the mistake the US made in 1930 of trying to increase its export competitiveness and reduce domestic demand for foreign goods. In that direction lays trade friction, which would have a devastating impact on Chinese businesses.
Perhaps not nearly as strong as the US in 1930, China is nonetheless in a reasonably strong position fiscally – although municipal reliance on land sales for revenues, contingent liabilities in the banking system and in provincial and municipal borrowing, and overall lack of transparency, make it difficult to judge. More importantly, however, there is widespread recognition among policymakers, unlike in the 1930s, that rapid and forceful fiscal expansion is key to creating new demand. Unfortunately it is not yet clear exactly how aggressively the Chinese government will expand fiscally and whether it will do so fast enough to replace declining US and European imports.
The second point may be the more important. Like the US in the 1920s China experienced a huge run-up in central bank reserves and, as the inevitable counterpart, low interest rates and excessive money supply growth. When this happens the financial system often responds by taking on excessive credit risk and over-investing. Given the complexity of the China’s formal and informal banking systems and the lack of transparency, it is difficult to know how vulnerable the banking sector is, but it is clearly something about which to worry. Warren Buffett once quipped that you can never know who is swimming naked until the tide goes down. The tide is receding and we are about to see how many naked bankers there are.
How the PBoC will respond to any signs of sharp money contraction is probably the most important question to answer and also the most difficult. On the optimists’ side the mistakes made by the US central bank in the 1930s have been so widely discussed that there is no question that Chinese policymakers understand the risk. The PBoC will undoubtedly do all in their power to counteract any monetary or credit contraction.
But things are not so easy. In the 1930s as long as the US was on the gold standard, it had limited flexibility in dealing with domestic monetary management. This is one of Eichengreen’s key points. Once the US got off the gold standard in 1933 it was able to pursue a wholly independent monetary policy, but its failure to counteract the initial credit contraction was a blunder with huge implications, and one from which it was only able to recover after tremendous pain. Certainly the PBoC would not make the same choice this time around, would it?
But can it choose differently? Unfortunately the PBoC is not as free to manage domestic monetary policy as the Fed was after 1933 because its primary obligation is to manage the foreign exchange value of the currency. This means that a crucial aspect of monetary policy in China is determined largely by net inflows or outflows on the trade and capital account.
The PBoC has other tools: most importantly its influence on credit creation (I am skeptical about the usefulness of open market operations) which it can expand partly by reducing the minimum reserve requirement for banks and partly by moral suasion within the banking system, but I am not sure how effective this is likely to be. Remember that much of the credit expansion from previous years seems to have migrated off the balance sheets of commercial banks (including into the informal sector) when the PBoC tried to constrain credit growth. In my opinion when underlying monetary conditions are consistent with rapid credit expansion there, is little the regulators can do to prevent this from happening. At best they can decide whether it happens in the regulated parts of the system or whether it simply migrates to other areas.
The reverse is also likely to be true. Attempts by the PBoC and other policy-makers to force banks to expand credit may result in higher loan growth reported on bank balance sheets, but overall credit growth within the economy is likely to be much less. If the underlying money supply is consistent with contracting credit, the system will most likely see contracting credit (and I am saying nothing about the possibility that much of the formal credit expansion reported by the banks will consist of empty lending into future NPLs).
With international trade falling, it is probably only a question of time before China’s trade surplus begins to shrink sharply (although a number of commentators who I respect a lot, including Brad Setser, might disagree with me on this), and as I wrote last week there is mounting evidence that some of the hot money that poured into China one year ago is now starting to leave. This suggests that China may begin to see rapid contraction of foreign currency holdings and, with it, a contracting domestic money supply.
This may be the biggest unexpected risk China faces. We must remember that as long as the main task of monetary policy is to set the value of the RMB in foreign currency terms, the PBoC has limited ability to manage the domestic money supply. If net outflows are large in 2009, the PBoC may be forced to preside over a monetary contraction, and this would be exacerbated if there were problems in the banking system that caused formal and informal banks to cut lending. This would undoubtedly worsen China’s difficult economic adjustment to the problem of overcapacity. It is vitally important that Chinese policymakers recognize the monetary constraints under which they work and prepare contingency plans. China can learn a lot from the mistakes of US policy in the 1930s.
