Understanding Globalization Ch. 2

1. Understanding Globalization Ch. 2 Dollar Devaluations

2. Problems with Macroeconomic Management: Its Not the Economy, Stupid! • $$ devaluations destroyed international system of fixed exchange rates, established by United States at Bretton Woods during World War II (Schaeffer 36). • DDs resulted in purchase of U.S. businesses, real estate, and natural resources by foreigners (Schaeffer 36). • In the 1990s, DDs resulted global monetary instability , economic crises in countries, and persuaded other countries to adopt U.S dollar as their official currency .

3. Bretton Woods agreement • U.S. dollar world standard and fixed value of other countries currencies in relation to dollar (Schaeffer 38). • Favorable exchange rates helped WE and Japan sell their products at home and abroad. Their products were both cheaper at home and abroad than U.S. products; For example, VW Beetles and Toyotas were less expensive in WE, Japan, and the U.S, while Fords were more expensive both here and abroad;

4. Bretton Woods agreement • U.S. military spending provided countries currency to pay for imports; dollars piled up and countries tried to cash in for gold; • In 1971, Nixon devalued dollar to increase U.S. competitiveness, altered relations between Western Europe (WE), Japan, and U.S.; • U.S. discontinued use of gold standard (i.e., redeeming dollars for gold) and forced devaluation of dollar (Schaeffer 39).

5. Dollar Devaluations and Economic Consequences • $$ devaluations resulted in purchase of U.S. businesses, real estate, and natural resources by foreigners • Nixons dollar devaluation and collapse of Bretton Woods system sought improve U.S. competitiveness • Result was unsuccessful: 1971 U.S. continued importing more goods than it exported (i.e., balance-of-payments problems) posting $2.3 billion trade deficit (Schaeffer, 39), ballooned to $25.5 billion by 1980, to $122 billion in 1985, to $170 billion in 1987 (Schaeffer 44); • Consequence: Manufactures and consumers failed to respond to macroeconomic changes in the way policymakers expected. • Lets explore how nations responded to macroeconomic change….

6. Dollar Devaluations and Economic Consequences • Japanese firms kept prices modest; lowered profits to control market share; were still competitive with U.S. automakers • U.S. firms were more concerned with short-term gains to placate stockholders; • U.S. consumers kept purchasing WE and Japanese goods (Schaeffer, 45). • Decline of dollar reduced U.S. assets, Japanese firms invested $235 billion in U.S. after 1985; purchasing govt. bonds ($30 billion in 1988) Sony purchased Columbia records, Rockefeller Center in NY city, and Pebble Beach in California;

7. Dollar Devaluations and falling trees • Forest service sold timber less than cost govt. to hire rangers and build roads; (340,000 miles of road) Between 1980 and 1991, Forest Service lost $5.6 billion; (Schaeffer, 47). • Increased timber sales from $3.5 billion board ft. in 1950 to 8.3 billion 1960, then 12 billion board ft in late 1960s; what effect does this rise in product create? • Rather than sustained-yield harvesting Forest Service and private industry overcut: 61 percent and 126 percent; • $$ devaluations reduced timber prices to foreign buyers, principally Japanese firms; • Japanese purchases increased from 3billion board ft in 1986 to 4.2 billion in 1988;

8. Dollar Devaluations and falling trees • Increased U.S. timber exports resulted in higher timber prices and fewer jobs; • Sale large quantities to foreign buyers reduced surplus and competition between domestic and foreign buyers; • Higher timber prices U.S.--$250 per thousand board ft in mid-1980s to $350 in 1992 to $474 in 1993; what did this effect? • Foreign buyers insisted on buying and shipping raw logs, which effected employment in U.S. mills; Export of 4.3 billion board ft in 1988 resulted in loss of between 13,800 and 23,000 jobs; Between 1986 and 1991, 163 mills closed in Northwest;

9. Dollar Devaluations and oil • Dollars are used to buy and sell oil around the world; therefore, valid evaluations played an important role in contemporary history of oil contributing to inflation in 1970s in 1980s and 1990s. • 1971 devaluation lowered revenue of oil – producing countries as dollars they were paid with worth less than before; 1973 OPEC oil embargo due to lost revenue, which increased oil prices to more than $35 a barrel; the 1985 devaluation had the opposite effect, resulting in falling oil prices declining revenues for oil –producing countries, which resulted in war.

10. Oil – Importing Countries • While United States save money, Japanese and European save money twice. They benefited from falling price of oil and from the devaluation of the dollar ( i.e, imported oil is cheaper). As James Sterngoldnoted, "the stronger yen also slashed Japan's import bills, since oil is paid for in dollars." The US provided protection to Kuwait and Saudi Arabia. An energy economist noted that "since Germany Japan depend heavily on Persian Gulf oil(without incurring these tremendous annual military costs) American effect subsidizes the economies of its two major trading competitors" (Schaeffer, 51).

11. Oil – Exporting Countries • For oil – exporting countries, price declines and dollar devaluation drastically reduced revenues. $121 billion in financial reserves amassed by Saudi Arabia in early 1980s had vanished. • Heavily populated oil – producing countries like Nigeria, Iraq, Iran saw their economic fortunes decline. Iraq, second-largest oil – producing country in OPEC, saw its revenues declined from $26 billion in 1982 $12 billion in 1988, why was also spending heavily to wage war with Iran (Schaeffer, 52). • Conclusion: 1985 $$ devaluation contributed to lower oil prices benefiting Western Europe, Japan, the United States consumers, while contributing to war in the Middle East.

