The United States is currently dealing with the symptoms of Dutch disease, which could potentially infect the entire world. It may be the end of the US. Dollar dominance.
A new Dutch disease in international trade is emerging; in the future, people may refer to it as the USA disease.
The Economist released a classic model that defined Dutch disease in 1977. In the model, there is a non-tradeable sector and two tradeable sectors.
The untradeable sector includes services, whereas the tradeable sector has two components: booming and lagging.
Traditionally, the commodities sector referred to the booming sector as the extraction of natural resources such as oil, natural gas, gold, copper, silver, etc. Typically, the lagging sector was manufacturing or agriculture.
Expanding one of these resources impacts the economy. The development of the classic model coincided with the discovery of a large gas field in the Netherlands, which led to a significant decline in the manufacturing sector.
The Dutch disease occurred during a period when the blooming sector experienced a significant increase in revenues, leading to an inflow of foreign capital and aid. Therefore, the given economy’s currencies are getting stronger compared to other countries. This results in the country’s exports becoming more expensive for others to buy, while imports become cheaper, altogether making other sectors less competitive.
The onset of the Dutch disease in the economy, also known as stagflation, may appear as a temporary issue for any economy attempting to avoid recession while managing inflation. However, as it persists and ceases to be temporary, it transforms into a permanent condition known as Dutch disease.
From the second half of 2024 and the quarterly analysis of 2024, followed by the consequences of the COVID pandemic, we have witnessed a significant surge in US indices, particularly the Nasdaq. This basically refers to the US top 100 entities, specifically tech companies such as Apple, Nvidia, Amazon, Alphabet, Netflix, etc. Even after a few hikes in interest rates, the classic lagging sector continues to thrive, reaching its highest point (ATH) in history, a phenomenon that typically drowns out the manufacturing and tech industries. Therefore, we can no longer refer to this as the lagging sector. This transition from the lagging to the booming sector is referred to as direct deindustrialization.
Additionally, commodities such as gold, US oil, silver, cocoa, and copper initially experienced growth due to the QE monetary policy, and subsequently, the US Federal Reserve initiated the QT monetary policy. However, global conflicts have kept these commodities at their highest levels, and they are all experiencing all-time highs (ATHs), thereby contributing to the thriving of the traditional booming sector.
Both tradeable resources are experiencing significant growth, which can impact the economy in two distinct ways:
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These booms increase demand for labor to work in industries, as they are growing significantly. Direct deindustrialization refers to a labor shift from the lagging sector to the booming sector. The US didn't experience this shift because it was already thriving, but here comes the quarantine in pandemic time. So they had that.
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The extra revenue these businesses generate leads to a phenomenon known as the "spending effect," which fosters a habit of overspending on unnecessary items and a direct shift towards consumerism. Haven't you noticed a change in people's money-spending patterns? All these luxury brands were already established before the COVID-19 pandemic, so why aren't they more well-known, and why are people now eager to purchase their products? A spending habit has developed. Indirect deindustrialization refers to this transition from the lagging sector to the non-tradeable sector, where the spending effect increases the demand for labor. Additionally, there will be a surge in demand for non-traded goods, leading to an increase in their prices. However, due to their international setting, prices in the traded goods sector remain relatively stable.
But there is a theory published by Friedrich August von Hayek in the 19th century named the neutrality of money, or Monetary Neutrality.
Monetary neutrality refers to the idea that changes in the money supply affect all prices and wages uniformly without altering the structure of production or the distribution of resources. In this neutral state, money serves merely as a medium of exchange and does not influence real economic decisions such as production, investment, or employment.
However, Hayek argued against the traditional view of monetary neutrality. He believed that money is not neutral in practice. According to him, changes in the money supply can have uneven and unequal effects across different sectors of the economy. These changes may cause some prices to adjust more quickly than others, thus impacting the structure of production and the allocation of resources.
Hayek also emphasized that sudden changes in the money supply, especially when unexpected, can exacerbate economic cycles of boom and bust. These fluctuations may lead to market distortions and misguided economic decisions. Therefore, Hayek argued that monetary policies should be carefully implemented to prevent economic volatility.
As is obvious, an issue is trying to shine in this regard.
During the traditional Dutch Disease, there was a significant surge in commodity prices, which directly impacted the export sector. Huge amounts of money were flowing into the Netherlands, but the manufacturing sector received less care and attention during this period. The trade balance was also quite favorable, but the exports from the natural gas sector were on the rise while those from the manufacturing sector were declining. As the exports grew, a significant amount of money poured into the economy, and the strengthening of the Netherlands' currency made imports even more affordable than manufacturing. This led to an increase in inflation, which compelled the central bank to raise interest rates. This, in turn, led to a decline in manufacturing and a shift in labor to services. It caused a slow-growing problem that could end up being something huge, which it did. The reason is clear: Maybe governments get greedy, just like other humans.
However, as a result of these conflicts, pandemics, and monetary policies, the US dollar index (DXY) has become stronger and more powerful compared to other countries' currencies, thereby making the US dollar appear more expensive, as it currently does. This results in the country's other exports becoming more expensive for other countries to buy, while imports become cheaper, altogether rendering those sectors less competitive. The Netherlands experienced a similar situation.
There are also numerous differences to consider. In the US, the manufacturing sector is doing well, but it's important to view this from a different perspective, given the significant changes in the economy over the past 50 years. Back then, the industry sector was primarily focused on manufacturing goods. However, in the modern economy, technology firms play a significant role. These sectors are generating more revenue than traditional industries, despite having a lower labor percentage. Although reports have not yet indicated it, labor has shifted from manufacturing to services. led to increased consumer spending. Take note that most tech companies, like Netflix, are more like services than manufacturers. In the past, cinemas were considered a service, but today, watching movies from the comfort of your home is considered a tech company. Its nature hasn't changed; people are using it for convenience. Consider Apple as an example. Back then, people viewed telecom as a service rather than an industrial product. Currently, the US does not manufacture the phones or any of their devices; instead, they import them, making Apple just another service provider.
We have learned from history that as these firms grow, consumerism leads to the spread of Dutch diseases, indicating a growing trend of deindustrialization.
People are experiencing inflation globally these days, and a closer examination, as I previously explained, reveals that the services sector is also growing stronger. So what about the traditional manufacturing industries, such as housing and automotive companies?
Housing is at a critical juncture, while the automotive industry is flourishing thanks to the success of a single tech company, Tesla. If the situation worsens, we could potentially relive the events of the 1960s; as traders, we must recognize the recurrence of history.