By the way whenever I say that money outflows could become a problem for China, inevitably someone rushes in to pour scorn on the idea that China is vulnerable to a 1997-style Asian crisis. I agree it isn’t, and I will repeat (again) that this is not and never has been the point of my concern about hot money outflows. China does not have a currency mismatch risk worth bothering about. The reason to worry about hot money outflow is that it has a domestic monetary impact.
very nice tie in with the monetary restrictions of the gold standard placed on the US. As you state, the problem lies in trade and industrialization, though poor monetary policy can make the problem much worse. However, monetary policy cannot solve the problem. Consider a ZIRP monetary policy existing side by side with firms who refuse to borrow to finance projects. Clearly the firms do not believe that there are any positive NPV projects, no matter the monetary policy. This is because all wants and needs have been satiated, or at least there are no economic agents willing to borrow to satiate wants and needs. ZIRP or not, the economic agents simply do not want to sacrifice any more of their future production for want/needs satiation today. It is an intractable problem.
Excellent entry Prof. Pettis
I would like to ask if you perceive the emergence of a clear policy momentum towards domestic credit expansion and abandoning the yuan peg to the dollar?
For time being, it seems to me the Chinese government is paralyzed with debates between various factions or it is still pondering what decision to take, probably considering, rightly or wrongly, the current peg and mercantilist policies, that served them so well, as being essential for the internal social stability and the viability of the current one party system.
How urgent would you consider to be the adoption of a monetary policy based on domestic credit expansion and moving off the “dollar standard” ?
What about Chinese PCE as a percent of GDP comapred to the US during the depression? It seems that the US consumers were on a much better footing than the Chinese. This can be a good thing or a bad thing depending upon how the Chinese choose to respond.
Michael,
There is some more to the story on 1930′s fiscal policy. Hoover boosted federal outlays by more than 100% at a time when GDP was shrinking. The result is that the budget deficit as a percent of gdp went from a .8% surplus in 1930 to a deficit of 4% in 1932, the last year of Hoover’s presidency. One can argue the U.S. didn’t respond fast enough, but FISCAL policy cannot be said to have been contractionary at the time.
source: http://www.gpoaccess.gov/usbudget/fy09/hist.html
Ironically, in 1932, FDR’s platform included bringing down the Hoover deficits which he thought imprudent. Once in office, though, he kept the deficit at 4-6% of gdp until 1937. The 1937-1938 “mini-depression” was caused by premature reversal of fiscal and monetary stimulus, which just goes to show that producing stimulus is easy, removing it is the hard part…
The United States did not have industrial overcapacity in the 1920s when measured by the wants and desires of consumers. If it had, the promise of “a car in every garage” would not have been so appealing. What it did have was an international credit structure based on the fiction that its World War I allies and enemies could repay their war debts and community banks with real estate loans that could not be supported by post-war farm incomes.
Your comparison with the 1920s is apt, but the analogy should be with the foolish attempt to maintain prices that had been created by the extravagance of a World War. The Dawes Plan and other “rescue” plans were the means by which we Americans kicked the can down the road so that the United States as the creditor nation did not have to recognize that it had monetized of the belligerents’ borrowings and embedded them in our own domestic prices. The only fetter of the gold standard was the refusal of the remaining democracies among America’s wartime allies – the British and French – to allow the U.S. to impose its post-war prices on the rest of the world. Their politicians insistence on restoring to their citizens the same right that Americans had – the one that allowed citizens to have free access to specie in exchange for credit currency – put the U.S. in the position of either writing off the principal balances of war loans or lending back to the British and French the gold they had spent in the first 2 ½ years of the Great War. It was, as Saddam Hussein might have put it, the “mother of all Option ARMs”.
[...] China has monetary echoes from the 1930s too (Pettis) [...]
Part of the reason why the U.S.suffered more than the European countries did during the Great Depression was that the major European countries defaulted on their loans. Unless the U.S. plans to default or deliberately inflate its way out of the massive debt, I do not see how China would suffer more than the U.S. did.
Good stuff Mike. One counterveiling point might be a surge in SME lending: certainly that is a policy objective now, and the most basic of government guarantees for depositors in the informal institutions that are expected to recycle growing amts of working capital to the labor intensive sectors of the country (many of which do things in severe, horrible, UNDERsupply — like healthcare) would induce significant flow growth. that is one goal anyway. best for chunjie.
Prof. Pettis-
I have been reading the same book and thinking along the same lines. A couple of questions: First, a natural consequence of counteracting outflows and or/increasing the money supply would be to weaken the CNY exchange rate- i.e. depreciate. At least until China’s trade surplus has substantially contracted (it hasn’t yet), this will be politically toxic and could trigger the protectionist backlash feared by many. As such, it seems China has no choice but to hold USDCNY steady- if it does, is there any effective way it can increase the domestic money supply subject to that binding constraint? If not, do you think China will risk the politically risky strategy of devaluation.
