Good Layman's guide to the financial crisis

[Dayuhan]

Herr Fuchs…

I asked:

How can you have an industrial recovery while consumption falls? What do you propose to do with that increasing industrial output?

And you replied:

Investment in industrial capital stock. Paying back debt with trade balance deficit.

I think this reveals a certain lack of comprehension about how business – not economics, but business – functions. Investment in capital stock doesn’t happen because some beady-eyed economic policy gnome decides that it ought to happen. It doesn’t happen because a government decides that investment in capital stock is desirable. It doesn’t happen because society decides to applaud investment in capital stock. It happens because individuals or companies with the capacity to invest determine that an opportunity for profitable investment exists. Decreasing consumption does not present an opportunity for profitable investment, because you don’t profit from your investment unless somebody somewhere buys the products or services that you invest in producing.

There is no choice between consumption and production because you can’t have one without the other. If production exceeds consumption, inventories rise. When inventories rise to a certain point, factory orders cease and production stops. Factories don’t produce goods because society esteems production, they produce goods because they have orders for goods… from consumers, or from people who believe they can sell the goods to consumers.

Our industry - especially the middle-sized companies (SME) - is very influential, and the share of industry at the GDP is by half greater than in the U.S.. The result is a huge trade balance surplus instead of deficit (this imbalance was roughly doubled by the Euro currency which is undervalued for us).

Confusion of cause and effect. German industry isn’t strong because SMEs are influential, SMEs are influential because German industry is strong. As you point out, this strength is supported by a favorable currency environment. The US economy didn’t assume its current shape because of policy decisions, it assumed it because an artificially overvalued currency created a long term disincentive to domestic production of goods.

You're patently wrong about German exports depending on U.S. consumption because said German-U.S. exports are too small.

Exports depend on foreign consumption. Part of this is the US, part is other places… but if German consumption is constant, German production cannot increase unless overall consumption increases or German goods take market share from other producers in other markets (meaning production somewhere else has to be reduced).

Exchange rates are only a part of this competitiveness. Germany did not cheer the "post-industrial services economy" for a generation. It still cheers its SMEs and their competitiveness. In fact, we underwent a series of painful industrial competitiveness-increasing reforms while we produced major trade balance surpluses. Our education system is trimmed for a huge output of skilled industrial labour and university graduate engineers.

Again, you confuse causes and effects. People don’t invest because they want to be cheered, they invest to make money. Societies will cheer whatever gets results, which is conditioned by the macroeconomic incentive environment. If your currency exchange rate favors export production, export production will succeed and people will cheer it. If your exchange rate environment penalizes exports and subsidizes imports, domestic production will falter, it will not attract investment, and nobody will cheer.

The problem for the US has been that because the dollar is a global currency, both produced and consumed outside the influence of US policy, the ability of policy to influence monetary factors is severely constrained.

I think you drastically overestimate the ability of policy to control economic factors, and the ability of government in a democratic society to develop policies that may not be found congenial by the voting public. It’s terribly easy to make pompous declarations about what the Americans or Germans or Chinese or anyone else should or must do. Influencing them to do it is rather more complicated.