Does US today equal UK 1929? Interesting parallels......

From: John Galt (taxationistheft2003_at_lycos.com)
Date: 09/06/04 

Date: 5 Sep 2004 17:36:11 -0700

Does anyone agree with this author that the US today, with the dollar
the reserve currency, a lot of foreign debt and ambitions of empire is
comparable to the UK in the 1920's and China today is comparable to
the US of 1920's.

I tend to agree with the premise, but I am a bit of a pessimist.
Thanks for your learned responses....

....and any suggestions on how to protect my money in such a
situation. What did the British pound do during the Great Depression?
 Will US$ do likewise?

China's Great Depression
By Krassimir Petrov

Having recently completed Rothbard's "America's Great Depression", I
couldn't help draw the parallels between America's roaring 20's and
China's roaring economy today, and I couldn't help conclude that China
will inevitably fall in a depression just like America did during the
1930s. The objective of this article is to present an Austrian
argument as to why this must happen; to substantiate my arguments, I
will be quoting Rothbard's Fifth Edition where relevant.

Before proceeding any further, I would urge all readers who haven't
read Rothbard's " America 's Great Depression", to pick up a copy and
read it. First, it is a real pleasant read, and Rothbard's witty style
of writing makes reading it fun. Second, the first part of the book
develops the Austrian Business Cycle Theory, which is indispensable
for understanding credit booms and their inevitable busts. Finally,
the second part of the book elaborates the development and the causes
of the Inflationary Boom of the 1920s and provides a basis for
comparison with the economic policies of modern-day China .

In order to establish our parallel, we need some historical
perspective of the relationship between a world superpower and a
rising economic giant. In the 1920s, Great Britain was the superpower
of the world, and the United States was the rising giant. As such,
Great Britain ran its economic policies independently, and the U.S.
adapted its own policies in a somewhat subordinated manner. Today, The
United States is the hegemonic superpower of the world, and China is
the rising economic giant. Not surprisingly, the U.S. runs its policy
independently, while China adjusts its own accordingly.

Continuing our parallel analysis, during the 1920s the British Empire
was already in decline, was militarily overextended, and in order to
pay for its imperial adventures, resorted to debasing its own currency
and running continuous foreign trade and budget deficits. In other
words, Britain was savings-short, a net-debtor nation, and the rest of
the world was financing her. Meanwhile, America was running trade
surpluses and was a net creditor nation. Importantly from a historical
point of view, the British Empire collapsed when the rest of the world
pulled the plug on their credit and began capital repatriation. Today,
the American Empire is in decline, is militarily overextended, and is
financing her overextended empire with the "tried-and-true" methods of
currency debasement and never-ending foreign trade and budget
deficits. In other words, America is savings-starved, a net-debtor
nation, and the rest of the world is financing her. At the same time,
today China runs trade surpluses and is a net-creditor nation. When
the rest of the world finally pulls the plug on American credit, will
the American Empire also collapse?

The cause of the Depression, as Rothbard explains, was a credit
expansion that fuelled the boom. According to Rothbard, "[o]ver the
entire period of the boom, we find that the money supply increased by
$28.0 billion, a 61.8 percent increase over the eight year period [of
1921-1929]. This was an average annual increase of 7.7 percent, a very
sizable degree of inflation (p.93)…The entire monetary expansion took
place in money substitutes, which are products of credit creation… The
prime factor in generating the inflation of the 1920s was the increase
in total bank reserves" (p.102). In other words, during the 1920s, the
United States experienced an inflationary credit boom. This was most
evident in the booming stock and the booming real estate markets.
Furthermore, there was a "spectacular boom in foreign bonds… It was a
direct reflection of American credit expansion, and particularly of
the low interest rates generated by that expansion" (p.130). To stem
the boom, the Fed attempted in vain to use moral suasion on the
markets and restrain credit expansion only for "legitimate business.
Importantly, consumer "prices generally remained stable and even fell
slightly over the period" (p. 86). No doubt the stable consumer prices
contributed to the overall sense of economic stability, and the
majority of professional economists then did not realize that the
economy was not fundamentally sound. To them the bust came as a
surprise.

