Adam Smith is justly regarded as the father of economics, in 1776 he wrote his masterpiece, "The Wealth Of Nations." The primary purpose of his book was to level an attack against the prevailing economic doctrine of Mercantilism. This doctrine held that the way to national prosperity and power was to have a favorable balance of trade. The theory stated that if your exports exceeded your imports, this would result in a flow of gold and silver into your country since in those days money was coined gold and silver.
Another happy result would be that you would also export your unemployment to your trading partners. In other words, it could be described as waging economic warfare against your trading partners. A war in which you would first steal their silver and gold and later their jobs as well.
Adam Smith argued in his work that in the long run this doctrine could not be made to work, that it was counterproductive and that it would lead to chronic warfare. In its place he advocated the concept of free trade. If you talk to most economists, they will tell you that the doctrine of free trade has swept the world. I don't know what cave they have been living in for the last 35 years or so, but I can assure you that Adam Smith would never buy it.
It all started to go terribly wrong in 1971 when the gold exchange standard that had been established at the Bretton Woods Conference of 1944 was abolished and replaced with the fiat money standard. Fiat money is paper money that is not backed up by gold or silver.
If Adam Smith were alive today, he would look at the world and weep. What he would see is not the free trade that he championed, but rampant Mercantilism.
The easiest way to prove this is simply to look at the United States balance of trade. For more than 40 years now we have run an unfavorable balance of trade. If free trade was being practiced, such a thing would be impossible, but such a thing is very possible under Mercantilism. Under a regime of free trade, if the most backward nation on earth trades with the most advanced nation on earth over any extended time period, the trade between the two nations would balance out. Trade would not be a zero sum game as it is under Mercantilism, but a win-win scenario as each nation would specialize in producing whatever it had a comparative advantage in producing. Both nations would be better off by trading with each other than they would be by not trading with each other.
The way it works today is that every nation pegs its currency to the dollar below its fair market value. By pegging their currency below fair value they guaranteed that the United States cannot compete.
The asian nations are of course the most blatant abusers of the system. I am sure that they cannot believe how stupid we are to allow them to destroy our industrial base.
The game however is over with. Our industrial base has been virtually destroyed. The world-wide crisis that we are now witnessing is proof that this intrinsically unsound system is now in its death throes. The asians have spent way too much time giggling stupidly at each other as they have congratulated each other at how brilliant they have been and not enough time consulting the thought of Adam Smith who they undoubtedly regard as a useful idiot.
Adam Smith would have informed them that to maintain such a system in the end would require them to lend America the money to buy their products. Such a system is basically unsound. All unsound systems must fail in the end. The asians today are sitting on the greatest mountain of dollars that the trading world has ever seen. They don't have a clue as to what to do with these dollars. I am reminded of the dog that chases the car. When the car stops the dog doesn't have a clue as to what to do.
Their greatest problem however, lies in the bloated export industries that they have created.
Industries that employ millions and that can only export if they lend America the money to buy their products.
How brilliant is this?
Fred Carch is the author of Forty Years A Speculator.
1 comment:
The United States has not had a current account surplus since 1975. We have not had a trade surplus with Japan since April, 1976. We have been in deficit with the EU since 1983. We have run trade deficits with both Russia and China for more than 20 years. How did America go from being the largest creditor nation in 1975 to the largest debtor nation by the end of the 1980's? To understand what has happened one must go back in time. Prior to 1860 much of the Western World practiced Mercantilism. After 1860, led by Great Britain, Mercantilism was abandoned in favor of the teachings of John Locke and the free trade principles of Adam Smith. Trade barriers throughout Europe came down. A great debate on economic policy took place in America. Lincoln for instance was a Mercantilist. For the next 110 years the Western World basically traded with itself. Good flowed across the Atlantic and trade disputes if they arose were generally settled quickly. By 1970 the world was changing. The post world war II era produced the eventual rise of Japan as an economic machine. Goods started to flow from Japan to the United States and to Europe. The problem was that goods were only flowing one way. America for instance was banned by Japan from selling rice or apples to Japanese consumers. While disputes like this in many industries were festering, Japan was quietly becoming a world power in automobile and electronics manufacturing. Auto's and electronics were exported out of Japan at an ever faster clip. By 1977 Japan was running steady trade surpluses with the United States and American politicians were raising alarms that Japan was simply practicing protectionism. What Japan was really doing is practicing a new form of Mercantilism which I have pegged, "Asian Mercantilism." Japan was more concerned with full employment in Japan than the loud voices of western politicians. By the late 1980's the United States and Europe were both running huge trade deficits with Japan. After 15 years of trade deficits America had found herself in the position of having gone from being the world's biggest creditor nation to being a debtor nation. The rise of China over the past 20 years has given the world another Japan but this time on steroids. If Japan practices Mercantilism then China practices Supra Mercantilism: Goods are exported, imports are controlled. The currency is massively controlled, not free floating. Production is favored over consumption. With a population of 1.5 billion China has been able to give Mercantilism a whole new dynamic. What we have in the world today are two competing economic models for prosperity. We have the Western model with relies on the system of Free Trade and we have the Asian system with relies on a super sized form of Mercantilism. We have the West running trade deficits and the Asians running trade surpluses. China, Japan, and South Korea are the producers of goods while Europe and America are the consumers. Who is winning the battle between Western Free Trade and Asian Mercantilism? Asia is clearly the winner. The question going forward needs to be how we reverse a trend that is leaving America and much of the western World indebted and economically broken. What the West now calls protectionism, the Asians call Mercantilism
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