October 12, 2008

Good article explaining the dollar devaluations

Creative destruction gone too far

Christopher Wood's point that "credit inflation always breeds deflations" is
well taken (Embrace Creative Destruction, WSJ Oct. 21). The rest of his
analysis is not.

In the first place, "credit inflation" is not a "natural" but man-made
phenomenon. Therefore, his embrace of "creative destruction" on behalf of
the world's exploited poor and powerless begs the question why the wilful
predatory sins of the world's rich and powerful should be visited upon them?

Indeed, from Indonesia , Thailand , and Korea , to Russia , the front-line
soldiers in Wood's "cleansing process" may rightfully ascribe their
predicament to brute-force mentality masquerading as economic science.
Specifically, Schumpeter's concept of "creative destruction" concerned
entrepreneurial competition where the fate of the world's Microsofts and
Netscapes was determined in the market place and not in the courts, nor did
it envisage IMF-funded bailouts for phantom capitalists in flight from one
disaster area to the next.

Secondly, now as in the 1930s, it may be impolitic to ascribe the present
crisis to lack of effective demand relative to aggregate world supply
capacity. Yet the fact remains that "over investment", "excess capacity"
and "overproduction" are all relative to the level of effective demand.

It is not rocket science to see that predatory capitalists were the chief
beneficiaries of the Third World Debt bonanza of the 1970s, the U.S. S&L
craze of the 1980s, and the Asia-Russia- Latin America credit bubble of the
1990s, while the clean-up costs in terms of bank "recapitalization" etc.
have been shouldered by the average would-be consumer. Nor is it rocket
science to see how this must deflate effective demand.
But, then, who cares?

Gunnar Tomasson, IMF 1966-1989, Bethesda , Maryland
Arno Mong Daastøl, University of Maastricht / of Oslo

Wall Street Journal Oct.21st, 1998

Embrace Creative Destruction

Global financial markets' exuberant reaction to the Federal Reserve's new
bias toward looser monetary policy is understandable given recent
turbulence. But it also signals that many investors still operate on the
assumption that falling interest rates are self-evidently good news for
equities. Thus, bad news has been good news for the past several years on
Wall Street: Any evidence of a slowing economy has inspired hopes of lower
interest rates, causing share prices to rise. This benign paradox has been
the underpinning of the so-called Goldilocks economy. Unfortunately for
those investors who put their savings in domestic stocks through mutual
funds, this particular game is up. The stock market has finally begun to
sniff deflation. Analyst earnings' projections are now being revised down,
as the realization grows that profits will disappoint. More and more
companies are beset by the key problem facing businesses in a deflationary
period: lack of pricing power. Technology, the engine of the Wall Street
bull market, will be the at the center of the storm as companies reverse
trend and slash their information technology budgets. American investors
will take some time to be convinced of the deflationary argument, since it
is counterintuitive to baby boomers brought up in the post-World War II
inflationary period. The deflationary tide is real, however, and it will
overwhelm short-term cyclical blips of the kind still preoccupying
mechanistic monetarists on the Federal Reserve Board. Fortunately, Fed
Chairman Alan Greenspan is a student of economic history as well as modern
macroeconomic theory. He knows that throughout recorded history, prices have
more often trended down rather than up. As a consequence, he has been
quicker to lower interest rates in response to deflationary symptoms than
the conventional central bankers at the Bank of England and the Bundesbank,
who can be relied upon to continue fighting the last war.
Mr. Greenspan has been acting more quickly because he understands what
should be obvious to anyone who has observed Asia during the past year or
Japan for the past eight years. The Asian crisis is not caused by specific
factors, such as corruption or cronyism, cited by most of the press and the
financial chattering classes who assemble at annual International Monetary
Fund/World Bank jamborees. Rather, Asia and emerging markets in general are
at the leading edge of a deflation crisis.
The root cause of the crisis is excess capacity. Asia has proved the key
victim precisely because it was the region where the multinationals and
international banks were most willing to invest and lend on account of their
unquestioned belief in the never-ending Asian miracle. This is nothing new.
Indeed it is the oldest story in capitalism. As students of the Austrian
school of economics will understand, credit inflations always breed credit
deflations. Financial markets amplify this tendency because they are driven
in the short term by herd psychology. Thus, in 1993 emerging markets
represented the future of world finance. In 1998 they are written off by the
consensus. Socialists would argue that these tendencies require regulation
to curb the excesses of the cycle. The Austrian economists held that
creative destruction, the cleansing process we are now witnessing (or should
be witnessing), is entirely healthy and, indeed, to be welcomed.
The most alarming point about Asia today is that excess capacity is not
being removed more quickly. Thus, in Korea the political leadership still
does not seem to comprehend that closing down capacity is the quickest way
to salvation. Likewise, China 's collective leadership still does not
understand that producing things nobody wants to buy is a complete waste of
time. They believe this specious activity is somehow a worthwhile form of
human endeavor because it can be described as "manufacturing. " But it is not
just manufacturing where the excess capacity needs to be removed. Consider
Long-Term Capital Management. The shocking leverage commanded by this
well-connected hedge fund represents a scale of excess, in the context of
the financial services industry, every bit as extreme as the debt taken on
by the Koreans to mount their drive into semiconductors. Both excesses need
to be expunged, which is not exactly an argument for Fed intervention.
Deflation does not have to be a malign force, especially if productivity is
rising. But when combined with huge indebtedness and collapsing asset
prices, the consequences are not pleasant, as is now clear from the
depression engulfing Asia . Prices are already falling at street level in
China and Japan . By next year prices should also be falling in Korea , Hong
Kong and Singapore .
If Mr. Greenspan does prove to be reasonably proactive, that should help
mitigate the pain. Unfortunately, it does not mean the U.S. can escape a
protracted bear market, or indeed a deflationary slowdown in the real
economy. Both are now signaled by the inversion of the yield curve.
Unfortunately, the unambiguous lesson of history is that it is harder to
reactivate deflating economies, via interest rate cuts, than it is to rein
in overheating economies through monetary tightening. This is a lesson which
the former Bank of Japan governor, Yasushi Mieno, was painfully slow to
learn in the early 1990s. This has also been the recent experience of
Chinese Premier Zhu Rongji, who has been behind the curve in recognizing
that deflation is now the greatest threat to the mainland economy. Leaders
can also wreak havoc by overreacting to the problems brought by deflation.
The bear market in the emerging markets will last much longer than necessary
if the seductive case for capital controls is not fought much more
aggressively. "Hot money" capital flows had nothing to do with the cause of
the problem, which is clearly overinvestment. If governments feel the urge
to "regulate" something, they should regulate the banks who foolishly lent
the money, be it to well-connected cronies or well-connected hedge funds.
Finally, none of the above means that emerging markets should be written of
as an asset class. Emerging markets are here to stay, if for no other reason
than the populations of developing countries have developed a taste for
capitalism and consumerism. The sooner creative destruction is allowed to
work, the sooner they will emerge on the other side.
Mr. Wood is the global emerging market strategist for Santander Investment
and author of "The Bubble Economy" (Atlantic Monthly Press, 1992).
Copyright (c) 1998 Dow Jones & Company, Inc. All Rights Reserved.

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