The End of Dollar Hegemony

The End of Dollar Hegemony

HON. RON PAUL OF TEXASBefore the U.S. House of Representatives February 15, 2006
The End of Dollar Hegemony
A hundred years ago it was called “dollar diplomacy.” After World War II, and especially after the fall of the Soviet Union in 1989, that policy evolved into “dollar hegemony.” But after all these many years of great success, our dollar dominance is coming to an end.
It has been said, rightly, that he who holds the gold makes the rules. In earlier times it was readily accepted that fair and honest trade required an exchange for something of real value.
First it was simply barter of goods. Then it was discovered that gold held a universal attraction, and was a convenient substitute for more cumbersome barter transactions. Not only did gold facilitate exchange of goods and services, it served as a store of value for those who wanted to save for a rainy day.
Though money developed naturally in the marketplace, as governments grew in power they assumed monopoly control over money. Sometimes governments succeeded in guaranteeing the quality and purity of gold, but in time governments learned to outspend their revenues. New or higher taxes always incurred the disapproval of the people, so it wasn’t long before Kings and Caesars learned how to inflate their currencies by reducing the amount of gold in each coin-- always hoping their subjects wouldn’t discover the fraud. But the people always did, and they strenuously objected.
This helped pressure leaders to seek more gold by conquering other nations. The people became accustomed to living beyond their means, and enjoyed the circuses and bread. Financing extravagances by conquering foreign lands seemed a logical alternative to working harder and producing more. Besides, conquering nations not only brought home gold, they brought home slaves as well. Taxing the people in conquered territories also provided an incentive to build empires. This system of government worked well for a while, but the moral decline of the people led to an unwillingness to produce for themselves. There was a limit to the number of countries that could be sacked for their wealth, and this always brought empires to an end. When gold no longer could be obtained, their military might crumbled. In those days those who held the gold truly wrote the rules and lived well.
That general rule has held fast throughout the ages. When gold was used, and the rules protected honest commerce, productive nations thrived. Whenever wealthy nations-- those with powerful armies and gold-- strived only for empire and easy fortunes to support welfare at home, those nations failed.
Today the principles are the same, but the process is quite different. Gold no longer is the currency of the realm; paper is. The truth now is: “He who prints the money makes the rules”-- at least for the time being. Although gold is not used, the goals are the same: compel foreign countries to produce and subsidize the country with military superiority and control over the monetary printing presses.
Since printing paper money is nothing short of counterfeiting, the issuer of the international currency must always be the country with the military might to guarantee control over the system. This magnificent scheme seems the perfect system for obtaining perpetual wealth for the country that issues the de facto world currency. The one problem, however, is that such a system destroys the character of the counterfeiting nation’s people-- just as was the case when gold was the currency and it was obtained by conquering other nations. And this destroys the incentive to save and produce, while encouraging debt and runaway welfare.
The pressure at home to inflate the currency comes from the corporate welfare recipients, as well as those who demand handouts as compensation for their needs and perceived injuries by others. In both cases personal responsibility for one’s actions is rejected.
When paper money is rejected, or when gold runs out, wealth and political stability are lost. The country then must go from living beyond its means to living beneath its means, until the economic and political systems adjust to the new rules-- rules no longer written by those who ran the now defunct printing press.
“Dollar Diplomacy,” a policy instituted by William Howard Taft and his Secretary of State Philander C. Knox, was designed to enhance U.S. commercial investments in Latin America and the Far East. McKinley concocted a war against Spain in 1898, and (Teddy) Roosevelt’s corollary to the Monroe Doctrine preceded Taft’s aggressive approach to using the U.S. dollar and diplomatic influence to secure U.S. investments abroad. This earned the popular title of “Dollar Diplomacy.” The significance of Roosevelt’s change was that our intervention now could be justified by the mere “appearance” that a country of interest to us was politically or fiscally vulnerable to European control. Not only did we claim a right, but even an official U.S. government “obligation” to protect our commercial interests from Europeans.
This new policy came on the heels of the “gunboat” diplomacy of the late 19th century, and it meant we could buy influence before resorting to the threat of force. By the time the “dollar diplomacy” of William Howard Taft was clearly articulated, the seeds of American empire were planted. And they were destined to grow in the fertile political soil of a country that lost its love and respect for the republic bequeathed to us by the authors of the Constitution. And indeed they did. It wasn’t too long before dollar “diplomacy” became dollar “hegemony” in the second half of the 20th century.
This transition only could have occurred with a dramatic change in monetary policy and the nature of the dollar itself.
Congress created the Federal Reserve System in 1913. Between then and 1971 the principle of sound money was systematically undermined. Between 1913 and 1971, the Federal Reserve found it much easier to expand the money supply at will for financing war or manipulating the economy with little resistance from Congress-- while benefiting the special interests that influence government.
Dollar dominance got a huge boost after World War II. We were spared the destruction that so many other nations suffered, and our coffers were filled with the world’s gold. But the world chose not to return to the discipline of the gold standard, and the politicians applauded. Printing money to pay the bills was a lot more popular than taxing or restraining unnecessary spending. In spite of the short-term benefits, imbalances were institutionalized for decades to come.
The 1944 Bretton Woods agreement solidified the dollar as the preeminent world reserve currency, replacing the British pound. Due to our political and military muscle, and because we had a huge amount of physical gold, the world readily accepted our dollar (defined as 1/35th of an ounce of gold) as the world’s reserve currency. The dollar was said to be “as good as gold,” and convertible to all foreign central banks at that rate. For American citizens, however, it remained illegal to own. This was a gold-exchange standard that from inception was doomed to fail.
The U.S. did exactly what many predicted she would do. She printed more dollars for which there was no gold backing. But the world was content to accept those dollars for more than 25 years with little question-- until the French and others in the late 1960s demanded we fulfill our promise to pay one ounce of gold for each $35 they delivered to the U.S. Treasury. This resulted in a huge gold drain that brought an end to a very poorly devised pseudo-gold standard.
It all ended on August 15, 1971, when Nixon closed the gold window and refused to pay out any of our remaining 280 million ounces of gold. In essence, we declared our insolvency and everyone recognized some other monetary system had to be devised in order to bring stability to the markets.
Amazingly, a new system was devised which allowed the U.S. to operate the printing presses for the world reserve currency with no restraints placed on it-- not even a pretense of gold convertibility, none whatsoever! Though the new policy was even more deeply flawed, it nevertheless opened the door for dollar hegemony to spread.
Realizing the world was embarking on something new and mind boggling, elite money managers, with especially strong support from U.S. authorities, struck an agreement with OPEC to price oil in U.S. dollars exclusively for all worldwide transactions. This gave the dollar a special place among world currencies and in essence “backed” the dollar with oil. In return, the U.S. promised to protect the various oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coup. This arrangement helped ignite the radical Islamic movement among those who resented our influence in the region. The arrangement gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as dollar influence flourished.
This post-Bretton Woods system was much more fragile than the system that existed between 1945 and 1971. Though the dollar/oil arrangement was helpful, it was not nearly as stable as the pseudo gold standard under Bretton Woods. It certainly was less stable than the gold standard of the late 19th century.
During the 1970s the dollar nearly collapsed, as oil prices surged and gold skyrocketed to $800 an ounce. By 1979 interest rates of 21% were required to rescue the system. The pressure on the dollar in the 1970s, in spite of the benefits accrued to it, reflected reckless budget deficits and monetary inflation during the 1960s. The markets were not fooled by LBJ’s claim that we could afford both “guns and butter.”
Once again the dollar was rescued, and this ushered in the age of true dollar hegemony lasting from the early 1980s to the present. With tremendous cooperation coming from the central banks and international commercial banks, the dollar was accepted as if it were gold.
Fed Chair Alan Greenspan, on several occasions before the House Banking Committee, answered my challenges to him about his previously held favorable views on gold by claiming that he and other central bankers had gotten paper money-- i.e. the dollar system-- to respond as if it were gold. Each time I strongly disagreed, and pointed out that if they had achieved such a feat they would have defied centuries of economic history regarding the need for money to be something of real value. He smugly and confidently concurred with this.
In recent years central banks and various financial institutions, all with vested interests in maintaining a workable fiat dollar standard, were not secretive about selling and loaning large amounts of gold to the market even while decreasing gold prices raised serious questions about the wisdom of such a policy. They never admitted to gold price fixing, but the evidence is abundant that they believed if the gold price fell it would convey a sense of confidence to the market, confidence that they indeed had achieved amazing success in turning paper into gold.
Increasing gold prices historically are viewed as an indicator of distrust in paper currency. This recent effort was not a whole lot different than the U.S. Treasury selling gold at $35 an ounce in the 1960s, in an attempt to convince the world the dollar was sound and as good as gold. Even during the Depression, one of Roosevelt’s first acts was to remove free market gold pricing as an indication of a flawed monetary system by making it illegal for American citizens to own gold. Economic law eventually limited that effort, as it did in the early 1970s when our Treasury and the IMF tried to fix the price of gold by dumping tons into the market to dampen the enthusiasm of those seeking a safe haven for a falling dollar after gold ownership was re-legalized.
Once again the effort between 1980 and 2000 to fool the market as to the true value of the dollar proved unsuccessful. In the past 5 years the dollar has been devalued in terms of gold by more than 50%. You just can’t fool all the people all the time, even with the power of the mighty printing press and money creating system of the Federal Reserve.
Even with all the shortcomings of the fiat monetary system, dollar influence thrived. The results seemed beneficial, but gross distortions built into the system remained. And true to form, Washington politicians are only too anxious to solve the problems cropping up with window dressing, while failing to understand and deal with the underlying flawed policy. Protectionism, fixing exchange rates, punitive tariffs, politically motivated sanctions, corporate subsidies, international trade management, price controls, interest rate and wage controls, super-nationalist sentiments, threats of force, and even war are resorted to—all to solve the problems artificially created by deeply flawed monetary and economic systems.
