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The Mother of All Snowballs

To understand the constant fluctuation of prices, it is wise to begin by looking at the way prices are determined. The value of a commodity is the sum of the values that went into its production. The different costs of production concern the matter to be transformed, the depreciation of buildings, machines and tools, the energy consumed and the work force. The market price should cover this value, plus taxes, land rent, interest and profit. Alternatively, it can be said that the market price of a commodity should cover the value invested plus the added value. The value invested comprises the tools, machines and buildings, the matter to be transformed and the energy consumed. (In fact, investments are no more than an accumulation of past added values. That the added values are from the past usually means their variations have a belated effect on prices.) The value added by labour comprises wages, taxes, interest, land rent and profit. These five elements of value are liable to variations, either up or down. However, some may rise while others fall, and the overall effect on prices can be nil.

What seems to have happened is that wages (outsourcing), taxes (rebates) and interest (Allan Greenspan) were consistently reduced. This left the lion’s share of value to rent and profit. It also allowed for a considerable reduction in market prices, during a ferocious competition that completely modified the distribution of production around the world. Then, once the downward trends of wages, taxes and interest had reached their limits, they could only move up again. This means that either both rent and profit fall, with a subsequent depreciation of real estate and stocks, or the market prices of commodities rise, resulting in inflation, or both.

There is, however, another side to the variations of prices on the commodity market, the monetary side. Supply is the quantity and the price of the goods on offer. Demand is the quantity and the value of money (credit, etc.) in circulation. If the quantity or, less likely, the value of money increases, so does demand. (An increase in the speed of circulation, and hence of spending, also increases demand. But electronic speed has reached a limit that is hard to beat. And how far in advance can incomes be spent?) There used to be a time when the quantity of money in circulation could increase without necessarily affecting consumer demand. Extra money would be put aside for a rainy day. But savings are no longer hidden under a mattress, or buried in a jam jar. They are converted into derivatives. All circulating money that does not become demand is exchanged for “almost-money”, and recirculated. Savings are merely spent by someone else, notably governments who balance their budget deficits by selling treasury bonds. Savings are not deducted from demand. The demand is simply resituated elsewhere, and its value is doubled by treasury and corporate emissions of “almost-money”. The money has been spent and is circulating, but the potential demand of the saver persists.

What seems to have happened is that the long term savings that had been paying off budget deficits were essentially pensions and life insurance set aside by the post-WW2 baby boom generation and, fatally, they are beginning to spend what they had saved. Past savings that had not been withdrawn from circulation are coming back on the market as an increased demand. Just when present savings are at an all time low. This in turn means that treasury bonds are in lesser demand. Just when budget deficits are in full expansion.

Demand for goods is sustained by spent savings. But demand for bonds is weakening at a time of predictable XL supply. The price of essential goods can increase but, as a consequence, the market value of bonds must drop and interest rates rise proportionally. This will affect already failing rent and profit, and already rising prices. At some point in the near future, sinking buying power will lead to a general claim for higher wages, countered by rising prices, etc. The start of an inflationary cycle that will deflate the going value of past debts in general and of treasury bonds in particular. A similar process took place in the 1950’s, wiping out the massive war-bond emissions and the reconstruction borrowing of the 1940’s. The comparison stops there, however, as the balance of power and wealth has completely changed since then.

A currency has two distinct values. One on its national market, and the other on the international market. The use of a currency is restricted to its national boundaries (except for the US dollar that is legal tender in a number of countries, and the particular multinational Euro zone). This means that foreign trade is ultimately an exchange of commodities, and woe to those nations with no or insufficient commodities to offer. They must sell their work abroad and send home the wages. As no nation is completely self-sufficient, the exchange of commodities is a necessity. This regularly leads to a trade deficit for some, and a trade surplus for the others. An unbalance that used to be settled by transfers of bullion. But very few of the new post-colonial nations had gold reserves (in the ground). So, for numerous other reasons, the gold standard was finally abandoned in 1973. To be replaced by a standard based on the US dollar. First by paper money (petro-dollars), provoking great movements of liquidities and wild fluctuations in the exchange rates between currencies, then by paper bonds.

What seems to have happened is that growing trade deficits have been settled with treasury bonds. The example was given by the Nixon administration (see Michael Hudson’s account). Then, progressively, the practice became universal. Up to the junk-bond crisis of 1997, when numerous nations of South America, Africa and Asia found themselves on the verge of bankruptcy. Since then, only the wealthier nations have been able to continue paying their trade deficits with treasury bonds, notably some members of the euro-group (France, Spain) and the USA.

Paying a trade deficit with a budget deficit is a convenient way of borrowing what is already owed, for a prolonged period. Except that the method relies on a strong foreign demand for treasury bonds, and this is no longer the case. In fact, the likelihood of a weak demand and a strong supply of treasury bonds on the international market will push up interest rates and bring down the market price of existing bonds. This will affect the exchange rates of currencies, and should make it easier for the depreciated ones to export a larger quantity of cheaper goods. But, coming at a time when demand is weakening, this could lead to protective commercial barriers. A depreciated currency will also make imports more expensive. Thereby reducing them and the trade deficit, while having an inflationary effect on prices. As for budget deficits, they will be ever harder to finance.

The question is, “Can the present situation snowball into something gigantic?” And the answer is that there seems no way to avoid it. As all the factors are linked together by a world market and a master currency, the US dollar. The only difficulty is to estimate how long the central banks can go on filling the breaches to hold back the flood, and to foresee when the salvaging process will be forced to the forefront of political debate. It is ultimately the nation’s wealth that has been squandered.

KENNETH COUESBOUC can be reached at kencouesbouc@yahoo.fr