The Hindu Business Line : The caboose of global growth

For the last couple of years, we have argued that the US dollar has to collapse, taking with it the US economy down the precipice. Not too many agreed with what we were saying, but these days the objective evidence of our economic argument has been far too obvious (refer ‘The Collapsing Dollar’, Business Line dated July 27, 2007).

Even the normally dollarphilic investment banks have started talking about a sub-40 level of the rupee-dollar exchange rate. But as we had explained in that article, the process of dollar depreciation has just begun and has a long way to go before one can expect a meaningful stability in the US dollar. In fact, the dollar index itself could pretty much go below 40 from its current level of 80 over the next five years.

The argument for a dollar collapse in our opinion was fairly obvious. The imbalances in the US economy are far too great (refer previous articles at http://financial-musings.blogpsot.com) for the existing status-quo condition of propping up the US dollar by the foreign central banks to continue without having disastrous inflationary impacts in their own economies. A related but not as obvious an issue is what happens to the rest of the world when the US dollar collapses completely.

Most analysts think of the US consumption as being the key to global growth and hence when the dollar collapses, global growth would stall. However, we think that a dollar collapse is actually great news for the rest of the world and that the global economic train can move faster without the dead-weight of US tugging along.

Again, we do not expect people to agree on what we are saying — at least for now. Even the sound money and libertarianism-oriented Economist carried an article a few years ago (‘Flying on One Engine’, September 2003) explaining why the world is dependent on US consumption for its growth. The Time magazine went a step further when they bestowed the honour of “Person of the Year” to the “American Consumer”.

We think such an argument is completely misplaced and contrary to the US being the engine of economic growth, it is indeed the Caboose that is slowing economic growth. This article explains the rationale for the same.

Supply: The key to growth

Ludwig Von Mises in his epic Human Action explains how the entire economics could be explained from the axiom that man uses scarce resources to satisfy his unlimited wants. But even if you do not want to get into too much economics, just think about how man would have needed cars and aeroplanes even thousands of years ago or how all of us needed cell-phones and e-mails even a couple of decades ago.

The demand was always there — what changed in the environment is the supply. We are sure that two billion Indian and Chinese want to have an American lifestyle — of individual cars and annual overseas vacations — but the key is what can be meaningfully produced and serviced. Production is the engine. Consumption follows.

Now let us proceed to examine what would happen if the world allows the dollar to collapse. Think of the goods produced in the world as being delivered to the ultimate consumers through a gigantic auction. All countries of the world participate in this auction and bid using their respective currencies.

The US for the last several decades has received a disproportionate share of this auction because of their currency status. To be fair to the US, at least till the late 1970s, they produced a disproportionate share of the goods on auction, and hence were entitled to a disproportionate share of the sale as well. But that has long ceased to hold true.

Now just imagine that the dollar collapses by 50 per cent against all major currencies. The goods on auction still remain the same — the production scenario itself does not change because the dollar has collapsed. All that the dollar collapse would imply is that the goods get consumed by the other countries that now become relatively richer.

We can enjoy much standards of living as there would be much more cars, oil, vacation trips and food for the rest of the world to consume as compared to what they have today. All these goods would become cheaper in local currency terms (although more expensive in dollar terms) enabling a much higher standard of living for the non-US population.

We can debate about whether the above transition would be smooth. Frankly, we do not know and we doubt if anybody knows. But eventually — perhaps a few days, maybe a few months or even a few years (though we doubt it would take that long), the standard of living would get redistributed through the process of currency realignments.

The China question

The standard question on a debate involving the dollar would be: “What would happen to all the goods produced in China?” Or a still more ridiculous argument would be “China’s economy is dependent on their exports to the US and if they cannot export, their economy would collapse”. All these arguments imply that the world cannot afford a collapse of the US economy.

Again the logic is faulty for the same reasons as the one earlier. A country has no more reason to export for its well-being as, say, our Planet Earth has to export for its growth. How are we as a planet able to grow without exporting to Mars or Venus? The only reason a country exports is so that it can import what it does not produce or is at a comparative disadvantage at producing as compared to some other country. And if all that China can import is paper US dollars in exchange for the goods, sooner or later they would stop exporting.

What would then happen to the goods? The minute the Chinese stop supporting the dollar to facilitate the exports, the Yuan would appreciate relative to the dollar. Then, all these goods that were beyond the reach of the Chinese consumer would be well within their purchasing power to consume. So the goods produced will stay in China and will now be consumed by the Chinese themselves thereby increasing their standard of living.

It is indeed amazing that the vice of American consumption based on borrowed money has been converted into a virtue that is driving global prosperity. Even more amazing is how the world at large has accepted such an obvious hoax without so much as questioning it for a second.

Ultimately, and at a period not too far in the future, the rather extended free lunches of the American consumer would come to an end. The world would, however, continue to grow and perhaps the Time magazine would then bestow the well-earned honour of “Person of the Year” on the Chinese worker who does all the savings and production.

(The author is a Director at Benchmark Advisory Services and can be contacted at shan.sundaram@benchmarkconsulting.in.