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 Richmans' Trade and Taxes Blog

My predictions from 2009 are coming true
Howard Richman, 6/3/2011

This morning, the Bureau of Labor Statistics announced that unemployment rose to 9.1% in June, after a rise to 9.0% in May. The following chart plots the unemployment rate since January 2007:

It is now clear that President Obama's stimulus plan and Bernanke's QE2 have failed. I predicted this failure after I read President Obama's inaugural address. On January 23, 2009, I wrote:

If Obama addresses the trade deficits, then his recovery plan should succeed. The hope generated by his presidency would be rewarded. And he would likely be considered one of the greatest economic presidents ever.

But if he doesn't take action to balance trade, his recovery plan will not work. He will need to borrow more and more for one stimulus package after another, just to keep unemployment low. Eventually this borrowing could destroy the U.S. government's credit rating and lead to a dollar collapse. That's when things would get really bad.

On September 9, 2009, I predicted that Obama's recovery would fail because the trade deficit would worsen, which indeed has happened as shown in the chart below:

I actually went into quite a bit more detail as to why Obama's recovery would fail. I wrote:

Some economists are predicting a normal recovery. Some are predicting a jobless recovery. I predict that there will be no recovery at all, other than a very temporary one caused by a blip in government spending.

Let me explain why in terms of the four factors that economists use to divide up the total spending in an economy (i.e., the "aggregate demand"). In order for a recovery to occur, the sum of these factors has to rise. Here's why I don't expect that sum to rise:

1. Consumption. Wages and salaries won't be increasing, and people are too deeply in debt to spend more money without more income.
2. Investment. None of the following types of business investment are likely to increase:
   • a. Manufacturing investment won't increase because China, following a mercantilist policy, will keep the dollar pegged to a rate where they can prevent investments in American manufacturing from becoming profitable, and President Obama will continue to do nothing about this problem.
   • b. Construction investment won't increase because of over-construction during the house price bubble and because house prices still have a way to fall.
   • c. Retail investment won't increase because consumption won't be increasing.
   • d. Energy investment in nuclear or fossil fuel energy sources won't increase because they will be discouraged by the Obama administration and the Democratic Congress.
3. Government Purchases. Although government purchases and subsidies of unprofitable energy production will stay strong, the government can't increase its already huge deficit spending much more.
4. Trade Surplus. An improving trade surplus (i.e. more exports or less imports) would help. But I expect the trade surplus to go the opposite way because many countries, including China, will manipulate their exchange rates to prevent American exports from increasing more than American imports, and President Obama will continue to do nothing about the problem.

I am not saying that there will never be a recovery, just that there won't be a recovery until our trade problem is solved. This prediction is not original with me. Economist John Maynard Keynes made the same prediction when he wrote in his magnum opus (The General Theory of Employment Interest and Money):

(A) favorable [trade] balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression. (p. 338)

Keynes's solution was for a trade deficit country to subsidize exports and restrict imports in order to balance trade. But President Obama's economic advisors are all unilateral-free-traders, so they won't do anything to solve the problem. And the Democratic Congress is much too subservient to the Democratic administration to do anything on its own.

A currency crash could also provide a solution. After a dollar crash, Americans would have a much lower standard of living, but the American economy would grow rapidly, led by foreign and domestic business investments in America's manufacturing sector. The main task of the President would be to get the government out of the way of the recovery.

Thus, due to the incompetence of his economic advisors, President Obama's term will either be marked by recession and stagnation or by a dollar crash. In either case, he will be a one-term president.

I also predicted the housing slump, shown on the chart below:

On October 16, 2009, I wrote:

Home sales declined in August, as did the average price at which houses were sold. An article in the Christian Science Monitor puts a positive face on the story. Here's a selection:

The median sales price of existing homes ... declined from $181,500 in July to $177,700 in August, according to a National Association of Realtors (NAR) report released Thursday....

Outside analysts downplayed the one-month decline. “We suspect it is just a temporary blip in the improving trend rather than a sign of renewed weakness,” wrote Paul Dales, an economist at Capital Economics, in an analysis....