(As an aside: If China had allowed its currency to float in the past, it would have both constrained the build-up of excess capacity and devaluation would be a more viable policy option today…live and learn).
Secondly, the United States itself attempted to devalue in the 1930s, devaluaing the dollar’s international gold parity by 33% in 1934. However, because most other countries were themselves forced off gold, the dollar nevertheless appreciated against many other currencies during the 1930s, notably against sterling. Using this example as a precedent and analogy, if China does attempt to devalue, do you think the attempt will fail anyway? Will a round of competitive devaluations globally crush trade flows and leave a stronger renminbi in both nominal and real terms in spite of China’s policy preferences?
This is quite interesting argument. As an amateur, I have a question for Prof. Pettis. PBoC would expand the money supply aggressively, if PBoC did what you suggest, got rid of pegging RMB to US Dollars. Then RMB should have gone weaker against US Dollar, not to say to Euro. This no-doubt will bring great difficulty in terms of the trading talk and diplomacy to China-US, China-Europe. It seems to me a diplomatic mission impossible at least to me given the high unemployment in US and Europe. Am I read your point correctly? And what would you suggest in that situation? Thanks.
How are we to understand the difference between the monetary effects of capital outflows, and the monetary effects of dollar depreciation in China? Thank you.
just a basic question…if the money supply shrinks b/c of fdi redemptions…can’t china just print more money to re-inflate the money supply?
Prof Pettis,
1.Hot money inflow helps expand domestic monetary policy,but hot money outflow doesn’t contract it.Because the created new money supply associated with every incoming $1 still rests in domestic system when it comes out. So in any case,PBoC wouldn’t find it hard to pump liduidity into the system when needed.
With the largest Foreign reserves in the world,PBoC will have no trouble in facing this outflow.In fact,we would like to see Foreign reserves declining,because it already caused so much headache and we don’t think SAFE can manage it wisely.
2.With global demand declines,of course there should be pickup in domestic consumption,although it would not be enough.The gov. should help with that which means essentially buying high from manufacturers and selling low to domestic customers.This is the least worst strategy.The 4trillion package will be directed to this cause,although the signs show that the gov. would spend it on investments.Sigh….
[...] Great Wall sounds much more appealing. Sorry. Here is a somewhat challenging and technical read by Professor Michael Pettis of China Financial Markets. Developments in China have MAJOR implications for global [...]
MoneyIllussionist
So,the chinese guy get the dollar for free from the People Bank of China?
I mean,if you sell your govement bond,and paralel it you get the value of it in dollar and you get the same amount of money in yüan too,this have to be a very good business.
Bloomberg headline today:
“Obama Deems China ‘Manipulating’ Yuan, Geithner Says”
Hooray! The first step in solving a problem is admitting that you have a problem. Let us hope that they follow words with action.
Michael, I know you are concerned about the Chinese adjustment, but it seems to me the sooner the Chinese start to develop their internal demand the better.
The world will be much better off if we see a negotiated shift back toward balanced trade.
Dear Prof Pettis and everyone,
I am not an economist, but just a participant of the market. I have a few things that i want to share and get some feedback.
I predict dow fall below 6500, hsi below 9000, and China will come out of this alive and well. And the real boom of China will start then, as only through trough, transformational changes could be made, only through transformational changes, China could excel.
I have been following a very simple logic since last Sept, and it has worked out very well with the stock market. And I just wanted to share and get some feedback from you.
The method is a very simple logic of event sequencing. (altho, determining the reasons and evidence to support each event requires tremendous amt of work).
At first is the deteriorating economy which dragged down the stock market, not until a very very depressed level, govt would step in which caused market to rally. Now, as clearly, bad news have set in, markets have been range bounded and we find ourselves in feelings of normality, of comfortability, altho in recession, depression whatever you believe. until MARKETS WORLDWIDE TUMBLE AGAIN, TO A VERY VERY DEPRESSED LEVEL before govts would extend its helping hand yet again. desperate times call for desperate measures, or shall I say, desperate measures (what we need), only comes as a result of very desperate times, and clearly we are not there yet!
There is much concerns surround China, not just on its economical condition, but rather social and political risks that might be led to. I believe many economists, “experts” have all gotten their facts right and everyone has a good point. HOWEVER, everyone missed the single most important thing that’s very unique about China, it’s the level of endurance that her citizens can bear. It is the by product of the 10yrs of Cultural Revolution that had made the Chinese pple, both urban and rural much more resilience during not just a economic downturn, but even starvation. And bad times will actually unite the country even more than good. This is something one will never be able to understand unless lived through.