In the short run, the issuer of a fiat reserve currency can accrue great economic benefits. In the long run, it poses a threat to the country issuing the world currency. In this case that’s the United States. As long as foreign countries take our dollars in return for real goods, we come out ahead. This is a benefit many in Congress fail to recognize, as they bash China for maintaining a positive trade balance with us. But this leads to a loss of manufacturing jobs to overseas markets, as we become more dependent on others and less self-sufficient. Foreign countries accumulate our dollars due to their high savings rates, and graciously loan them back to us at low interest rates to finance our excessive consumption.
It sounds like a great deal for everyone, except the time will come when our dollars-- due to their depreciation-- will be received less enthusiastically or even be rejected by foreign countries. That could create a whole new ballgame and force us to pay a price for living beyond our means and our production. The shift in sentiment regarding the dollar has already started, but the worst is yet to come.
The agreement with OPEC in the 1970s to price oil in dollars has provided tremendous artificial strength to the dollar as the preeminent reserve currency. This has created a universal demand for the dollar, and soaks up the huge number of new dollars generated each year. Last year alone M3 increased over $700 billion.
The artificial demand for our dollar, along with our military might, places us in the unique position to “rule” the world without productive work or savings, and without limits on consumer spending or deficits. The problem is, it can’t last.
Price inflation is raising its ugly head, and the NASDAQ bubble-- generated by easy money-- has burst. The housing bubble likewise created is deflating. Gold prices have doubled, and federal spending is out of sight with zero political will to rein it in. The trade deficit last year was over $728 billion. A $2 trillion war is raging, and plans are being laid to expand the war into Iran and possibly Syria. The only restraining force will be the world’s rejection of the dollar. It’s bound to come and create conditions worse than 1979-1980, which required 21% interest rates to correct. But everything possible will be done to protect the dollar in the meantime. We have a shared interest with those who hold our dollars to keep the whole charade going.
Greenspan, in his first speech after leaving the Fed, said that gold prices were up because of concern about terrorism, and not because of monetary concerns or because he created too many dollars during his tenure. Gold has to be discredited and the dollar propped up. Even when the dollar comes under serious attack by market forces, the central banks and the IMF surely will do everything conceivable to soak up the dollars in hope of restoring stability. Eventually they will fail.
Most importantly, the dollar/oil relationship has to be maintained to keep the dollar as a preeminent currency. Any attack on this relationship will be forcefully challenged—as it already has been.
In November 2000 Saddam Hussein demanded Euros for his oil. His arrogance was a threat to the dollar; his lack of any military might was never a threat. At the first cabinet meeting with the new administration in 2001, as reported by Treasury Secretary Paul O’Neill, the major topic was how we would get rid of Saddam Hussein-- though there was no evidence whatsoever he posed a threat to us. This deep concern for Saddam Hussein surprised and shocked O’Neill.
It now is common knowledge that the immediate reaction of the administration after 9/11 revolved around how they could connect Saddam Hussein to the attacks, to justify an invasion and overthrow of his government. Even with no evidence of any connection to 9/11, or evidence of weapons of mass destruction, public and congressional support was generated through distortions and flat out misrepresentation of the facts to justify overthrowing Saddam Hussein.
There was no public talk of removing Saddam Hussein because of his attack on the integrity of the dollar as a reserve currency by selling oil in Euros. Many believe this was the real reason for our obsession with Iraq. I doubt it was the only reason, but it may well have played a significant role in our motivation to wage war. Within a very short period after the military victory, all Iraqi oil sales were carried out in dollars. The Euro was abandoned.
In 2001, Venezuela’s ambassador to Russia spoke of Venezuela switching to the Euro for all their oil sales. Within a year there was a coup attempt against Chavez, reportedly with assistance from our CIA.
After these attempts to nudge the Euro toward replacing the dollar as the world’s reserve currency were met with resistance, the sharp fall of the dollar against the Euro was reversed. These events may well have played a significant role in maintaining dollar dominance.
It’s become clear the U.S. administration was sympathetic to those who plotted the overthrow of Chavez, and was embarrassed by its failure. The fact that Chavez was democratically elected had little influence on which side we supported.
Now, a new attempt is being made against the petrodollar system. Iran, another member of the “axis of evil,” has announced her plans to initiate an oil bourse in March of this year. Guess what, the oil sales will be priced Euros, not dollars.
Most Americans forget how our policies have systematically and needlessly antagonized the Iranians over the years. In 1953 the CIA helped overthrow a democratically elected president, Mohammed Mossadeqh, and install the authoritarian Shah, who was friendly to the U.S. The Iranians were still fuming over this when the hostages were seized in 1979. Our alliance with Saddam Hussein in his invasion of Iran in the early 1980s did not help matters, and obviously did not do much for our relationship with Saddam Hussein. The administration announcement in 2001 that Iran was part of the axis of evil didn’t do much to improve the diplomatic relationship between our two countries. Recent threats over nuclear power, while ignoring the fact that they are surrounded by countries with nuclear weapons, doesn’t seem to register with those who continue to provoke Iran. With what most Muslims perceive as our war against Islam, and this recent history, there’s little wonder why Iran might choose to harm America by undermining the dollar. Iran, like Iraq, has zero capability to attack us. But that didn’t stop us from turning Saddam Hussein into a modern day Hitler ready to take over the world. Now Iran, especially since she’s made plans for pricing oil in Euros, has been on the receiving end of a propaganda war not unlike that waged against Iraq before our invasion.
It’s not likely that maintaining dollar supremacy was the only motivating factor for the war against Iraq, nor for agitating against Iran. Though the real reasons for going to war are complex, we now know the reasons given before the war started, like the presence of weapons of mass destruction and Saddam Hussein’s connection to 9/11, were false. The dollar’s importance is obvious, but this does not diminish the influence of the distinct plans laid out years ago by the neo-conservatives to remake the Middle East. Israel’s influence, as well as that of the Christian Zionists, likewise played a role in prosecuting this war. Protecting “our” oil supplies has influenced our Middle East policy for decades.
But the truth is that paying the bills for this aggressive intervention is impossible the old fashioned way, with more taxes, more savings, and more production by the American people. Much of the expense of the Persian Gulf War in 1991 was shouldered by many of our willing allies. That’s not so today. Now, more than ever, the dollar hegemony-- it’s dominance as the world reserve currency-- is required to finance our huge war expenditures. This $2 trillion never-ending war must be paid for, one way or another. Dollar hegemony provides the vehicle to do just that.
For the most part the true victims aren’t aware of how they pay the bills. The license to create money out of thin air allows the bills to be paid through price inflation. American citizens, as well as average citizens of Japan, China, and other countries suffer from price inflation, which represents the “tax” that pays the bills for our military adventures. That is until the fraud is discovered, and the foreign producers decide not to take dollars nor hold them very long in payment for their goods. Everything possible is done to prevent the fraud of the monetary system from being exposed to the masses who suffer from it. If oil markets replace dollars with Euros, it would in time curtail our ability to continue to print, without restraint, the world’s reserve currency.
It is an unbelievable benefit to us to import valuable goods and export depreciating dollars. The exporting countries have become addicted to our purchases for their economic growth. This dependency makes them allies in continuing the fraud, and their participation keeps the dollar’s value artificially high. If this system were workable long term, American citizens would never have to work again. We too could enjoy “bread and circuses” just as the Romans did, but their gold finally ran out and the inability of Rome to continue to plunder conquered nations brought an end to her empire.
The same thing will happen to us if we don’t change our ways. Though we don’t occupy foreign countries to directly plunder, we nevertheless have spread our troops across 130 nations of the world. Our intense effort to spread our power in the oil-rich Middle East is not a coincidence. But unlike the old days, we don’t declare direct ownership of the natural resources-- we just insist that we can buy what we want and pay for it with our paper money. Any country that challenges our authority does so at great risk.
Once again Congress has bought into the war propaganda against Iran, just as it did against Iraq. Arguments are now made for attacking Iran economically, and militarily if necessary. These arguments are all based on the same false reasons given for the ill-fated and costly occupation of Iraq.
Our whole economic system depends on continuing the current monetary arrangement, which means recycling the dollar is crucial. Currently, we borrow over $700 billion every year from our gracious benefactors, who work hard and take our paper for their goods. Then we borrow all the money we need to secure the empire (DOD budget $450 billion) plus more. The military might we enjoy becomes the “backing” of our currency. There are no other countries that can challenge our military superiority, and therefore they have little choice but to accept the dollars we declare are today’s “gold.” This is why countries that challenge the system-- like Iraq, Iran and Venezuela-- become targets of our plans for regime change.
Ironically, dollar superiority depends on our strong military, and our strong military depends on the dollar. As long as foreign recipients take our dollars for real goods and are willing to finance our extravagant consumption and militarism, the status quo will continue regardless of how huge our foreign debt and current account deficit become.
But real threats come from our political adversaries who are incapable of confronting us militarily, yet are not bashful about confronting us economically. That’s why we see the new challenge from Iran being taken so seriously. The urgent arguments about Iran posing a military threat to the security of the United States are no more plausible than the false charges levied against Iraq. Yet there is no effort to resist this march to confrontation by those who grandstand for political reasons against the Iraq war.It seems that the people and Congress are easily persuaded by the jingoism of the preemptive war promoters. It’s only after the cost in human life and dollars are tallied up that the people object to unwise militarism.
The strange thing is that the failure in Iraq is now apparent to a large majority of American people, yet they and Congress are acquiescing to the call for a needless and dangerous confrontation with Iran.
But then again, our failure to find Osama bin Laden and destroy his network did not dissuade us from taking on the Iraqis in a war totally unrelated to 9/11.
Concern for pricing oil only in dollars helps explain our willingness to drop everything and teach Saddam Hussein a lesson for his defiance in demanding Euros for oil.
And once again there’s this urgent call for sanctions and threats of force against Iran at the precise time Iran is opening a new oil exchange with all transactions in Euros.
Using force to compel people to accept money without real value can only work in the short run. It ultimately leads to economic dislocation, both domestic and international, and always ends with a price to be paid.
The economic law that honest exchange demands only things of real value as currency cannot be repealed. The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or Euros. The sooner the better.