I expected this decline, and I expect that house prices will continue to decline. The real blip was the temporary pause in the fall of house prices, bought at huge expense to taxpayers by the incompetent economists of the Federal Reserve and the Obama administration.

Instead of tackling the cause of our economic problems, the demise of our manufacturing sector due to our toleration of mercantilism, they continue to treat the symptoms, such as the falling house prices. Has America ever been more ill-served by incompetent leadership?

The current strategy is for the United States government to use its good credit rating to borrow from abroad while the Federal Reserve creates massive amounts of new dollars out of thin air. This borrowed or created money is then used for one expenditure after another. The goal being to reduce household savings (just 5% of disposable income in January) and increase fixed investment by America’s businesses. So far this strategy is not working.

One of my predictions is still in the process of coming true. On March 23, 2009, I predicted an eventual dollar crash. I wrote:

The current strategy is for the United States government to use its good credit rating to borrow from abroad while the Federal Reserve creates massive amounts of new dollars out of thin air. This borrowed or created money is then used for one expenditure after another. The goal being to reduce household savings (just 5% of disposable income in January) and increase fixed investment by America’s businesses. So far this strategy is not working.

World Bank President Robert Zoellick is the latest policy maker to look ahead, see that the world's current stimulus plans will fail, and recommend a slight variation. On March 21, he predicted that the world’s economy will contract by between 1 and 2% this year, despite worldwide government budget deficits. He added that the current stimulus packages will then produce a “sugar high,” a surge in economic activity that will be temporary. Being the world’s chief banker, his solution was that a greater proportion of the stimulus plans be given to the world’s bankers.

While Zoellick is to be commended for looking one move ahead, it is also possible to look two moves ahead. When Zoellick's "sugar high" hits, the Federal Reserve will be facing a very difficult choice between two bad alternatives:

1. High inflation. The Fed can let the expanded money supply cause high inflation.
2. High interest rates. The Fed can contract the U.S. money supply causing high interest rates, leading to economic stagnation in the United States accompanied by an upward spike in bankruptcies and U.S. debt payments to foreigners.

Either one will probably produce a dollar crash. The inflation would cause the crash immediately; the increasing debt payments as a percentage of our GDP would cause it eventually. Once the dollar crashes, here's how the events would unfold, as described on pages 188-9 of our 2008 book Trading Away Our Future:

Once the dollar starts to plunge, there would be such a rush to sell dollars on foreign exchange markets that the dollar would collapse in value. The United States would experience inflation. Interest rates would skyrocket. Trade would become balanced but at a severely reduced level of imports.

The skyrocketing oil prices and need to cut back on oil imports would force the United States to begin rationing gasoline, probably using an equitable electronic system like Martin Feldstein’s 2006 "Tradable Gasoline Rights" proposal.

If the Federal Reserve decides to inflate the money supply in order to pay off US debts with cheap dollars, we could experience runaway inflation. At the most extreme, the dollar might even be replaced with a new currency as has happened in Brazil multiple times. The Brazilian reis was replaced with the milreis, the milreis by the cruzeiro, the cruzeiro by the mil cruzeiro, the mil cruzeiro by the cruzado, the cruzado by the milcruzado, and finally the real.

There is an alternative path that is not being considered by American policy makers, the Program for a Strong America that we lay out in our book, Trading Away Our Future. Instead of fighting household savings, we should encourage them by replacing our current income taxes with the FairTax or a Value-Added Tax. Households would then provide more savings to local banks who would lend them to American businesses, making it entirely unnecessary for America to save the national banks or continue to run trade deficits by borrowing from abroad.

If we balance our trade at the same time through Warren Buffett’s Import Certificates plan, then the surge in investment by American and foreign businesses in new American factories would immediately pull the United States out of the great recession. Our plan would prevent the coming dollar crash, but would also work if enacted afterwards.

The dollar hasn't started to crash, but we are seeing the Federal Reserve starting to inflate the money supply on purpose. The following graph shows the effect of the Federal Reserve's actions upon inflation rates:

So there you have it. Back in 2009, I explained the economic statistics that we are experiencing today and also those that we will experience tomorrow.