Jan 9, 2003
The increase in the price of gold reflects uncertainty in the outcome of the planned invasion of Iraq. War increases costs. Commodity prices go up in anticipation of disruptions in supply. The increased risk of loss causes fearful insurers to demand higher premiums, or refuse to provide any coverage at all. Oil tankers are kept in port for lack of insurance. The dislocations of war tend to cause inflation, and this increases the rate of interest demanded by lenders. There are further factors, e.g. the fear of a fall in the relative value of the US dollar. The US dollar declines as the average price of oil increases. The unstable economic and political situation in South America, especially as it affects the oil industry of Venezuela, contributes to a world oil shortfall, and puts upward pressure on oil prices.
The US is now the greatest debtor nation in history by far, and is uncomfortable to find it must attract 50% or more of its routine borrowings from European and Asiatic sources. The Europeans have begun to find the US currency, along with other US assets, less attractive. The amount of US debt assumed by Europe has fallen from USD 50 billion in 2001 to only USD 400 million in 2002. The question is where this is to be made up, if not in Asia. The Japanese have traditionally been bidders for US bonds, but one must wonder if this can continue indefinitely.
Interest is the fee paid for the use of money. It is usually based on an annual rate, expressed as a percentage. A loan of RM 100 for one year, at a rate of 10%, would require on the due date repayment of the principal amount (RM 100) plus the interest (RM 10), for a total payment of RM 110 on the due date. This is an example of a simple commercial loan, and the true interest rate is indeed 10%. But when a consumer makes a loan by paying with a credit card, or signing a long-term loan agreement to buy a major item such as a car, the true interest may be much higher, because the loan and interest are repaid in monthly installments, and the full amount of the money is not available for the entire period of the loan.
Inflation is an upward trend in the price of basic commodities. It is usually measured by changes in the price of selected goods and services, such as food, clothing and transportation. When such things as gasoline and steel cost more, the consumer has less to spend on other items, and this causes consumer demand to fall. Because the US economy is a consumer-oriented economy, any reduction in consumer spending is a direct threat to the overall health of the country. Inflation has not been troublesome for the past fifteen years or more.
There is a historical relationship between the rate of inflation and the rate of interest. Lenders usually demand an interest fee that exceeds the amount of inflation by 3% or more. Governments are sensitive to their creditworthiness because it directly determines the interest they must pay on their bonded indebtedness.
Monetary policy provides a means of regulating the national economy. When the economy shows signs of becoming too active, threatening to introduce inflationary pressures, the interest rate can be raised to reduce the demand for loans. When the economy slows down, the interest rate may be lowered as an incentive to make loans that stimulate business activity. In addition, a government may spend money by signing contracts for goods and services in an effort to generate increased economic activity. In addition, income taxes and other burdens on the economy can be reduced, to put additional funds in the hands of the consuming public.
We may now apply these ideas to the present world situation. Because the US has the largest economy in the world today, it is important to observe its operation, if only from a distance, since US activity affects the whole world. It is a superpower economically as well as militarily, and it exercises this economic superpower in its own self-interest.
During the past year the US Federal Reserve has lowered interest rates eleven times in an effort to stimulate the US economy. These efforts have not been sufficiently effective to overcome the negative effects of reduced tourist travel and aircraft demand. Since 9/11 the US government has accelerated its military activity in a unilateral "war on terrorism." This decision to act precipitately and independently, while failing to join in UN cooperative activities, has introduced a concerned uncertainty onto the world economic scene.
The movement of US military equipment and personnel to the Middle East and Southeast Asia has raised the national budget such that what was a large surplus has now become an enormous deficit. The planned invasion of Iraq is expected to cost at least USD 50 billion, with perhaps four times that amount required to maintain a permanent force there. All of this expense must be paid for, and the money must be borrowed in the world capital markets through the sale of bonds.
The US sells its bonds by auction through licensed primary dealers, and overseas buyers generally bid for half or more of the bonds offered. Recently, however, the large debt of the US has begun to trouble overseas lenders, and they have become more moderate in their bids. The Europeans especially have shown a sharp decline in the amount of their US bond purchases over the past year. The value of US currency has slipped noticeably against the Euro in recent months, suggesting a loss of confidence in its future as a medium of international exchange. The lack of interested buyers of US bonds tends to put upward pressure on the interest rate that must be paid, increasing borrowing and carrying costs to the US taxpayer.
The international bond market is competitive, and the countries with strong economies contest for the available supply of capital. When the interest rate on US bonds must be increased to attract buyers, it puts pressure on a low basic rate established domestically by the Federal Reserve in its regulatory efforts.
The decline in tourist activity has had a serious negative effect on all aspects of the aircraft industry, affecting everything from aluminum producers to the national balance of trade. Loss of aircraft export sales represents a major portion of the deficit in the US balance of payments. Increases in the price of fuel have put upward pressure on airline tickets, and all other types of transport as well. This increase in costs tends to be inflationary, with the consequence that people find it difficult to maintain an accustomed standard of living.
During periods of inflation labor unrest increases, as workers strike for increased wages. Employers, in a climate where workers are terminated to trim costs, are forced to agree to wage demands or face prolonged shutdown. Often the dispute cannot be resolved and bankruptcy of the firm results. As the number of unemployed people increases, a loss of consumer activity appears in statistical reports as lower retail sales. As retail sales fall, producers are forced to idle plant facilities and terminate more workers.
Inflation tends to increase costs and wages simultaneously, while depressing economic activity that results in higher unemployment. Higher costs drive wages up, and the higher wage costs require increased prices of manufactured goods and services. This is the unhappy spiral of inflation, a squeeze for which those on fixed incomes have no defence.
The US President has introduced an economic stimulus package of USD 675 billion, at a time when the US national debt is already about USD 6. 4 trillion, an increase of just over 10% in US indebtedness. Such a foolhardy move indicates the US economy is facing serious problems. These problems have been directly caused by a long and continuing failure in US foreign policy.
The decision to support Israel blindly led to the present world situation, but the US refuses to see this is the primary cause of the problem. The American administration, rather than address this root cause, insists it will find a resolution in the destruction of Iraq, and after that, further world-wide police activity in an effort to provide protection and security for US citizens. Meanwhile Israel continues to occupy Palestinian land under US protection.
An exasperated world sits sadly and anxiously by, watching wanly as the US bets the farm defending a craven racist regime.
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