New Research To Help Guarantee Future Of Oil Supplies

New Research To Help Guarantee Future Of Oil Supplies


Scientists at the University of Liverpool are working with leading oil companies to further understanding of the nature of oil and gas reservoirs within deeply buried submarine channels.
An ancient submarine channel preserved as rock in Karoo. (Image courtesy of University of Liverpool)
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Professor Stephen Flint and Dr David Hodgson, from the Department of Earth and Ocean Sciences, have been awarded £1 million by a global consortium of 11 of the world’s leading oil companies to study how sand is transported through and deposited in deep-sea submarine channels. Scientists will study ancient channel systems in the Karoo area of South Africa, which are now exposed above sea level.
Submarine channels transport sediments such as sand, mud and silt from shallow marine waters to the deep sea and contain much of the recently discovered oil and gas reserves outside the Middle East. The cost of drilling a well to extract new reserves in slope channel reservoirs can cost over $50 million (£29 million) and so it is crucial that exactly the right position is targeted. Only sand filled channels can produce oil and so scientists at the University will work on predicting which channels contain sand and which are filled with mud and silt, based on analysis on the characteristics and setting of the Karoo systems.Professor Flint said: “We will be using the latest laser imaging, satellite mapping, helicopter-based high resolution photography and 3-D computer modelling in our field work to capture the data required to understand and predict sand transfer and storage mechanisms.”
The computer models will be used by oil companies to guide development of new oilfields throughout the world, in order to dramatically increase the efficiency of oil recovery and help guarantee future energy supplies. The team will also use the data to improve understanding of the mechanisms of sand transfer from shallow shelf to deep ocean floor, in order to predict how submarine landslides and related natural hazards, such as tsunamis, occur.
Professor Flint added: “It is important that new and efficient ways of increasing recovery of oil reserves are found. Many factors can disrupt the supply of oil, such as increased costs, disputes, and natural disasters. Our research will help in providing accurate identification of areas of interest to oil companies, but it will also help us explain and better predict how sediment is distributed to the deep oceans.”

U.S. Trade Deficit Reaches All-Time High

ABC News: U.S. Trade Deficit Reaches All-Time High

Surge in Oil Imports Helps Drive U.S. Trade Deficit to All-Time High in October
By MARTIN CRUTSINGER
The Associated Press
WASHINGTON - A surge in oil imports and a flood of Chinese televisions, toys and computers helped to drive the U.S. trade deficit to an all-time high in October.

The Commerce Department reported Wednesday that the gap between what America sells overseas and what it imports rose by 4.4 percent to $68.9 billion, surpassing the record of $66 billion set in September.

The United States incurred record deficits in October with most of its major trading partners including China, the 25-nation European Union, Canada and Mexico. This development is certain to increase protectionist pressures in Congress, with many lawmakers already unhappy with the Bush administration's trade policies.

The worse-than-expected October performance was blamed in part on the Gulf Coast hurricanes. They curtailed domestic production of oil, chemicals and plastics, forcing companies to turn to overseas suppliers.

Nigel Gault, an economist at Global Insight, a forecasting firm in Lexington, Mass., said the sharp deterioration in the deficit would shave about 1.1 percentage points from economic growth in the final three months of the year. He predicted it would come in at about 3 percent.

He also forecast that this year's trade deficit would reach $730 billion, compared with the record of $617.6 billion last year. He predicted next year's deficit would be an even worse $760 billion before the deficit finally begins to improve in 2007.

On Wall Street, the Dow Jones industrial average rose 59.79 points Wednesday to close at 10,883.51.

