Intervention Has Failed, Let's Look to the Free Markets
Early 19th century military theorist Carl von Clausewitz surmised that war is the continuation of politik by other means, making armed conflict a separate space of achieving political or policy ends through the most extreme means. On September 22, 1985, at the Plaza Hotel in New York City, officials from governments and central banks of the "G-5" (France, West Germany, United Kingdom, Japan and the United States) signed an agreement that intended to accomplish the largest U.S. dollar devaluation in history outside of 1934. The impetus behind this gathering of financial power was the dollar's steady rise in the first half of the decade of the 1980's.
To the political powers and policymakers, the strong dollar was a "cross of floating fiat" strangling the manufacturing sector within the domestic US economy. Weaker currencies of manufacturing powerhouse economies, notably West Germany and Japan, had led to the perceived influx of imported manufactured goods against which US producers would not be able to compete in terms of price. There was some truth to this notion as manufacturing jobs peaked in 1979 at just shy of 20 million. Having collapsed to about 16.5 million in the double dip recessions of the early 1980's, manufacturing failed to achieve that previous high despite massive economic growth in the subsequent recovery. By the time the Plaza Accord was signed, manufacturing jobs in the US had only regained the 18 million level and had actually begun to slide backward again.
Through the efforts of the various central bank signatories, an estimated $10 billion in "money" was effectively channeled into manipulating "floating" currency crosses to achieve the desired dollar devaluation. The heaviest blow of devaluation fell to the Japanese yen. In February 1985, a US dollar was traded for 260 yen. By September, the yen had strengthened to 236 to the dollar; by April 1986 it was 155. The dollar kept falling until April 1988 where the yen stood at 125 for every dollar. By then, the political appointees of the G-5 had reconvened in Paris to arrest the Yen's slide with the Louvre Accord.
The internal Japanese response to the strong yen was to counteract any contraction tendencies with "stimulative" monetary policy. The loss of manufacturing competitiveness within the yen on a macro level, according to orthodoxy, would be offset by loose monetary policy that would absorb that manufacturing shock through increasing domestic, internal demand. M2 money growth had averaged about 0.64% per month over the 4-year period preceding the Plaza Accord. By September 1990, the 4-year average was 0.86%.
We know what happened as a result, at least in the sketch of the big picture: asset bubble collapse in 1990 inaugurating two decades of ongoing economic malfunction. Beyond that simple synopsis, however, lies an increasingly unappetizing analog to economic, academic orthodoxy practiced on such a massive scale. The standard response to the growing Japanese recession after the Bank of Japan popped the asset bubble by increasing interest rates throughout the second half of 1989 and all of 1990 was to reverse course. Japanese government bill rates that had been as low as 2.38% in mid-1990 as part of the Plaza-driven monetary stimulus were forced upward to 5.55% by June 1991. By February 1993, bill rates were back down to 2.38%; then 1.63% in September 1993 (longer-term interest rates followed much the same course). Interest yields on bills were lowered to 0.88% in April 1995; followed by 0.75% that July and finally 0.37% by September of that year.
Over that same period where "stimulative" interest rates were being forced upon the Japanese economy, M2 money growth had absolutely collapsed. By mid-1995, the 4-year average monthly rate of money growth was only 0.14%! Apparently the "cost" of credit money was not the sole factor in determining the private sector's appetite for monetary expansion.
Even more curious, however, was the response of Japanese business. Culturally, unemployment was to be avoided, but the slack in business had to come from something. For more than two decades, the Japanese manufacturing economy had managed to average a remarkably steady 2,100 hours worked per employed person per year. Under the strain of yen re-valuation, by 1989 that utilization had fallen to a fourteen-year low of 2,089 hours. And by 1995, Japanese manufacturing hours were only averaging 1,911 hours per annum per employee (8.5% below 1989). It was an internal shift or re-valuation of labor to increasing part-time employment, a process that seems to be still ongoing. The latest data (2010) estimates that the average Japanese manufacturing worker now only gets about 1,752 hours of work in a year (16.1% below 1989).
This micro side of the Japanese economic adjustment was actually two-sided. Japanese businesses carefully navigated cultural sensitivities with regard to maintaining some semblance of full employment, but were not so timid about what some now call off-shoring. To be profitable in a global trade framework of the strong yen/weak dollar meant finding cheaper workers.
