Tuesday 27 January 2004

Pic of the day: We could need another chair here. (Screenshot from The Sims.) Notice the gloom.

Economic game of chairs

George W. Bush sounds confident that his economic policy is working. Reliable official statistics show that the economy is booming, indeed growing at a speed that you are likely to see only a few times in a lifetime. Things are looking bright here in Norway too: Homes are being traded briskly and at ever higher prices; unemployment, while still higher than average for the last 10 years, is way below European standards and even lower than in the USA. But despite all this our central bank has slashed interest rates to their lowest level in our generation and promises further cuts. Back in the USA, the Federal Reserve is in no hurry to raise their interest rates either. Judging from their actions, or the European Central Bank for that matter, we are in the throes of the Great Depression.

What is wrong with this picture? The central bankers seem to be swimming on dry land. Everything is just peachy and they're desperately trying to avert a worldwide disaster. Are they all just paranoid, or do they see something that most people don't?

***

No prize for guessing what side I am on. I trust I have spoken clearly enough in the past about the dark clouds ahead for the American economy and for everyone else who depends on it. The problem is basically that both government and citizens dig themselves down in debt. You can do this for a while, spending money from the previous boom and borrowing money from the next boom to cushion the recession in between. But you cannot eliminate the downtime between booms, so as to have a boom all the time; not this way. After the partying, you have to clean up.

Not all countries are in this situation. Take China for instance. The country seems to be in just such a continuous boom. The economy grows by 5-10% a year, and it just goes on and on. If they can do it, why can't we? The simple answer is their starting point. China is a developing country; and unlike many others honored with that name, it is actually developing. There is a lot of potential for productivity growth when you move millions of people from subsistence farming to the 21st century. In Europe, to take an extreme contrast, you have to research and develop new technology or better organization just to keep production up as the workers slowly grow old and retire.

For a long time the United States of America has been a "consumer of last resort", providing opportunity for export for countries all over the world. The Federal Reserve (the U.S. central bank) is not only keeping interest rates down to stimulate the American economy; another effect is to weaken the dollar. This makes it harder for other countries to export to the USA, and easier for the USA to export to other countries. This is necessary to correct the imbalance in the American economy. On the other hand you don't want the dollar to fall too fast and too far. For many years the US dollar has been a "world currency", and changing this very fast could lead to economic chaos all over the world, not to mention the complications for America itself. Banks and corporations all over the world are holding a reserve of dollars for use in international trade, not necessarily with the USA itself. If the dollar loses its status as a world currency, those banks and corporations would try to sell the dollars they no longer had any use for. This would cause a sudden drop in the value of the currency, a change that did not reflect real changes in the trade balance. To have this happen very fast would be a very bad idea indeed.

Right now there is a kind of competition among nations to keep their currency from rising too high. Even my native Norway, which enjoys a large trade surplus, is unwilling to see its industry close down or leave for other countries just because of a strong currency. Most other nations don't have the luxury of a strong economy and a large accumulated fund saved up during the good times, the way Norway has. So everyone is trying to keep their currency down, much like in the game where one person is left standing when the music stops playing. We are all hoping that someone will bring a chair before then.

But just in case, it might be an idea for common people to look for an escape route. Put aside a little money, perhaps, or not take on a lot of obligations for the future that may be hard to fulfill if times get harder.