The short term weakness in the stock market both in China and HK is actually the greatest opportunity of a decade. Best buying opportunity is when things are looking absolutely the worst if you got the facts right.
“The fact that other people agree or disagree with you makes you neither right nor wrong. You will be right if your facts and reasoning are correct” – Ben Graham.
“The central principle of investment is to go contrary to the general opinion.” – Keynes
Thanks.
[...] much more appealing. Sorry. Here is a somewhat challenging and technical read by <a href=”http://mpettis.com/2009/01/there-are-monetary-echoes-from-the-1930s-too/”>Professor Michael Pettis of China Financial Markets</a>. Developments in China have MAJOR implications [...]
It is interesting.I started to think about it.
If the chinese goverment try to pump more yüan into the economy paralel with the fall of the FX reserves,the effect will be the same like if they leave the pegging of the yüan and allow it to be stronger.
I mean,if you get 1 $ for 3 yüan, that is exactly the same like if you say that you pump yüan into the economy paralel with the fall of the xchg reserve.
Of course,there is a diferecne:if you pump the yüan,you will give money to guys who not deserve it and (by a high chance) can not use it,in the other case you will give money to the business guy who know how to handle the money and how to make jobs.
So,if china allow to the yüan to be stronger,or if it pump more money into the economy have the same effect.
In the world there must be production=consumption (adjusted for temporary inventory changes, real net investments etc.)
When the mercantilist countries grow faster than other countries, an imbalance sooner or later emerges where the wilingness to produce and accumulate overwhelms the depreciation plus the willingness to consume.
What is produced on the margin becomes increasingly worthless. Today China produces on the margin.
This is mirrored financially. China is working like crazy to add to its dollar reserve, but 1% of inflationary value destruction of the existing reserve requires an ever higher addition to reserves. They are collecting fruits, but have collected and stored so much that the stored fruits are rottening quicker than new fruits are added.
This forces China’s economy down AND their consumption up. Unfortunately there is a mismatch between what THEY want to consume and produce, because they have produced for the Americans. That is, some Chinese investments are worthless.
The mismatch will be corrected as exports are replaced by domestic consumption. Made investments must be written off, new investments must be made.
There is a point in a small country keeping a currency reserve in a large country. But less the other way round. As China grows, it makes ever less sense with huge US reserves. China should now use these reserves. Why not distribute the currency reserve to the population. Could there be any more optimal use…
I have an interesting model.
Let say: now,the hot money outflow from China mop up the cash (M1) from the economy.
Of course it is bad, because the result of it will be the collapse of the economy,as we experienced it during the Great Depression.
Due to this,the PBoC will put more money into the economy.
Equitation:
Sum_money = money_multiplier(cash_from_FX_reserves+cash_from_the_PBOC)
The point is simple from this equitation:
cash_from_FX_reserves=exchange_rate*size_of_FX_reserves
Can you see?
Your target is that to keep the Sum_money on level.
Of course the multiplier fall rapidly (as we can see it in the US) so they have to work hard to keep it in line.
Parallel it,the FW reserves fall rapidly too.
But, if you want to keep the sum of the money on level,you can do it by issuing new money OR by simply allow to the currency to be stronger.
Both have the same monetary effect,but the xchg rate will give money to that who know how t use it,in the case of the inflationary money it will go to the corrupt officials.
Result?
China and the US try to increase the Sum_money.
The outflow of the hot money help the US to reach this target,and the US have better system to pump inflationary money into the economy with a higher efficiency.
China down,US up.
Prof. Pettis, quick question on one of your statements in an earlier response in your blog — you said, “Actually the value of US manufacturing is three to four times the value of Chinese manufacturing.” I quoted this statement to a friend, who pointed out the recent Global Insight study claiming that China would supplant the U.S. as the world’s largest manufacturer in 2009 (referenced in a Financial Times article). Is this a comparison of apples to oranges? What measure of manufacturing value are they describing, and what measure are you referring to?
Thanks very much in advance for your response.
(This post is about investing rather than economics per se. Hope nonee of you mind
)
LEON: “The short term weakness in the stock market both in China and HK is actually the greatest opportunity of a decade. Best buying opportunity is when things are looking absolutely the worst if you got the facts right.”
I have been bearish on China for a few years but I actually think it may end up being the largest and most important economy in 50 years. The stars are aligning in its favour but it will go through serious issues, including dismantling the totalitarian system they run. In any case, to answer your thought…
Even if you have a long-term bullish view of China, there is always the possibility that you will end up bankrupt if you get in too early. Remember, someone in the 1920′s could have argued that USA would end up being the dominant economic power, with great prosperity in the long run. Yet if they invested in the stock market or in most businesses in the 1920′s or 1930′s, they would have likely ended up bankrupt.