Critics pointed to the rising deficits as evidence that President Bush's trade policies have failed to protect U.S. workers from an onslaught of imports made in China and other low-wage countries. These critics blame the trade deficits for the loss of 3 million manufacturing jobs in the U.S. over the past five years.

"Month after month, we see new record trade deficits that spell real trouble for the United States," said Sen. Byron Dorgan, D-N.D. "Behind these deficits are massive numbers of American jobs lost to foreign countries."

The administration is pursuing free trade deals with individual countries and negotiating a new global trade agreement under the auspices of the World Trade Organization. Critics say that approach is not working.

"We just don't see how current U.S. strategy is going to reverse these very dangerous trends," said Alan Tonelson, a research fellow at the U.S. Business and Industry Council. The group represents mainly small U.S. manufacturing companies.

Various lawmakers said the administration has failed to do enough to address China's trade practices. They mentioned taking tougher action to force China to let its currency to rise in value against the dollar as a way of making U.S. goods more competitive.

Treasury Secretary John Snow said the key to improving the trade deficit was to get Europe and other major trading partners to boost their economic growth. That way, they could buy more U.S. exports.

He told reporters that America's strong growth and low unemployment showed that the U.S. economy was now in a "sweet spot." He spoke in a joint session with Commerce Secretary Carlos Gutierrez and Labor Secretary Elaine Chao where the Cabinet members highlighted the president's economic record.

Analysts had expected the October deficit to improve because global oil prices retreated after setting record highs in early September.

The average price of a barrel of imported oil did decline slightly to $56.29 in October, but the volume of shipments shot up as buyers turned to overseas suppliers following Gulf Coast production shutdowns. The total bill for imports in October hit a record of $25.8 billion, up 7.8 percent from September.

A surge of Chinese shipments of televisions, toys and computers delivered to U.S. stores for holiday shoppers pushed the U.S. deficit with China to a new monthly record of $20.5 billion. So far this year, the deficit with China is running at an annual rate of $200 billion, far above last year's record deficit of $162 billion.

Administration efforts to reimpose quotas to halt a flood of Chinese clothing and textiles coming into the United States appeared to be having an impact as these imports were down 10.9 percent in October.

For October, imports of all goods and services rose by 2.7 percent to an all-time high of $176.4 billion, led by the surge in oil shipments. U.S. exports also rose but by a smaller 1.7 percent to $107.5 billion, reflecting in part a rebound in sales of commercial aircraft following the end of a strike at Boeing Co.

The United States set deficit records with a number of trading partners, including a $12.1 billion imbalance with the European Union, an $8.1 billion imbalance with Canada, the country's largest trading partner, and a $4.8 billion deficit with Mexico.


On the Net:

Trade report: http://www.census.gov/ft900

September Trade Gap Set Record - New York Times

September Trade Gap Set Record - New York Times

By VIKAS BAJAJ
The United States trade deficit widened by a surprisingly large 11 percent in September, reflecting both a surge in energy imports after Hurricane Katrina and a steep drop in airplane exports because of a strike, the government reported yesterday. The trade gap with China also set a record.

The United States imported $66.1 billion more in goods and services than it exported in the month, breaking the record of $60.4 billion set in February, the Commerce Department reported.

The trade deficit in the first nine months of the year totaled $529.8 billion, about 18 percent higher than in the first nine months of 2004. That figure itself was up 21 percent over the period in 2003.

Economists had expected the trade deficit to widen to $61.5 billion in October, according to a survey by Bloomberg News. Some analysts said the gap would narrow in the coming months but others were not as sanguine, saying the deficit would have been wider even without the one-time effects seen in September.

"One-third of the widening of the deficit is the oil bill, and aircraft sales explains most of the rest," said Carl Weinberg, chief global economist at High Frequency Economics, a research firm.

After Hurricane Katrina hit New Orleans at the end of August, gasoline and natural gas prices surged and imports of the products increased to make up for lost domestic production. Natural gas imports climbed 30 percent, to $3.7 billion, and petroleum products and fuel oil jumped 22.8 percent, to $6.8 billion. (Crude oil imports, however, fell by $350 million, reflecting the shutdown of oil import terminals and refineries on the Gulf Coast.)

At the same, exports fell by $2.8 billion, mostly because of the drop in airplane sales. The Boeing Company said a strike by machinists in September delayed the delivery of 30 planes. Food exports fell $296 million, reflecting transportation disruptions caused by the shutdown of the Port of New Orleans.

Mr. Weinberg said he expected the trade deficit to narrow as aircraft sales pick up - Boeing projects an 11.7 percent increase in sales in 2006 - and energy prices retreat. The Labor Department reported yesterday that the price of petroleum-based imports fell 4.4 percent in October after surging 8 percent in September. Prices of all imports dropped 0.3 percent, only the second decline this year, after rising 2.3 percent in September. Excluding petroleum products, import prices rose 0.8 percent in October.

But other economists say the trade deficit will remain at today's levels, or could deepen, because domestic demand for foreign products remains strong and the dollar has strengthened against the euro and Japanese yen this year, making American exports more expensive in other countries

"Only with very weak U.S. growth or a major drop in the U.S. dollar will the trade deficit improve on a sustained basis," said Ethan Harris, chief United States economist for Lehman Brothers. "The reason you need these dramatic movements is that the U.S. has, according to almost every study, an incredible appetite for imports."

The trade deficit with China, the largest with any single country, rose 8.8 percent, to $20.1 billion in September and was up 28 percent, to $146.3 billion, for the first nine months of the year. Exports to China fell 17 percent and imports rose 4 percent in September.

This week, American and Chinese government officials reached a deal to restrict the growth in textile imports from China for the next three years. The Bush administration and Congress are also pressing China to allow its currency, the yuan, to appreciate much more against the dollar. Democratic, and even some Republican, lawmakers have threatened to impose sanctions on the country.

President Bush plans to visit Beijing late next week, and the growing trade deficit with China is expected to be at the top of his agenda.

Economists note that the United States has an increasingly complex relationship with China, in part because it is the largest holder of federal government debt.

"If the Chinese abandon our Treasury market, we would see an enormous jump in interest rates," Mr. Harris said, "and, of course, if we stop buying their products their economy is going to go into recession."

The Chinese government reported yesterday that its October trade surplus with the rest of the world jumped to a record $12 billion in October. It had a total trade surplus of $80.4 billion for the first 10 months of the year, 2.5 times the figure for the period last year.

In other economic news, the Labor Department reported yesterday that claims for unemployment benefits rose about 2,000, to 326,000 last week. Claims were down by about 5,000 from the comparable week last year.

The University of Michigan said yesterday that its consumer confidence index edged up to 79.9 this month from 76.5 in October, its first increase in three months.

Japan's shaky deficit solution

Japan's shaky deficit solution - Business Asia by Bloomberg - International Herald Tribune

WEDNESDAY, OCTOBER 26, 2005


The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real
GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

The Japanese government is cutting spending and increasing taxes to deal with its long-term budget and debt woes. The strategy is far from certain to succeed as Japan nurtures a fragile economic recovery and tries to end a stubborn, decade-long bout of deflation.

The higher levies include a gradual rise of 5 percentage points in Social Security payroll taxes and the rollback of a personal income-tax cut enacted in 1999.

Contrast these actions with those of President George W. Bush, who has rejected higher taxes to close the long-term gap in Social Security finances. Meanwhile, the Bush administration is still trying to extend a variety of temporary income-tax cuts in the face of serious projected long-term fiscal imbalances.

Bush has proposed some spending cuts, though most have been rejected or ignored by Congress at the same time that spending has soared for many domestic programs, for the wars in Afghanistan and Iraq and in response to hurricane disasters.

Japan's problems are at least as big as those facing the United States. Its budget deficit is about twice as large relative to the size of its economy. Japanese debt is equivalent to about 160 percent of gross domestic product, or more than four times the level of debt owed by the United States.

That daunting reality is partly mitigated by Japan's high personal savings rate, which allows its government debt to be financed domestically. Much of the U.S. debt is held by foreigners, including the central banks of Japan, China and other East Asian nations.

