New International Cast in Depressing Drama
While the short-term risk in the U.S. bond market is that interest rates will rise due to the currency crisis, it's important to remember that the global economic environment is still highly deflationary.</br></br>For five years, the U.S. economy has played the role of global borrower and spender of last resort. Since 1985, Treasury Secretary James Baker has been trying to persuade Europe and Japan to pursue more expansionary policies, but so far they have resisted. Japan has announced numerous supplementary budgets, but then failed to spend the sums promised.</br></br>If the collapse of the dollar now forces the U.S. to introduce a more restrictive mix of monetary and fiscal policies, American domestic demand may not recover from its first quarter slump and the whole world economy could drift toward recession. In fact, the international economic scene is increasingly similar to the period 1928-1933: Growth has ceased in the Southern Hemisphere nations due to a combination of debt crises and falling commodity prices, and stock markets in the Northern Hemisphere have been booming due to surplus liquidity and expansionary monetary policy while real growth has lagged. Now the competitive devaluation policies that characterized the Southern Hemisphere during the first half of the decade are spreading to the Northern Hemisphere: Protectionism is becoming a more acceptable solution to the problem of payment imbalances. The difference between the current period and 1928-1933 is in the roles being played by the major countries.</br></br>In the 1920s, the U.S. was replacing Britain as the world's dominant capital exporter while still adhering to restrictive trade policies. Now Japan is displacing the U.S. as the world's dominant capital exporter while remaining effectively mercantilist in its trading practices.</br></br>Also in the 1920s, Britain was the first major country to slide into recession due to an overvalued exchange rate; in 1931, it devalued its way back into a recovery by abandoning the gold standard while continental Europe and the U.S. remained wedded to monetary orthodoxy. After letting the exchange rate rise sharply during the first half of the decade, the U.S. also is trying to restore its manufacturing sector by devaluing the dollar today.