Japanese businesses, at the margins, took their cheap yen loans elsewhere and built facilities and productive capacity in lower-cost nationalities - Indonesia, Thailand, Taiwan, etc. These "Asian Tigers" were built up as the cheap labor substitute for the "Japan, Inc." trend of the 1970's and 1980's. Augmented by "hot money" inflows from the US and Europe, the key to the rise of the Asian Tigers were their US dollar pegs.
The problem of these dollar pegs is manifested in the near-statutory diktat that one currency is overvalued. On the assumed macro level this is a desirable condition since it is likewise assumed that it will create and grow the export economy of that nation. But on a micro level, individual economic agents find unintended means to express profit opportunities in these forced imbalances. Businesses in the Asian Tiger countries began to fund themselves by loans in foreign currencies - a boon when the local currency is given a boost by the dollar peg. However, the opposite spells disaster should the peg fail.
A stronger US dollar in response to a reversal of the Plaza Accord in 1995 began to pressure the Tigers. As fewer foreign reserves now flowed east, these governments had little choice but to raise interest rates to try to keep money flowing in, at the same time their respective central banks drained their reserve balances. By early 1997, the strain was too much for the Tigers to maintain the intentional currency imbalances, and the "Asian flu" was set loose. In June 1997, the Thai government finally gave up the dollar peg and the rout was on throughout Asia.
Indonesia, South Korea and Thailand felt the brunt of the currency re-adjustment. Since so much debt was denominated in foreign currencies, the ability to repay those foreign debts with local currency was directly impacted by these currency adjustments. Each currency peg lost was answered by default, bankruptcies, market collapses and cratered economies. The IMF estimates that the Thai baht's devaluation from mid-1997 to mid-1998 led to a 40% decline in US$ GDP for Thailand. The Philippines, Malaysia and South Korea, each saw 35% - 39% reductions in US$ GDP. The most dramatic disaster was Indonesia, where the rupiah saw an 83% devaluation.
The Asian flu was an economic tragedy for the Tigers, as well as Russia and other countries. The damage was also acute in Japan due to that yen-driven manufacturing exposure. The breakdown in international trade after 1997 finished off whatever was left of Japan, Inc. Real per capita GDP had seemed to bottom out in 1993 at -0.15%, after averaging 4.07% from 1981 to 1989. In 1995 and 1996, it appeared as if there was a long-awaited turnaround on the horizon when real per capita GDP perked up to 1.63% and 2.40%, respectively. But by 1998, the Japanese economy was once again shrinking at a devastating -2.29% pace that year (and a further contraction in 1999).
The employment-population ratio, which had been steady throughout the booming 1980's and even the first phase of collapse in the early 1990's, finally began to reverse under the economic strain. After rising to 62% in 1992, partially due to the shift in part-time work (more workers but less total hours), the ratio fell back below 61% by 1995. At the start of the Asian crisis in 1997, the employment-population ratio was still a healthy 61%, but had fallen below 60% by 1999. By the time of the full dot-com bust in 2002, the ratio was down to 57.5%.
These types of statistics should sound quite familiar to any observers of the US economy. The US civilian employment-population ratio peaked at 64.7% in April 2000, the exact top in the stock-tech bubble. Since that time the US dollar has undergone another devaluation, though at a far slower pace. The scale of the dollar's weakening matches that of 1934 in terms of scale, but it has been much less perceptible coming at such a measured pace. Ostensibly the dollar's movement echoes the politics of the Plaza Accord, namely the competiveness of US manufacturing against cheap imports (how many times have politicians of both parties appealed to the "export economy"?), though it appears as if recent history had forced a theoretical update toward a measured approach to currency revaluations. But dollar devaluation has been an abject failure in either regard.
As I noted above, US manufacturing jobs in late-1985 were slightly more than 17.5 million. By 1995, before the Reverse Plaza Accord, US manufacturing jobs totaled about 17.2 million - hardly the renaissance in US manufacturing that was envisioned and expected. Domestic manufacturing absolutely collapsed in the 2000's dollar devaluation, contrary to orthodox intent and any apparent theoretical redo. By early 2007, there were less than 14 million manufacturing jobs in the United States. The Great Recession destroyed a large portion of those that were left and they have not come back; there are only 11.9 million manufacturing jobs as of the last employment report.