The principal problem is the deflation that has dogged the economy for much of the past decade.

It is not just that real economic growth has been stagnant or worse over the past 10 years. With prices falling, nominal gross domestic product has also gone down, and with it, the incomes and spending on which taxes are based.

Paul Sheard, chief economist for Asia at Lehman Brothers, said in an interview that since the end of 1997, nominal GDP in Japan has declined 2.5 percent while real GDP has increased 7.3 percent.

Over the same period, nominal GDP rose 46 percent in the U.S. and real GDP climbed by more than a fourth.

"At the moment, Japan remains in a deflationary trap," Sheard said. "It needs a real kick in the pants to get it out of deflation." Instead, the country "is only edging slowly toward an exit."

The deflation has had a devastating impact on the budget.

For example, government tax receipts, which were running around ¥60 trillion, or $522 billion, in the early 1990s, had fallen to just over ¥40 trillion by 2004 and are not expected to be much higher this year. With spending expected to exceed ¥80 trillion this year, the government will have to finance more than half its budget with borrowing.

The government's goal is to achieve a so-called primary balance in its budget seven or eight years from now. That is, to have tax receipts at least equal to spending on everything other than interest payments on debt.

At that critical point, if the average interest rate paid on the outstanding government bonds is lower than the growth rate of nominal GDP, the debt-to-GDP ratio would begin to fall.

The government assumes that deflation will end soon, and that real growth will be strong enough that nominal GDP will be increasing at a 3.5 percent to 4 percent annual rate within a couple of years and continue at that pace indefinitely.

Even if that assumption turns out to be correct - and some analysts in Japan regard it as overly optimistic - tax receipts might still be too low to achieve the target of a primary budget balance.

Mikihiro Matsuoka, a senior economist at Deutsche Securities, said in an interview that it would take a "minimum of a two percentage point increase in the value-added tax" and more spending cuts, in addition to the other actions planned, to reach a primary budget balance on the government's timetable.

Kiichi Murashima, an economist at Nikko Citigroup, agreed with that assessment, and added that Prime Minister Junichiro Koizumi "has promised not to increase the consumption tax."

The issue of an increase in value-added tax will have to be decided late next year, presumably by Koizumi's successor, if the prime minister steps down next fall, as he has said he will, according to Murashima. Any increase would become effective in 2008, he said.

This sort of timetable assumes that the economic expansion, which has run for several years, will continue without interruption. In particular, it assumes that the planned tax increases will not dampen consumer spending enough to cause a recession.

Japanese economic growth also remains vulnerable, in Murashima's opinion, to an economic slump in the United States.

"If U.S. growth slowed to 2.5 percent next year, Japanese growth would slow to 1 percent," he said. "The yen likely would appreciate and exports would not grow strongly in that case."

Matsuoka is more optimistic. He expects Japanese growth next year and the year after to be about 2.5 percent, only slightly less than the 2.7 percent increase last year. And that should be fast enough to lift prices, as measured by the GDP deflator, in 2007.

So even if all goes really well for Japan, it is going to be a long slog before the government begins to fill the huge hole in its budget and halt the rapid rise in its debt. If things take a notable turn for the worse, they might just explode.

Greenspan's conundrum

Asia Times Online :: Asian news and current affairs

By Axel Merk

US Federal Reserve Bank Chairman Alan Greenspan is confused - why are long-term interest rates so low? Is what he calls "too low" a risk premium courtesy of his successful policies? Inflation runs at an 18-year high. Will gold climb further, and the dollar resume its decline?

Let us start with Greenspan's "conundrum". Many flat out say the market has it all wrong and will come to its senses, suggesting that long-term interest rates will rise dramatically. Maybe. Market prices reflect the average of all participants' expectations. If your opinion diverges from the average, then you may choose to invest accordingly in anticipation that the market will converge on your scenario. Of course, in the future, market prices will not reflect the facts then, but expectations at that point; be aware of the old saying that markets may stay irrational longer than you can stay solvent. While we often disagree with what the average is thinking, it is a good starting point in any analysis. If you know your



opponent's strategy, it is much easier to win than if you are convinced of yourself and blindly execute your own strategy without reference to your environment.

Similarly, if Greenspan tells us he doesn't understand the yield curve (the relationship between longer and shorter dated securities), we should be worried. He might just push the economy in the wrong direction if he doesn't know where it is heading.

Enough modesty - let us attempt to explain what so few have been able to. Some say low long-term rates suggest we have no inflationary pressures. Joe Battipaglia, an eternal bull who tells us to "look at the facts", dismisses arguments that inflation is in the pipeline and that the soaring price of gold is a reflection of jewelry demand picking up in Asia and China. With due respect to Battipaglia, this is nonsense. The gold price, in our view, clearly signals that we have inflationary pressures and a flight to hard money; the expected increase in jewelry demand cannot fully explain its rise.

But why are long-term interest rates so low then? Is it the foreign purchases of US debt? They are a factor in holding long rates down, but let us keep in mind that foreign governments tend to purchase mostly shorter-dated maturities. What about corporate America as a buyer of longer-dated debt securities? While the US consumer is heavily in debt, corporate America has amassed enormous amounts of cash after cleaning up its balance sheets - many US corporations are now adding to the demand rather than supply in the fixed-income markets as they manage their cash.

We believe there is another story behind the low rates of longer securities that is all too obvious: the US economy is slowing down. But there is a difference: after all, we had GDP growing at 3.3% in the 2nd quarter - not exactly a sign of a stalling economy. One can argue that GDP is overstated because of inflation, and that an economy that must offer "employee discounts" to sell cars is in trouble. We would like to take it a step further. We had one airline after another declare bankruptcy; now the world's largest automotive supplier, Delphi, has declared bankruptcy. General Motors and Ford are likely bankruptcy candidates. What is happening is that corporations cannot pass costs on to consumers. Greenspan has been arguing that prices have to rise at some point because of costs being passed on. Stagflation advocates have said that wage pressure will build. What is different from the 1970s is that we now have Asia at our doorstep flooding us with cheap goods. The analysis cannot stop there. We believe that companies that cannot adapt will simply disappear (or be kept alive with subsidies or protectionism). If you are a European exporter and cannot pass on your higher costs and lower margins due to a strong euro, you might just vanish.

The Greenspan conundrum, unplugged, means: Our low long-term interest rates suggest that we are going to lose entire industries in the looming economic downturn. Industries that cannot adapt quickly enough to our global economy will be wiped out; cutting expenses is important for them, but will not be enough, as no developed country can compete with the cost of labor in Asia. Instead these companies must focus on superior value. Some European firms have long embraced a luxury brand model; but that may not be enough if these firms do not control their distribution channels. As an example, Safeway dictates what the cost of a six-pack of beer is. If you can't meet that price, there will be others that will.

There are a number of reasons why it is so much more difficult to pass on higher costs these days. Much of it has to do with Asia over-producing goods as a result of their subsidized exchange rates. Asia believes that it must generate economic growth at all cost to provide jobs and political stability. The result is a surge in world commodity prices (we had high commodity prices before the hurricanes) and low consumer goods prices. In addition, take a US consumer that is heavily in debt, and you end up with very little pricing power. Corporate America is squeezed by both high raw material prices and a lack of pricing power, resulting in accelerated outsourcing. US policy makers have added to this vicious cycle with low taxes and low interest rates. What US policy has done is to accelerate a cycle to the point where the transition is too fast for old economy companies to keep up.

The US economy is a diversified economy with great success stories; one of the more recent ones is the rise of Google. Google is all that "old economy" is not: flexible and capable of thriving in this environment. Highly accommodating monetary and fiscal policies have helped pick up the slack of ailing industries. This is not the place to discuss whether an economy can survive long-term if it entirely dismantles its manufacturing base and exclusively focuses on services. What we do know, though, is that the accommodating policies have created inflationary pressures in just about all sectors of the economy where we cannot import goods from Asia. And while we are at it, we also created a phenomenal housing bubble that has allowed the US consumer to increase spending (by taking out home equity loans and refinancing) while real hourly wages have been on the decline.

