The XXX Economy

The E= Y equation should be familiar to any person who attended a basic course in Macro Economics. The equation says that the overall production of a National Economy or “Y” is consumed during the same period of time ( Year , month...), represented by the “E” or Aggregate Demand. The identity sets a sort of closed circle by equating the Economy main parameters under any circumstance (Note even non sold products are considered a sort of non voluntary demand , or unemployment so in any case the identity holds... but lets leave that interesting debate for another post ). Whoever studied economics can skiop the next two paragraphs.

The “E” , the Demand, has three main aggregates : Some products are consumed by us as Private demand (“C”), some as Public demand (“ G”overnment) and the rest remains “I” Investments ( in simple words, the products that are used to produce more in forthcoming periods). The basic equation looks like this:

E = C + G+ I = Y

If we add other countries than the picture becomes a bit more complicated as the circle is opened and the country can sell part of its production abroad ,as Export “X” or to bring products from abroad, Imports “M” . The former is added to the demand and the later is another source of products so it is subtracted from the demand. The new equation looks like this

E = C + G+ I + X – M = Y

Now, back to Planet Earth.... the ongoing recession is a classical case of a Demand crisis ,as the capacity to produce goods and services ( Potential Y) is much higher than what actually people are ready to buy. It is important to note that THE ABOVE EQUATION STILL HOLDS but with unemployment, spare capacity , piled stocks etc.

In order to increase the E and thereby the Y and employment , governments have tried to work with the equation above : First by increasing the “G” generating huge deficits in their accounts ( 800 billions in the US and so on) ended with austerity measures . Another policy applied was to encourage “I” by reducing interest rates ( only yesterday the Bank of Japan announced that it will reduce its interest rate to 0 ) and consumption “C”- ended with record balance obligations in Central Banks loaded with dubious stuff . Least and not last the explicit attempts to maintain asset prices is aimed to sustain “C” (If people feel rich , they consume more ,,, that at least what the theory says) - the end is a more poor consumer , with less employment and less wealth. .

It is natural that All these policies seem to have some influence, but very limited due to the special circumstances and because they do not address what THIS BLOG AND OTHER PEOPLE have been saying for a long time : ONLY A POLICY OF REDISTRIBUTION CAN GURARANTEE A BALANCED, JUST AND SUSTAINABLE ECONOMY. Please read previous posts in case you don´t believe....

Since the above policies are deemed to fail ( as predicted ) and the evidences are against the Green Shots illusion are piling, the last bullet in the policy makers arsenal is to try and get some demand form the outside world , i.e. encouraging Exports (X). The new paradigm is X X and More X ! Though, since it impossible to force sovereign countries to buy your stuff, you must try to convince them by lowering your prices which is equivalent to make your currency cheaper.

It is not that simple to manage currency rates since currency markets are supposed to be “floating” and “free”. Therefore Central banks make use of a serie of methods to lower their currency : Announcement of lower interest policies ( QE 2 in US ) , Lower interest rates ( Japan) , Purchasing of currency ( Japan, Switzerland, Israel) or direct control of exchange rates ( China) . That is what I call the XXX economy, since the export lead recovery is just another pathetic XXX sign , a sort of “we know what it´s there but we don´t want to know about it “ attitude. Nude reality is there after all.

These steps are part of the background for the last violent in the currency markets ( Euro Dollar from 1.6 to 1.18 and back to 1.38 in question of months... high value of the Japanese Yen despite the weakness of its economy ... etc. ) in the last months, and the best is yet to come. Anyhow, the managers of that game are conscious that their efforts are futile : If all the countries are trying to make use of export as a way out of the crisis and all of them apply the same devaluation policy, we will be soon back in the starting point and no effective devaluation will take place.

The futility of currency devaluations lead to an escalation of the attempts to generate demand, tht time by avoiding competition from abroad in stead of looking for new markets . History tells us that in the end some countries simply close their gates to foreign competition in order to maintain some internal demand for its industry. According to some economists, that “Beggar Thy Neighbor “ policy in the 30 reduced drastically the international commerce and exacerbated the impact of the financial crisis as Former US Secretary of Labor R. Reich recently said

“Smoot-Hawley here we come. Willis Hawley and Reed Smoot, you may recall, sponsored the Tariff Act of 1930 that raised tariffs to record levels on more than 20,000 imported goods. The duo said this would protect American jobs and revive the economy. It did the reverse, plunging the nation ( AND THE REST OF THE WORLD .... Blogger note ) into an even deeper depression....”

I could not find better words to end that blog. Despite the gloomy perspective we should not forget that a progressive and reasonable way-out is available. It´s only a matter of consciousness and choice.