Dollar crisis part 2

14. Deflation occurs when supply exceeds demand. World War I, when the began and 1917 when the U.S entered the war, U.S gold reserves rose 64%, as Europe exchanged its gold for U.S goods. Once the war end, gold continue to flow into the U.S as allies repaid their war debt. The credit base double during this time period, industrial machinery and equipment output rose by 205% and all producer durables increased by 257%. This surge in industrial capacity created an oversupply by 1926 and as a result the wholesale price declined. In 1921 the fed sold large amounts of government debt and caused credit to contract by 8% through the economy into a brief recession. When the dollar earnings of the surplus nations are deposited into their domestic banking systems, those dollars, being exogenous to those banking system, act as high powered money and spark off an explosion of credit creation. Excessive credit creation permits over-investment, which, in turn, causes excess capacity and deflation. So long as the huge US current account deficits continue to flood the world with dollars, global deflationary pressures are very likely to continue to build, as reckless credit creation results in more industrial capacity than can be absorbed at the prevailing price level. 15. Falling product prices make it impossible for businesses to repay their bank loans. A similar process occurs when excessive credit creation causes asset price bubbles in the stock market and the property market. Rapid loan growth causes asset prices to rise. Frequently banks accept the inflated assets as collateral for additional loans. This process continued for so long in Japan that the imperial gardens in Tokyo came to be considered as valuable as California. Eventually, it becomes impossible to pay the interest expense on such extraordinarily overvalued assets. The owners default, the banks then refuse to make new loans, the house of cards in asset prices begins to shake, panic sets in, the bubble pops and banks fail. 16. During 1999 and 2000, the final two years of the New Paradigm Bubble, imports into the United States jumped by $307 billion, an increase of 33% over the level of 1998. Then in 2001, US imports fell by $79 billion, or by 6.3%. The impact of that decline in US demand on the rest of the world was extraordinary. 17. That year, the economic growth rates of all the United States’ major trading partners decelerated abruptly. Stock markets experienced a spiral downward affect, commodity prices fell, and government finances came under strain all around the world. The same consequences can be expected during the second phase of the recession, when the US consumer is finally forced to stop spending more than he earns. At that time, imports into the US will decline and all those countries that rely on exporting to the United States will suffer. China will be one of the hardest hit since it a leading supplier of cheap consumer goods to the US. When China’s exports to the US decline it will not have the cash to act as an engine of growth for the rest of Asia. Asia should not harbor false hopes of China replacing the Unites States as importer of last resort. Instead, Asian policy makers should recognize that the era of export led growth will end once the US current account deficits can no longer be financed and they should act now to develop sufficient domestic demand.