Today, in a similar fashion, the seeds of Depression are sown in China
. Economists hail the growth of China , many not realizing that China
is undergoing an inflationary credit boom that dwarfs that American
one during the roaring ‘20s. According to official government
statistics, 2002 Chinese GDP growth was 8%, and 2003 growth was 8.5%,
and some analysts believe these numbers to be conservative. According
to the People's Bank of China own web site
(http://www.pbc.gov.cn/english/baogaoyutongjishuju), "Money & Quasi
Money Supply" for 2001/01 was 11.89 trillion, for 2002/01 was 15.96
trillion, for 2003/01 was 19.05 trillion, and for 2004/01 was 22.51
trillion yuan. In other words, money supply for 2001, 2002, and 2003
grew respectively 34.2%, 19.3%, and 18.1%. Thus, during the last three
years, money supply in China grew approximately three times faster
than money supply in the U.S. during the 1920s.

No wonder the Chinese stock market has been booming and the Chinese
real estate market is on fire. Just like the U.S. in the 20s, China
finances today foreign countries, mostly the U.S. , by buying U.S.
government bonds with their trade surplus dollars. Just like the Fed's
failed attempts of moral suasion during the 20s, the Chinese
government today similarly attempts in vain to curtail growth of
credit by providing it only to those industries that need it, that is,
only to industries that the government endorses for usually political
reasons. Also, for most of the current boom, Chinese consumer prices
have been mostly tame and even falling, while prices for raw
commodities have been skyrocketing, which perfectly fits the Austrian
view that prices of higher-order goods, such as raw materials, should
rise relative to prices of lower-order goods, such as consumer goods.
This indeed confirms that credit expansion has already been in
progress for a considerable time, and that inflation now is in an
advanced stage, although it has not yet reached a runaway mode. Thus,
economic conditions in China today are strikingly similar to those in
America during the 1920s, and the multi-year credit expansion implies
that a bust is inevitable.

There are also important parallels regarding currency and export
policy. During the 1920s, the British Pound was overvalued and was
used by smaller countries as a reserve currency. While Britain ran its
inflationary policies during the 1920's, it was losing gold to other
countries, mainly the United States . Therefore, "if the United States
government were to inflate American money, Great Britain would no
longer lose gold to the United States" (p. 143). Exacerbating the
problem further, the Americans artificially stimulated foreign
lending, which further strengthened American farm exports, aggravated
the net-export problem, and accelerated the gold flow imbalances. "It
[foreign lending] also established American trade, not on a solid
foundation of reciprocal and productive exchange, but on a feverish
promotion of loans later revealed to be unsound" (p. 139).
"[President] Hoover was so enthusiastic about subsidizing foreign
loans that he commented later that even bad loans helped American
exports and thus provided a cheap form of relief and employment—a
cheap form that later brought expensive defaults and financial
distress" (p.141) Thus, the preceding discussion makes it clear, that
the fundamental reasons behind the American inflationary policy were
(1) to check Great Britain's drains of gold to the United States, (2)
to stimulate foreign lending, and (3) to stimulate agricultural
exports.