So, my concern is that if you invest too early, even if your long-term macro view is correct, you will end up with big losses. Now, one could argue that my thinking will lead to them missing out on the bottom. Yes, you probably won’t get the bottom. But if your macro view is as bullish as you are implying, whether you invest now or in 6 months or an year or whatever won’t matter in the long run.
Furthermore, if China is to become a world economic power, it will have to open up its capital markets (they have been doing this very slowly over a decade.) This may not happen until they democratize their government but I don’t see them becoming an economic power without getting access to foreign capital. For instance, from what I understand (I’m just a newbie sitting over in Canada), China doesn’t really have a bond market to speak of; or any sort of venture capital market. You don’t necessarily need foreigners to fund their businesses but most of the private wealth (not goveernment wealth) is held by citizens in the wealthy countries. Governments are very bad allocators of capital and generally don’t know what the hell they are doing anyway. So access to foreign private capital will help China. For example, a big chunk of the railroads in America in the 1800′s was financed by Europeans.
If what I say is correct, then, when they do open up their local stock markets, we will have far greater investment opportunities, including smaller companies or rural companies, or whatevever. Right now, you are pretty much limited to a few Hong Kong or Chinese red chips. If you are a small investor like me, what are the chances that these widely followed stocks are mispriced? Except for the contrarian macro case you are suggesting, there is little reason to believe that you will price these large-cap Chinese companies better than the market.
Anyway, I share your sentiment but feel it’s way too early. I personally am waiting to see how China handles a big recession (2nd one after the 1997 crisis) before doing anything…
CLN, I am not a policy insider but I do not see any real discussion of an abandonment of the RMB peg. I think the real debate is over depreciation versus moderate appreciation.
David Pearson, I agree with your comments. I think China has a much better understanding of fiscal issues than the US did in the 1930s, although it is not clear that fiscal expansion is going to be easy even if they understand the magnitude of the needed expansion.
Seatrus, the foreign bond defaults in the 1930s were painful to US bondholders and so may have affected their consumption, but it was not the primary cause, or even a major cause, of the US contraction.
Dan, although loans in the formal sector are surging (on the books, at least) I wa sunder the impression that most of this was going to SOEs and government projects, not to SMEs. What is your sense of where loans are going and how they are being used?
George, if I understand your question, then yes, China’s reserve and currency policies are complicated by the adverse impact they might have on Europe.
MoneyIllusionist, the PBoC would offset dollar outflows by buying central bank bills, but these are a close enough substitute for money that it won’t have much effect on the overall money supply. It is hard for me to figure out how monetary policy works in China except to say that it is far more complicated than open market operations.
Leon, I agree that the Chinese people will endure whatever problems they face, and I have never doubted it. My point is to understand what is likely to happen to the macro-economy.
Bomlat, if injecting liquidity causes prices to be higher than they otherwise would have, at a macro level that is indeed the same as appreciating the currency. Because of the impact of currency on foreign debt and money assets, and the impact of higher prices on domestic debt and money assets, there are some distributional effects and possibly financial distress effects.
Joseph, I don’t know the Global Insight study and have no idea what they mean by their numbers, but suspect that they are defining their way into a conclusion. My main point is that the idea of China as being the world’s factory is, like much of what is said about China, pretty meaningless – no less so than the idea that the US produces only services.
How about a government purchase of land from farmers which they can still use to farm?
[...] fascinates me so much, that I 1. subscribed to his blog immediately, 2. forced myself to finish this and this to understand what he meant by “overcapacity” and the analogy with the U.S. [...]
By just looking at a chart of historic oil prices its clear that going off the gold standard in 1971 destabilized the price of oil. This seems to correspond to the decline of manufacturing businesses in the US, particularly the automotive industry. How can you have a lean, competitive business with a 30 year planning horizon when the cost of fuel can double (or halve) in a year?
http://en.wikipedia.org/wiki/File:Oil_Prices_1861_2007.svg
The gold standard need not handcuff a nation’s monetary policy. The exchange between gold and the nation’s currency can be changed as needed. With a gold standard, however; it is hard to change the value of currency secretly – which is a good thing. It builds trust, honesty and stability into the market economy.
It is interesting also to note that globalization isn’t guaranteed to make everyone more prosperous as we have been told. As a result of globalization China and the US have found themselves in a pathologic relationship from which they may not be able to easily extricate themselves. This of course has major global implications.
In the end globalization can only be as effective at bringing prosperity to mankind as are the relationships that form between nations because of globalization. I think that is worth noting.