This file is a short single-author economic essay. Written in July 2000, it is an Austrian-style diagnosis of the late-1990s U.S. boom, treating the strong dollar, trade deficits, debt growth, derivatives, equity inflation, and Federal Reserve policy as interconnected signs of an unstable credit expansion rather than a durable “new economy.”
Sennholz begins from what appears to be a contradiction:
One of the great economic puzzles of our time is the international strength of the U.S. dollar, the huge U.S. trade deficits notwithstanding.
The essay’s main thesis is that this strength is not proof of permanent American productivity gains or Federal Reserve mastery. It reflects international capital inflows that can reverse. The hoped-for “soft landing” is therefore structurally implausible, because the boom has been built on monetary expansion, leverage, and malinvestment.
It is well-nigh impossible, they contend, to execute a soft landing of an economic boom that is the longest since records began more than a century ago.
The key conceptual move is Sennholz’s use of Böhm-Bawerk’s analysis of the “passive trade balance.” Trade deficits do not automatically weaken a currency if foreign capital is flowing in. On the contrary, the capital account can sustain imports, asset markets, and exchange rates simultaneously.
As long as a country attracts foreign capital, its current account, which covers imports and exports of goods and services, tends to be “unfavorable” and its currency remains strong.
He then reads Southeast Asia’s 1997 crisis as a warning: capital inflows, pegged currencies, central-bank credit, real-estate speculation, and foreign withdrawals formed a cycle that turned apparent prosperity into collapse. The United States, though vastly larger and issuer of the world’s reserve currency, is said to display the same pattern in amplified form.
The situation may be comparable in the United States.
The middle of the essay accumulates evidence: a rapidly expanding M3, record current-account deficits, household and corporate debt, share buybacks financed by borrowing, and unprecedented margin debt. Sennholz’s emphasis is not simply on “debt” as a moral failing, but on debt as the financial mechanism by which asset prices are kept aloft. Derivatives intensify the danger because they concentrate leveraged exposure in banks, brokerages, and insurers.
Derivatives are the single greatest danger, especially to financial institutions.
The Fed’s predicament follows from this structure. If stocks fall and foreign capital flees, defending the dollar requires higher rates; cushioning recession requires lower rates. Either path worsens one side of the crisis. Thus the institution credited with prolonging prosperity becomes trapped by the conditions it helped create.
The dangers of a looming recession, together with a weakening dollar, would present the Fed with the choice of two inevitable evils.
Sennholz also explains why the dollar may have seemed stronger than its fundamentals warranted: the euro’s weakness, European welfare-state rigidities, and capital flight to Wall Street. This comparative argument matters because it makes dollar strength relative and temporary, not intrinsic. If Europe reforms, he suggests, the euro could recover and reveal the dollar’s overextension.
The essay’s polemic against the “new economy” is historical. Sennholz does not deny that computers and the Internet improve productivity; he denies that such gains justify speculative valuations. Earlier “new economies,” in the 1920s and 1960s, also combined optimism, political self-congratulation, and temporary prosperity before painful readjustment. The phrase therefore becomes, in his reading, an ideological cover for cyclical excess.
The conclusion states the Austrian causal claim most directly: monetary manipulation distorts the market’s structure of production, and recession is the process by which those distortions are corrected.
The economic maladjustments due to many years of monetary manipulations by the Federal Reserve System are the prime source and mover of the inevitable readjustment.
For Sennholz, the problem is not merely bad timing by central bankers but the belief that central banking can override market correction. Policy can lessen burdens by allowing adjustment, but it usually prolongs distress through further credit expansion and deficit spending. Japan’s post-1990 stagnation serves as his final cautionary example. The essay ends with its governing aphorism:
Political intervention is ill-designed for soft landings.
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