Similarly, today the dollar is overvalued and used as the reserve
currency of the world. The U.S. runs its inflationary policy and is
losing dollars to the rest of the world, mainly China (and Japan ).
Today, the currency and export policy of China is anchored around its
peg to the dollar. The main reason for this is that by artificially
undervaluing its own currency, and therefore overvaluing the dollar,
China artificially stimulates its manufacturing exports. The second
reason is that by buying the excess U.S. dollars and reinvesting them
in U.S. government bonds, it acts as a foreign lender to the United
States . The third reason is that this foreign lending stimulates
American demand for Chinese manufacturing exports and allows the
Chinese government to relieve its current unemployment problems. In
other words, the motives behind the Chinese currency and export policy
today are identical to the American ones during the 1920s: (1) to
support the overvalued U.S. dollar, (2) to stimulate foreign lending,
and (3) to stimulate its manufacturing exports. Just like America in
the 1920s, China establishes its trade today not on the solid
foundation of reciprocal and productive exchange, but on the basis of
foreign loans. No doubt, most of these loans will turn out to be very
expensive because they will be repaid with greatly depreciated
dollars, which in turn will exacerbate down the road the growing
financial distress of the banking sector in China .

Therefore, it is clear that China travels today the road to
Depression. How severe this depression will be, will critically depend
on two developments. First, how much longer the Chinese government
will pursue the inflationary policy, and second how doggedly it will
fight the bust. The longer it expands and the more its fights the
bust, the more likely it is that the Chinese Depression will turn into
a Great Depression. Also, it is important to realize that just like
America 's Great Depression in the 1930s triggered a worldwide
Depression, similarly a Chinese Depression will trigger a bust in the
U.S. , and therefore a recession in the rest of the world.

Unless there is an unforeseen banking, currency, or a derivative
crisis spreading throughout the world, it is my belief that the
Chinese bust will occur sometime in 2008-2009, since the Chinese
government will surely pursue expansionary policies until the 2008
Summer Olympic Games in China. By then, inflation will be most likely
out of control, probably already in runaway mode, and the government
will have no choice but to slam the brakes and induce contraction. In
1929 the expansion stopped in July, the stock market broke in October,
and the economy collapsed in early 1930. Thus, providing for a latency
period of approximately half a year between credit contraction and
economic collapse, based on my Olympic Games timing, I would pinpoint
the bust for 2009. Admittedly, this is a pure speculation on my part;
naturally, the bust could occur sooner or later.

While I base my timing of bust on the 2008 Olympic Games, Marc Faber,
however, believes the bust will occur sooner. According to him, the
U.S. is due for a meaningful recession relatively soon, which in turn
will exacerbate already existing manufacturing overcapacities in China
. This, coupled with growing credit problems, makes him believe that
China will tip into recession sooner than the Olympic Games. In other
words, Dr. Faber believes that a U.S. recession will trigger the
Depression in China . Indeed, that very well may be the trigger, but
if so, it still remains to be seen whether the Chinese government will
let the bust run its course or choose the route of a "crack-up" boom,
come hell or high water.

We should also consider another possible trigger for a bust, namely
trade surpluses turning into trade deficits due to the accelerated
rise of prices for resources, such as commodities, which China must
import. Faced with trade deficits, China may decide to dishoard
surpluses by selling U.S. government bonds, or it may decide to
abandon its peg to the dollar. In either case, this will exacerbate
the problems of the ailing U.S. economy, which in turn will boomerang
back to China .

Finally, the bust may be triggered by a worldwide crisis in crude oil
supplies. Peak oil supply is around the corner, if not already behind
us, and Middle East or Caspian instability could sharply cut oil
supplies. Historically, oil shortages and their concomitant rise of
oil prices have always induced a recession. China 's growing
dependence on oil ensures that should an oil crisis occur, it will
slip into recession.

To summarize, the likely candidates for a trigger to the Chinese
depression are (1) a worldwide currency, banking, or derivatives
crisis, (2) a U.S. recession, (3) the containment of runaway
inflation, (4) the disappearance of Chinese trade surpluses, and (5)
an oil supply crisis.

Whatever the trigger of the bust in China , there is little doubt that
this will provide the onset of a worldwide depression. Just like the
U.S. emerged from the Great Depression as the unrivalled superpower of
the world, so it is likely that China will emerge as the next.

Krassimir Petrov, Ph.D.
http://www.gloomboomdoom.com/marketcoms/indexmarketcoms.htm

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