We do not see a conflict in low long-term rates and high gold prices - at least not for now (depending on Federal Reserve actions down the road, long-term rates can easily rise substantially). What about inflation and economic growth going forward? The Fed has been steadily raising rates. Bill Seidman, respected for his role in handling the Savings & Loan (S&L) crisis in the 1980s and now chief commentator on CNBC, says Federal Funds rates would need to move to 5.5% just to have a neutral impact on economic growth. We agree: even with the many small increases in rates, we still have an accommodating monetary policy, one that fosters growth and inflation. At the same time, the economy is clearly slowing down. Because consumer debt is at record levels and consumer spending comprises an ever larger share of the US economy, the economy is ever more sensitive to changes in interest rates. The federal government is also more interest-rate sensitive: not only has the absolute debt increased dramatically, but since the former treasury secretary, Robert E Rubin, abolished the 30-year bond, the duration of federal debt has significantly decreased. In plain English: the government has joined the large portion of irresponsible consumers by refinancing its debt with the equivalent of adjustable rate mortgages.

Corporate America has reasonable-looking balance sheets, but we cannot rely on them to bail this economy out. The reason Corporate America has not invested much of its cash is because it sees the shakiness of the American consumer and is reluctant to invest. Policies in the US and Asia have led to such a rapid acceleration in the pace of change that much of the developed world cannot keep up. We hear a lot about the US economy being less energy-dependent than in the 1970s. That's only partially true. We consume a lot more than we did in the 1970s. Nowadays, many of the goods are produced abroad, but it still takes energy to produce them. For now, foreign producers have absorbed the high energy cost through lower margins. We still need to transport these goods within the US, which is causing us plenty of pain with high energy prices. In Asia, companies also get squeezed more and more. While China is a cheap-labor country, it is not a low-cost country.

We believe Asia will continue its path as long as it can afford it. We also believe that we cannot assume Asian countries will react rationally when US consumption slows. It is unclear whether Asian countries will try to devalue their currencies even further in a desperate attempt to continue to sell to the United States, even at a loss. Governments in Asia may be more interested in political stability - presumably achieved through economic stability - rather than internal transformation. Some argue that Asia would be better off if the region deployed its massive labor force to focus on internal growth rather than feeding the US consumer. While that may be the case long-term, political leaders are afraid of the transition: if its largest customer, the US, were to diminish in importance, the void would pop some of the bubbles that years of over-expansion have caused within Asia.

What does this all mean for the dollar? We believe the dollar continues to be at serious risk as the balance of payments between the United States and the rest of the world is unsustainable and further escalating. Currently, foreigners have to purchase more than $2 billion worth of US denominated assets each day just to keep the dollar from falling. Until a year ago, many of these purchases were direct purchases of US government securities. Over the past year, a shift to direct investments has taken place; the highest profile move was China's failed attempt to purchase US oil firm Unocal. As China is rebuffed from securing its future resource needs in the US, it has moved to purchase resources in other regions in the world. Not only is China diversifying away from US dollar assets, more and more governments openly talk about moves to diversify their dollar holdings. As countries look for alternatives to the US dollar as a reserve currency, gold and the euro are gaining a higher profile. We also believe countries will intensify dealing in the local currencies of their trading partners. For example, as China wants to diversify its export market, it may acquire more euros to subsidize its sales to the region; conversely, as China is going to get ever-more resource hungry, it will engage in more trade with resource rich countries, notably Australia and Canada.

If US consumption drops, there might be a drop in the trade deficit. A lower trade deficit will require fewer purchases by foreigners of US dollars. However, a drop in the trade deficit may not be enough to support the dollar. The United States next year will pay more to foreigners in interest charges on its own debt than it receives in interest. With US debt growing rapidly, interest rates rising and much of US debt in short-term securities, this will have a negative impact on the balance of payments. Also, if - as we suspect - US consumption slows just as the housing market enters a more-serious decline, foreigners may be less willing to invest in US assets. We do not believe the fundamental pressure on the dollar will go away unless and until policies are put in place to foster savings and investment rather than consumption. In the short term, an already negative US savings rate may decline further as this winter's higher heating costs will surprise many. This will be offset in the medium term by an inability to extract further equity from refinancing; US credit card companies are also about to double the minimum payment required on outstanding balances, which may provide short-term relief to the reported savings rate. For now, consumers continue to believe that their real earnings will grow and have refused to cope with reality.

In the meantime, expect inflationary pressures to continue to build, just at a time when the US economy is slowing.

Axel Merk is Manager of the Merk Hard Currency Fund

US-China: Free market or statism

Rebelion. US-China: Free market or statism

US-China: Free market or statism

James Petras
Rebelión
The most striking aspect of the US (and European) trade conflict with China is Washington’s systematic rejection of the free market and its resort to heavy-handed dependence on state intervention. Equally astonishing, supposedly orthodox free market economists have joined the chorus of protectionist politicos (like Robert Zoellick, Deputy Secretary of State) in questioning China’s free trade policy and demanding that China abide by US directives instead of the free play of market forces (Financial Times Oct.7, 2005 p5). Worse still, some experts like Fred Bergsten, US director of the Institute for International Economics, are demanding more concessions from China under threat of a major economic confrontation. (Financial Times August 25, 2005, p 11).

Political Myths and Economic Realities
The US yearly trade deficit with China ($186 Billion USD by July 2005) is largely a result of US inefficiencies, not Chinese trade restraints. China has the lowest import barriers of any large developing country. In areas where the US has invested, innovated and is efficient, in agriculture, aeronautics and high tech, the US has a trade surplus. The US trade deficit is largely in the appliances, electronics, clothing, toys, textile and shoe industries where many US corporations have invested in Chinese subsidiaries to export back to the US. Over 50% of Chinese exports to the US are through US multinational corporations. The US trade deficit is in large part between the US state and its own MNC’s located in China.

China’s exports are largely based on imports of parts from overseas, which are assembled and then sold abroad. According to the Financial Times, “…China is merely the last stop for a lot of the goods Asia exports to the US, importing…components from elsewhere in the region – including Japan. The local value added in its exports is as low as 15% (FT Oct 11, 2005 p5).” In other words China is a huge importer from other countries with which it has a trade deficit, largely with Asian manufacturers, oil exporting countries and Third World exporters of raw materials. China’s overall trade surplus is largely based on its commerce with the US. US tariff and quotas against Chinese goods will prejudice world trade.

Contrary to US political and academic ideologues, China is one of the most liberal economies in Asia. By 2003 the ratio of China’s stock of inward investment (inflows of foreign investment) to GDP was 35% - against 8% in South Korea, 5% in India and just 2% in Japan (Financial Times Sept. 15, 2005 p 11). Moreover, China is the world’s third largest trading nation. In 2004, China’s ratio of trade to GDP reached 70%, far greater than the US and Japan which have ratios to trade to GDP below 25%.

Orthodox economists and US Congressional members argue that China’s currency (renmimbi) is undervalued and that a larger revaluation would reduce the US trade deficit. Over the past several years the US dollar has been devalued in relation to several currencies – including the Euro, the pound and the Swiss franc – and yet the US trade deficit has increased. The focus on Chinese currency reform is totally beside the point. The key problem is that US capitalists are not investing in domestic productive sectors, they are not upgrading their productive sites, nor are they introducing technological innovations to lower costs. Instead they are investing overseas, in non-productive sectors at home, speculating in real estate, today (and IT, yesterday), increasing profits via cuts in labor costs – hardly a sound method to compete with low-cost labor producers.

The failure of the US MNCs to support a universal national health plan and their reliance on private medicine increases the cost of production by 10% contributing to the loss of competitiveness of US enterprises and an increase in the trade deficit.

