The View From 1776

Republican and Democratic politicians, through ignorance of economics or sheer perversity, have for three quarters of a century pursued Federal spending programs that foment inflation, which makes domestic goods uncompetitive with foreign products.  As long as foreign goods are cheaper than domestic manufactures, imports will continue to take a big share of the market. 

Reacting to job losses, rising costs of living, and other economic dislocations, liberals (and too many conservatives) hypocritically blame China and other countries for exporting too much to us.

Liberal socialist Senator Charles Schumer and RINO Senator Lindsay Graham have led the growing parade of protectionists who cudgel Treasury Secretary Paulson for his failure to impose more trade restrictions on China and to obtain Beijing’s agreement to allow the yuan to float against the dollar.

The culprit, however, is not China, but our failure to maintain a sound dollar.

To finance endless expansion of Federal spending, the Federal Reserve uses bookkeeping entries to create dollars faster than the growth in real output of goods and services. The inevitable result is, by definition, inflation. 

Internationally this is a “beggar thy neighbor” policy. 

Other countries must either convert dollars from exports into their own currencies, creating inflation there, or convert the dollars into some other, non-inflationary asset.  China has recently begun to redeploy some of its dollar exchange reserves.

In the 1960s and 70s, France justifiably retaliated against our exporting of American inflation by exchanging its rapidly devaluing dollar foreign exchange reserves for gold at the New York Federal Reserve Bank.  To stem the exodus of our gold reserves, President Nixon closed the gold window permanently, leaving other nations with huge, inflationary floods of Eurodollars.  The slowing and eventual decline of Western European economic growth dates from that time.

When the dollar declines against the Deutsche Mark or the French Franc, our exports become cheaper in those currencies.  In the short run (until inflation again pushes production cots up), this tends to boost exports and production here.  But Beijing’s tying the yuan to the dollar means that the inflationary devaluation of the dollar confers no exporting advantage upon our exports. 

Hardly ever mentioned is the fact that China’s tying its currency to the U. S. dollar means that ongoing inflation here is automatically imported into the Chinese economy.  That process is what led to the collapse of the Bretton Woods international monetary system under Presidents Johnson and Nixon.

An exporting country like China will accumulate growing surpluses of dollars received in payment for its goods.  China has elected to link the yuan to the dollar, which means that, when Chinese exporters receive payment in dollars, the Chinese money supply has to be expanded to match conversion of export-generated dollars into domestic currency.  This causes general price inflation within China. 

Since 1990, the rate of inflation in China has more than doubled.

An Associated Press article of April 20, 2007, reported,

The signs of a surging economy are everywhere: flashy luxury cars, glitzy shopping malls, expensive restaurants and construction cranes in many neighborhoods.

For most Chinese, this is a good thing. It means more jobs, higher incomes and rising affluence. But China’s leaders, fearful of accelerating inflation and the risk that all this investment could collapse in a debt crisis if borrowers go bankrupt, are trying to apply the brakes.

As the U. S. dollar declines in foreign exchange value against other currencies not tied to the dollar, the real, inflation-adjusted value of China’s exports declines. 

This is precisely what happened in the 1970s, when OPEC abruptly began jacking up the price of oil to offset the inflationary devaluation of the dollar.  To compensate, the Fed made matters worse by pumping out more dollars, while Congress imposed new taxes and American workers were pushed upward into higher tax brackets by rising nominal incomes.  Disposable personal incomes and business profits throughout the 1970s, after adjustment for inflation, actually fell.

The result was stagflation: rising unemployment, falling economic activity, higher taxes, and catastrophic inflation.

A repetition of this disaster is precisely the scenario that liberals in Congress and Democratic presidential candidates are promising us beginning in 2008.

Despite what Keynesian (i.e., socialist) economists tell us, there is no necessary linkage between inflation and rapid economic growth.  From our own history we know that the expansion of the American economy was extraordinarily rapid during the 19th and early 20th centuries.  Yet prices, apart from war periods, were remarkably stable, while we were on one version or another of the gold standard.

The key variable is maintaining a sound currency, which we have signally failed to do except during the brief tenure of Fed Chairman Paul Volcker in the early days of the Reagan administration.  Only by reducing Federal spending can we avoid the same stagnation and financial ruin now confronting France and Germany.

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