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Institute ranked the usa third in the world, behind only Hong Kong
and Singapore, in its assessment of economic freedom, which was
understood to be a function of institutional support for competition,
property rights, personal choice and sound money. In contrast, China
ranked 86th, a consequence of its state-directed pattern of growth.
Nevertheless, the comparative advantage of cheap labour ensured that
China became very important as a source of manufactured goods. The
resulting contrast was readily apparent in the computer industry, with
the usa concentrating on higher-end machines, and China on the
cheap production of lower-end counterparts. As a result, in 2004 China
was the leading world exporter of small, labour-intensive computers.
Low costs led to major American investment in China, while by 2004
overall imports from China were responsible for 2 per cent of the us
gross domestic product. The trade deficit with China, which in effect
imposed a tariff on imports by undervaluing its currency, was a record
$202 billion for 2005. This helped China to manage its transition
away from Communist economics, but at the cost of a heavy burden
to the usa.
Economic growth was not a constant across sectors. Acute competi-
tiveness ensured that comparative advantages on the part of other
producers rapidly affected American concerns. This hit heavy industry
particularly hard; it suffered from a number of problems, including
the impact of the value of the dollar in export markets and relatively
high wage rates. As a consequence, there was recession, closures and
unemployment in traditional areas of heavy industry, which were con-
centrated in the North-East and the Mid-West. This played through into
the detailed configuration of political loyalties and issues, and also
affected internal migration patterns. National policy was also affected,
as with the pressure for quotas on steel imports in the early 2000s,
which was successful in the short term.
p ol i t i c s 151
Trends in the world of finance were also a crucial backdrop to polit-
ical developments. In particular, generally cheap money eased borrowing
and helped the usa to weather economic problems without shifting
too much of the burden onto middle America (not that those made
unemployed would have agreed). Since the dollar was the world s prin-
cipal reserve currency within the period covered by this book, the usa
has not had to hold official reserves as large as other states; in fact, in
2005 it held only 2 per cent of world reserves, a small percentage given
the size of the economy. Japan, China, Taiwan, South Korea, Hong Kong
and Singapore each held considerably more. This situation helped to
increase sensitivity to financial, as well as economic, relationships
between the usa and East Asia. In July 2005 China not only revalued
against the dollar, but also announced that the yuan would no longer be
pegged to the dollar, instead floating it against a number of currencies.
The usa was a major beneficiary of net capital inflows throughout
the period ($102 billion alone in September 2005). This lessened the
money available for other states, with detrimental consequences for
their economy. From the 1970s the greater yields enjoyed by oil-produc-
ing states, particularly Saudi Arabia, were invested in the usa, a crucial
aspect of the relationship between the two economies and states.
Similarly, the beneficiaries of East Asian economic growth, particularly
Japan, invested in the usa, thus helping the Americans to finance
imports from East Asia. The inflow of foreign capital was encouraged
with the ending in 1984 of the withholding tax on interest on income
paid to non-residents. This inflow led to the large-scale purchase of
Treasury bonds, which reduced bond yields and ensured that the federal
government could borrow in order to cover expenditure.
The practice of coupling large budget deficits with tight monetary
policy, a policy particularly obvious in the 1980s, helped to keep inter-
est rates attractive in the usa relative to other parts of the world.
Attractive interest rates kept the demand for the dollar strong in
foreign exchange markets, since the rest of the world saw the dollar as
a ticket to high interest rates. In the late 1990s and early 2000s, in
contrast, interest rates were kept low in order to encourage growth,
but foreign central banks still bought dollars in order to keep their own
currencies low and thus aid exports. A strong dollar kept imports
152 a l t e r e d s t a t e s
cheap, holding down the price of oil, and cheap imports kept workers
content with lower wages, paving the way for a rejuvenation of capi-
talism. Thanks to the capital inflow, banks and other institutions could
lend money for housing and personal expenditure, both readily and at
low rates of interest. This helped to maintain economic growth and
restore confidence after crises, such as the nasdaq stock bubble burst
in the spring of 2000; it also cushioned politicians and people from the
consequences of their own profligacy. Having fallen below 11,000 in
June 2001, and below 8,000 in 2003, the Dow Jones Industrial Average
stock-market index rose above 11,000 in January 2006. The inflow of
capital was also a product of the credit-worthiness of the economy and
its underlying strengths; there was a sense too that financial manage-
ment was more open, and less susceptible to political pressures, than
the situation in other large economies. This openness encouraged
confidence in American assets.
Government was dependent on easy money in order to sustain the
borrowing booms that kept consumers happy; they also helped to fuel
demand and thus both growth and imports. Consumers (in work) also
benefited from the weakness of protectionism, for inexpensive
imports in the 2000s increasingly from China helped to limit price
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