Chinese economic policy with regard to foreign investment is far more liberal than US policy. In 2004, foreign invested enterprises in China accounted for 57% of China’s exports. In contrast in the US, the Committee on Foreign Investments in the United States (CFIUS), constantly resorts to “flexible” definitions of “public interest”, “national” or “strategic” interests to prevent foreign investors from investing and acquiring US firms. The highly publicized and successful US political intervention against the Chinese petroleum company, CNOC’s, attempted acquisition of UNOCAL is the most recent example.

Moreover the efforts of New York Senator Schumer and his congressional allies to slap a 27.5% tariff on imports from China would not reduce the US trade deficit as US importers would turn to other efficient Asian producers and Chinese manufacturers could relocate in adjacent countries. The result would be increased consumer costs, adversely affecting US domestic commerce without creating new jobs for US workers.

The “protected industries” in the US include some of the worst garment sweatshops paying below the minimum wage, some of which can be found in close proximity to Senator Schumer’s offices in New York City. The problem is not foreign competition – that should be a given in a free market economy – but becoming efficient, which means investing in high tech and automated production, training, paying highly skilled workers, engineers and designers and providing stable employment so that workers can accumulate the experience and know-how which contributes to greater productivity.

The 1995 Uruguay Round Agreement on Textiles and Clothing (which the US signed) purported to eliminate quotas by January 1, 2005. US textile manufacturers had ten years to upgrade, modernize, and restructure prior to the advent of free trade. Instead they chose to rely on lowering labor cost, subcontracting to sweatshop labor contractors and political payoffs to lobbyists, politicians and labor bosses to impose new restraints on Chinese exports. The US reneged on its agreement to end quotas, pressuring China to limit Chinese exports to the US throughout 2005 and beyond (Financial Times Sept. 1, 2005 p1).

Current US “quotas” on Chinese exports already affecting textiles, clothing, color televisions, semiconductors, wood furniture, shrimp and steel have only increased the cost to US consumers and domestic sellers and increased profits for US monopoly producers in these same sectors, making them even less competitive. US producers paying monopoly’ prices to protected domestic manufacturers are hardly likely to be in a position to export and improve the US balance of payments.

The argument of “unfair competition” based on cheap labor is not convincing. The cost of labor is not the decisive factor affecting market competition or trade balances. Many low wage labor countries are not competitive. Many high-wage and high benefit Scandinavian and Low Countries compete successfully in the market relying on quality and specialized products, having abandoned production of labor-intensive consumer items. The resort to moralizing about trade terms especially by anti-union employers who avoid pension and health payments and provide the least time off for vacation and maternity in the Western world is pure cant. The fact is that substantial sectors of the US economy are not competitive given the product lines in which they are engaged, the inferior quality of their goods, the lack of long-term, large-scale investments in upgrading technology and productive organization and the siphoning off of profits to speculative sectors or to offshore subsidiaries.

Hiding between tariff walls, quotas and demagogic “China bashing” is simply an excuse to avoid the harsh discipline of the free market. Facing up to the free market would force the US business and political elite to own up to the fact that we have, in many sectors, a second-rate capitalism directed by a third-rate state.

The Myth of the “China Threat”
Instead of accepting the economic challenge from China and recognizing the need for re-thinking the misallocations of resources and the over-reliance on the paper economy, retrograde business elites and overpaid trade union bosses have joined forces with neo-conservative ideologues in promoting the idea of China as a national security threat which needs to be confronted militarily. The fusion of militarism abroad and protectionism at home has gained many adherents in Congress and in the executive branch – setting the stage for a self-fulfilling prophecy. Faced with increasingly bellicose rhetoric from Washington, China looks eastward toward strengthening its military and economic ties with Russia and Central Asia while diversifying its trade with Asia, Latin America, the Middle East and Africa.

US militant “protectionist militarism” with its confrontational approach to China threatens to block the free market of knowledge and technology. China’s dynamic growth is not primarily based on “cheap labor” – it relies on the production of millions of highly trained scientific and professional workers each year. Each year tens of thousands of Chinese students, professors and scientists train abroad – many in the US. Very few US students pursue advanced degrees in science and engineering, with the result that foreign students – including Chinese – are increasingly critical to the US science workforce. In this free flow of ideas and scientists, both China and the US theoretically benefit – from a “free market” perspective. But as we have argued the US is opposed to the free market – especially in the free flow of scientific ‘know-how’.

The US is doing everything possible to restrict the exchange of scientists, technology and knowledge – by a wide-ranging definition of “national security”. Given their military definition of the China challenge, Washington argues that Chinese students and scholars should be restricted in what they study, what they learn as well as their access to technology. Universities, under Pentagon and Department of Commerce ruling, would have to secure special licenses and mark restricted areas within laboratories to prevent foreign students from using supercomputers, semiconductors, lasers and sensors in their research. The Department of Commerce plans to tighten controls in the export of commercial technologies (Financial Times Sept. 1, 2005 p 11). From a free market perspective US export controls to China are self-defeating, lessening exports thus increasing the trade deficit, and have little impact on China’s access to technology via Japan, Korea and Europe. In contrast, in July 2005 the European Union signed contracts with China to develop commercial usages of the Galileo satellite navigation system.

From a militarist-protectionist perspective the restrictions on ideas and the free circulation of scientists and students can be seen as part of a campaign of political and perhaps military confrontation and encirclement.

‘China bashing’ is merely a response to the loss of competitiveness. Nationalist demagogy in a declining global power is a compensatory mechanism for the failure of US capitalism to keep up with the competition – at least from its locus in the US economy.

China’s Competitive Advantages
China not only out-competes sectors of advanced capitalist countries but it competes successfully with low wage nations through the constant application of innovative techniques of production. Moreover China is increasingly competitive at middle and high-end goods that go beyond consumer durables, garments and electronics. The competitive advantages are derived from the priorities designated by the state and the use of financial mechanisms and incentives. The claim that China “artificially” keeps its currency low thus gaining a competitive advantage is only voiced by the US and some European states. No one in Asia, Latin America, Africa or Oceania is complaining. With many regions of the world, China has a negative balance of payments, so that its overall surplus is much smaller than the China bashers who focus only on US-China bilateral relations would lead us to believe. Japan’s global current account surplus is larger than China’s by $153 billion to $116 billion USD (FT Oct. 11, 2005). There are no complaints from Japan, South Korea, India, Brazil, Argentina, Russia or Iran about an undervalued currency. In global terms, Japan and Germany account for 30% of the global current account surplus (228 billion Euros) and China only 8% ($70 billion USD).

The US trade and budget deficit is exclusively a problem of internal failures: low or negative savings, high speculation, no up grading of backward or uncompetitive sectors, artificial propping up of uncompetitive state subsidized sectors and large-scale, long-term US investment in productive facilities in China. Out of ignorance or cowardice, US Congressional leaders like Senator Charles Schumer refuse to confront the fact that the US trade deficit is in large part a product of the imbalance between exports by US MNCs located in China selling to the US market over exports from US based manufacturers. For US politicians, it is easier to get re-elected by taking cheap shots at an emerging economic power than to confront China-based US MNCs which finance electoral campaigns.

The US Imperial Threat to China
Throughout history, established global states, which are indebted and dependent on rising new powers, generate politicians who react with irrational resentment and belligerence. The gross failure of the Federal Reserve to contain the irrational exuberance in the paper and speculative economy over the past two decades, its complicity in the growth of unsustainable trade deficits, its outrageous support for tax cuts divorced from any link to the export economy marks the Bank and its Chairman as among the principle culprits in the decay of the US competitive position in the world market.

The danger is that as the US competitive position declines, a coalition of backward industrialists and civilian-militarists will try to compensate by provoking political confrontations and even inventing military threats to justify a military build-up. The politics of confrontation however will cause greater harm to the US MNCs than to China. After all it is the US which has imposed political barriers to the entry of Chinese investors in the US, while China has welcomed over 100 billion dollars from the leading US MNCs into the Chinese market. It is China which is financing the US trade deficit by purchasing US T-notes of declining worth, sustaining US over-consumption and under-investment.