12. Global Consequences, 1990-2000 • Reducing value of dollar in relation to yen did not reduce trade deficit and job loss;, resulting in rise of Japanese prices; cost of Japanese manufacture to build a car went from $13,000 to $17,875 in 1995; • Dollar increased in 1996; for every dollar rise in exchange rate, Japanese automakers make $360 million in economic benefits; • Helped Japan out of recession in Japan; More impt!! If U.S. did not revalue dollar, Japense investors threatened to sale off bonds, which would lead to a rise of interest rates to attract new buyers; by 1998, U.S. trade deficit rose to more than $350 billion;

13. Dollarizing Economies • El Salvador and Guatemala dollarized economies in 2001; Argentina, Brazil and Lithuania “pegged” their currency to the dollar while keeping their own currency in circulation; • Two reasons for dollarizing economies—need for a stable currency and to curb inflation (Schaeffer, 56). Switch to dollars makes it difficult to raise prices, not enough dollars to make purchases; • Problems with dollarizing economies– country surrenders ability to make monetary decisions; U.S. officials make decisions w/out consulting other countries; • Create two-tiered economies---people with access to dollars obtain advantage; “Dollar apartheid” People with dollars bid up prices of local goods and services;

14. Ch. 3: Fighting Inflation in 1970s • "In the four years between 1965 in 1969, your wage increases were completely eaten up by price increases. Your paychecks were higher you are not better off," Nixon opined. • 20 million Americans in 1971 found it difficult to increase incomes to keep pace with inflation. The rate of inflation was 6% annually, a savings account offering 4 percent was losing value; would you rather be earning or paying interest? • Nixon's Wage and Price Controls--Slowed but did not curb inflation. By 1973 prices were escalating and the consumer price index rose by a new postwar record, approximately 9 percent; Oil Crisis-- in 1974 OPEC pushed up oil and price level rose to 12 percent; • Soviet crop failures (1973 and 1974) resulted in increased Inflation for food crops;

15. Fighting Inflation in 1979 • Federal Reserve used its control over money and credit to tighten supply of money and credit; By decreasing money supply, the price or interest rates that banks, investors, businesses have to pay for money rises; make it harder to borrow money, invest, or build new factories, slowing the economy and leading to unemployment. • High interest rates rewarded the wealthy, the top 10% of the population "own 72% of corporate and federal bonds (Schaeffer, 66) • Combination of falling prices and rising interest rates drove 400,000 farmers out of business during the early 1980s; Loss of family farms decimated local community;

16. High interest rates and unintended consequences • With high interest rates, foreign and domestic investors rushed to buy US bonds; • Foreign and domestic investors rushed to buy US bonds which attracted money from around the world; high interest rates attracted Latin American investors, who spent their money on US bonds rather than on development projects in their own countries. A process called “capital flight." • In 1978 before US interest rates rose, Latin American investors sent $7 billion overseas, but in 1980, Latin Americans invested nearly $25 billion overseas, most of the United States, reducing domestic investment resulted in economic crisis,

17. Fighting Inflation in 1980s • President Reagan promised to cut Taxes and increase military spending • The Reagan Administration, with high interest rates, sold bonds and raised the money needed to increase military spending, while not increasing taxes ; the government increase military spending 50%, from 201 billion a year in 1982 to $300 billion in 1987. • In 1985, foreigners (mostly from Western Europe and Japan) purchased $71.4 billion in US securities. However, the United States spent $279 billion on the military. • While Federal Reserve's high interest rate policy pulled money out of the European and Japanese economies, Reagan ministrations defense spending much of it back.

18. Western Europe and Japan And high U.S. interest rates; • Western Europe and Japan benefitted from high interest rates. • They profited from interest-rate that were higher than they could obtain a home. • They benefited from increased US military spending in their countries. • Flood of foreign currency and United States increased the value of the dollar, make it easier for them to sell their products in the United States. The stronger dollar undermined competitiveness in foreign markets.

19. Social consequences of Inflation • Inflation is a Discriminatory Economic Process • High interest rates diminished savings accounts; Govt. interest higher than S&Ls • Money flows out of S&Ls—1979 Federal Reserve raised interest rates return on three-month T-bills reached 12% in 1979, approximately 16% in 1980; money flooded out of S&Ls which offered depositors only one half or one third as much. • In 1981 investors withdrew $21.5 billion from S&Ls, five times as much as they had in 1969; Depository Institutions Deregulation and Monetary Control Act in 1980 allowed S&Ls to increase interest rates on savings accounts; however, they loan money out at fixed rates and S&Ls begin to lose money, about $4.6 billion in 1981

20. Social consequences of Inflation: Less affordable Housing and Homelessness • In 1972, housing industry built $2.4 million new homes. But in 1984 with larger demand for housing, industry built only 1.7 million homes. During the 1990s, industry built 1.1 million homes. • In 1980s, inflation declined, but a shrinking supply of houses and a growing demand for houses continued to push prices up. • Decline in number of houses available pushed apartment prices higher; • While rents rose, federal housing assistance to the poor decline. Reagan administration cut housing assistance from $27 million in 1982 lesson $8 billion in 1987 federally subsidized housing units declined from 200,000 to 15,000 (Schaeffer, 75).