G-8 Dithers While the US Dawdles

With market-watchers the world over increasingly alarmed by spreading economic problems, much hope and attention was focused on Japan last weekend as finance ministers and central bankers of the Group of Eight nations gathered, apparently to map out a coordinated global response. In particular, the hope was that delegates would conjure a plan to save the dollar from the dustbin and stop the price of oil and food from pushing the world into crisis.

The G-8 includes Britain, Canada, France, Germany, Italy, Japan, Russia and the United States. With the exception of Russia, the members represent the “Old West” that has dominated the free-market world economy for almost half a century. As very little of promise or substance emerged, we can only hope, against all evidence to the contrary, that much was accomplished behind closed doors.

What the ministers and bankers did not explicitly acknowledge, but what must have been evident to them all, is that the source of the falling dollar, and global economic instability, is the United States itself.

Starting in the 1970s, the US began moving away from its heritage as a producer nation to one in which consumers account for 72 percent of gross domestic product. As a result, American wealth has been massively run down by a combination of inflation, unsustainable debt issuance and long-term devaluation of the US dollar. But although Americans have in fact lost their wealth, they have yet to ratchet down their lifestyles accordingly. This disconnect is the source of global economic instability.

The best way to put America’s standard of living back in line with its wealth, and to relieve the world of its economic imbalances, is through an American recession and the continued fall of the dollar. In fact, the downsizing of the American airline industry and the fall of the housing market are symptoms of this trend. But recession carries unpleasant political repercussions. As a result, politicians always prefer to see one boom replaced by another.

Clearly the US, which would largely bear the costs of recession, prefers serial bubble blowing and dollar devaluation as the best policy going forward. The question is whether it can hoodwink, bully, or otherwise convince the rest of the G-8 to go along. The problem is that that the economic stagnation which is evident in the United States is nowhere to be seen in the rest of the world.

This puts the G-8 delegates into a difficult quandary. If they follow the US’s lead to lower interest rates to avoid a recession, they risk unleashing inflation, which is already a major problem the world over. If they indicate increased rates to curb inflation, they risk driving the US into a severe recession. Similarly, to engage in a program of currency intervention to support the dollar (which the US lacks the means or desire to do unilaterally) involves the prospect for even greater overseas accumulation of dollar reserves, which has already proven to be a huge drain on national balance sheets.

So what did the G-8 do? They talked and did little. Admittedly, they discussed some laudable issues like world poverty and green alternative energy (which will most likely be the next government-financed asset boom). But there was no indication of likely action.

Instead, the G-8 policy statement that emerged at the meeting’s end included no mention of lax lending in the United States or of irresponsible central bank liquidity injections, or even of the US freeze of on-shore oil drilling. Instead, the G-8 took sideswipes at non-G-8 members, including unbridled criticism of the oil-producing countries. U.S. Secretary of State Hank Paulson had the temerity to maintain that higher oil prices were due not just to changes in supply and demand, but also to a failure by oil-rich nations to build enough wells and refineries. Talk about the pot calling the kettle black!

All in all, it was deeply disconcerting to witness the G-8’s inability to decide upon real initiatives but to seek to blame others instead. It pointed to the fact that the severe problems currently faced by holders of US dollars are likely to continue into the future.

John Browne is senior market strategist – Euro Pacific Capital, Inc. of Darien, Connecticut, USA. Euro Capital publishes the free, on-line investment newsletter http://www.europac.net/newsletter/newsletter.asp