In contrast to Washington’s restrictive policies on Chinese investments in US energy companies, China welcomed large-scale investments by Peabody Energy (the world’s largest coal company by sales) in joint venture mines (Financial Times Sept. 21, 2005 p19).

China is increasingly diversifying its trade and sources of energy. Its trade in Asia surpasses that of the US. China has increased its security links with Russia as a counterweight to the bellicose posturing of the US neo-conservative militarists and liberal Democratic “humanitarian” imperialists.

Washington’s increasing reliance on rearguard statism, whether in imposing tariffs, quotas, political restrictions on takeover bids, or blocking private investments is doomed to failure. Ultimately the US competitive or non-competitive position in the world market will determine who will be the next economic superpower. The only way for US capitalism to answer the China challenge is to save, invest, innovate, produce and compete in a free market – free of atavistic statism and militarism.

Washington continued effort to weaken China’s export capacity to lower its trade deficit has taken the form of an open-ended crusade. In July 2005, China announced a 2% revaluation of the renminbi and shifted from a peg against the dollar to a link to a basket of currencies. China promised even greater flexibility over time, to allow its exporters to adjust to the more competitive conditions. The US economy, with all its inefficiencies, could not take advantage of this opportunity and demanded more concessions, a bigger re-valuation and less exports, hoping that state intervention would weaken China’s export industries. The escalation of Washington’s demands on China is ‘open-ended’ – one concession granted ‘confirms’ neo-conservatives in the Bush Administration that they can secure others, setting the stage eventually for a ‘recovery’ of US export competitiveness. Even the US Federal Reserve Chairman recognizes that a stronger Chinese currency (or other Asian currencies) will make little difference to the US trade deficit (FT Oct. 11, 2005 p5). As all G20 countries meeting in Beijing pointed out the problem is the structural weaknesses in the US.

If we blow away the statist froth, propounded by our free-market economists, we would recognize that what China is demanding is that the US really live up to its free market ideology.

US Treasury Secretary John Snow, driven by the protectionist pressures from a Congress responding to backward sectors of the US economy and civilian militarists in the Executive, endlessly seeks to impose diplomatically what the US economically cannot achieve via the market – a reduction in the US trade deficit. Behind the veneer of diplomacy, Washington threatens a “trade war” via exorbitant tariffs of 27.5% and a hostile propaganda campaign labeling China a “currency manipulator”. A “trade war and demonization” strategy will most likely strengthen the civilian militarists and their campaign of military encirclement and nuclear brinksmanship in the Taiwan Straits. The confrontational strategy will provoke a Chinese defensive response which will lead to major US economic crises – as China unloads its US Treasury Bonds and reallocates its trade surpluses from the US to internal, Asian and European options. Washington will also see a loss of Chinese markets, investment opportunities leading to an attack on the profit margins of major US MNCs in China as Beijing increases its economic exchanges with Asia, Russia and the rest of the world.

If the civilian militarists’ war with Iraq heightened the economic deficits and weakened the US competitive position, a neo-conservative confrontation with China will likely precipitate a deep structural crisis and probable collapse of the US economy, as we know it.

Conclusion
US colonial wars, the re-concentration of income in the upper 1% via tax cuts, the relocation of US MNC subsidiaries as overseas exporters to the US rather than exporters from the US, the dominance of the speculative economy (IT, real estate) and the ascendance of import intensive commercial capital over productive capital are the main reasons for the unsustainable $700 billion dollar current account deficit and the $500 billion dollar budget deficit. The speculator-militarist empire builders seek to divert attention from their failed policies by engaging in blatant deception and falsely blaming the ‘devious and threatening’ Asians, especially the Chinese. A report published in September 2005 by two leading European think tanks totally demolishes this ideological smokescreen. They point out that the US current account deficit grew by $529 billion between 1997 and 2004 but China accounted for only 7% of this rise, compared to 30% for Russia and the Middle East (Financial Times Sept. 16, 2005 p2). US “blame the Asians” demagogic calls for Asian currency re-valuation would lead to deflation and economic stagnation without solving the US trade deficit. The key to lowering the trade deficit is for the US to engage in structural adjustments. These include re-introducing taxes on the very rich and developing an industrial and monetary policy that promotes local production for export and penalizes speculative investment and overseas relocation. This would increase local saving and investments, lower imports and stimulate exports.

Given the political ascendancy and economic centrality of multinational capital, the major investment banks and financial houses and the extensive web of real estate-construction and mortgage banks along with militarist neo-conservative control of the White House, there is virtually no possibility that US capitalism can rectify, correct or reform its strategic direction.

In the face of the embedded power bloc, which protects non-competitive producers and promotes US re-location of production abroad, the only logical outcome is the militarist-protectionist amalgam which defines US policy today. The backward sectors of US capital, together with the neo-conservative militarists, and the reactionary trade union bureaucracy promote “protectionist nationalism” at home and imperialist wars abroad. The competitive free-market multinational corporations promote overseas market openings but rely on a state, which depends politically on the extensive non-competitive manufacturing and subsidized agricultural sectors and the civilian militarists.

The calls by US economists for China to reform its currency, to accept US quotas on its exports, to retain a highly inferior military defense system while facing US power in the Far East is an attempt to forge a hodgepodge “consensus” between free market manufacturing MNCs and militarist-protectionists. Harmonizing interests between a rising industrial capitalist power like China and a militarist-speculative-commercial power like the US is a difficult chore in the short run and an impossible task in the medium term. China’s booming demand for commodities has helped many Third World countries, while US agricultural subsidies and trade constraints have hurt these countries. US military belligerency in the Middle East has alienated the majority of the Arab and Muslim world, and divided Europe and its own population. Germany and Japan have accumulated massive trade surpluses at the expense of US-based exporters. The US ruling elite’s resort to militarism in all of its brutal, colonial and invasive forms in Iraq and Afghanistan has exacerbated both the external and internal deficits, while demonstrating the strategic military weakness of an empire predominantly dependent on local satraps and military sepoys to sustain it. The US empire emptied of its domestic manufacturing export sector and relying on speculators and commercial importers (compradors) projects a militarist ideology to shore up the empire. These very forces have substantially weakened the competitive position of the US in relation to China’s rising free market technological-industrial power.

The Chinese leaders cannot capitulate to US demands without destabilizing their own rule and the economic model they preside over. Strong capital inflows in 2005 from US, European and Asian speculators are betting on a re-valuation of the renminbi (China’s currency), creating conditions for a financial crisis if the Chinese regime recklessly moves toward an unregulated monetary policy. Secondly the ruling class free-marketeers in command of Chinese policy have gutted the public welfare system in favor of privatization, forcing Chinese workers, employees and shop owners to save to pay for education, housing, health care and retirement and thus have less income for domestic consumption. Chinese savings to pay for basic services limits domestic consumption and forces the Chinese regime to realize profits via exports. Accepting US dictates on reducing exports will destabilize the entire free market model. The elite basis of Chinese rule, in which 5% of the population controls over 50% of all private assets, faces escalating opposition from unemployed workers, exploited peasants and displaced urban and rural dwellers. Between 2001 and 2004 mass protests grew from 4,000 to over 70,000. China needs to create 15 million jobs a year, which requires the GDP to grow at least 8%. The Chinese ruling class believes economic growth will stabilize their rule. Since the growing social inequalities are embedded in the concentration of political-economic power at the top, they can only be changed by socialist movements from below. The rulers’ program is to “increase the pie” hoping the trickle down effect will increase consumption and stabilize their rule and privileges. US pressure on China’s rulers to increase domestic consumption and decrease exports threaten to undermine domestic class relations and undermine the growth and profit rates. The free-market, export-oriented Chinese ruling class, like its US imperial counterpart, is hardly volunteering to sacrifice its class power and privileges to accommodate its economic competitors.