What is extremely interesting is that we have two examples of currency intrusions at opposite ends of the spectrum ending up in largely the same place. The Japanese yen was forced to appreciate, and it led to asset bubbles and economic collapse that have reduced the overall level of productive activity inside the economy. The US dollar has been twice devalued, leading to asset bubbles and economic collapse that stubbornly and contrary to all expectations led to the pronounced reduction of overall productive activity. All of these orthodox adjustments ended up in largely the same place where labor resource utilization has had to bear the brunt of the monetary intrusions.
The common theme from all of these measures has been the central bank response to currency adjustments: financialization. It has been unchallenged conventional wisdom that epic forces of economic adjustment could have been softened or even countermanded by "stimulating" money demand. Yet in all cases that stimulative money has ended up as asset inflation running away into massive asset bubbles and economic disaster within every economic system that has adopted or attached itself to this orthodox monetary order.
The reasons for these epic failures are simple: political intrusions into the natural, free market economic system are incapable of yielding stability. I should be clear here in that stability refers to a stable system, not stable results. Political agents mistakenly appeal to stable results, regardless of the far more important stability of the system. As such, manipulated systems are intentionally imbalanced because of political considerations that are largely unrelated to economic considerations of efficiency and sustainability, or even profits and costs on the individual agent level. Since they are inherently unstable, they require more and more effort and resources just to maintain them (drawing those resources away from productive uses). Instead of allowing the market economy to innovate and increase productive capacity, intentional imbalances create speculative opportunities for easy money - Wall Street loves volatility and imbalances. Capital dies in these political economies.
Another obvious commonality between Japan of the 1990's and the US today is "stimulative" interest rates that do nothing of the sort. Interest rates are forced down to zero by central banks, but broad money growth stalls and stagnates. There is an orgy of "free money" that nobody, outside of governments, seems to want. In any system that favors such an imbalance of speculation there should be no surprise that true productive investment withers as banks dominate. Japan and the US suffer the same malaise - overbearing monetary conditions that do not reflect the aggregate individual desires for true stability outside of the political gloss of macro variable definitions.
When real money flows between the free exchanges of individuals and businesses it creates real wealth. The central bank imposition of political "macro" goals and policies upsets that natural order, rerouting monetary flow further and further into the banking/credit system. The centralization of the monetary tools of exchange has been the primary impediment to money growth into productive sectors. Decentralized money, almost by definition, is incapable of yielding such monetary and currency imbalances. Markets, unfettered by political influence, will not long remain in imbalanced states. Scarcity in money enforces discipline on the markets and the larger economy since speculation is directed inward as the primary tool of closing any imbalances. This is the self-correction inherent in free market capitalism. Speculative processes in the "free money" financial world of political central banking are much like bureaucracy - it seeks only to sustain itself at the expense of everything else.
A disciplined market or currency regime will favor the creation of real wealth over the chase for central bank fiat. Scarcity ensures that the only path to success is through the real economy and through the sustainable, profitable deployment of real resources. Money is not dead; it has meaning in the flow of the economic system. Volatility, rather than embraced, is abhorred as an impediment to self-sustaining success.
Economics is not supposed to be the extension of politics into pocketbooks or foreign "reserves". Human history certainly reveals that temptation to appeal to monetary intrusion in the face of economic hardship or the hard choices that will always arise in any complex system. Gold was prized and valued not just as a means to store or convert individual wealth, but as the hard-won wisdom of human history expressed as the realization that politics will always appeal to money for its own ends - and those appeals always end in the disastrous aftermath of unintended consequences. The means to achieve economic revival lay not in the macro interventions of political considerations and methods, but in the free market, uninhibited focus of micro agents freely pursuing self-interest along a decentralized matrix of self-correction and sustainability. What von Clausewitz understood about the essential nature of war has yet to be realized in the parallel realm of orthodox economics, and the costs of that ignorance will continue to be paid in the rolling financial crises of these dead-money, speculative systems.
