Why did the West deindustrialize?
How much of the deindustrialization can be explained by various nations having overvalued currencies?
Suppose we wanted to build an International Relations (IR) model that explains the deindustrialization of the West. Can this be done?
This is a difficult subject, where building a useful model is undermined by the unknowability of where the leadership made a mistake, versus where they had incomprehensible motives. For instance, over-valuing the USA dollar, was that a mistake, or was it a case where the leadership of the USA was loyal to some group that benefited from an over-valued dollar?
Have you seen WTF Happened in 1971?
The Bretton Woods system was set up in 1944:
https://en.wikipedia.org/wiki/Bretton_Woods_system
Under this system, currencies had a fixed rate of exchange. This helped establish an unusually stable environment and perhaps contributed to the famous 28 years, 1945-1973, the greatest economic boom in history.
In 1946, the USA dollar was set equal to 360 Japanese yen. Assuming that value was correct for 1946, it would have been incorrect by the late 1950s, as productivity in Japan grew more quickly than in the USA.
The same case can be made versus the USA dollar and European currencies, but the case is especially clear with Japan. At nominal rates, in 1965, Japan had the same GDP as Peru. This almost certainly means that the Japanese yen was under-valued. The true Japanese economy was obviously larger than the economy of Peru.
By the 1960s, the USA dollar was overvalued. We know this because the USA went from having a trade surplus to a trade deficit. By the mid 1960s, people had started joking about the American "rust belt" which was the first sign of deindustrialization. The double recession of 1958 and then 1960 seems to have been a crucial turning point. In 1959 the New York Times ran an article that pointed out that the recovery of industrial jobs was going at a surprisingly slow speed. After this double recession, the USA was flooded with imports from Europe and Japan. 1958 was the peak year for wages of men under the age 25. Perhaps this is why 1958 was the peak year of the Baby Boom. It had been an era where an 18 year old could graduate from high school and immediately get a good paying union job, and then immediately get himself a nice apartment, all of which made it easy for teenagers to get married and have children. But this whole system began to unwind after 1958.
And yet, the USA financial sector began to grow rapidly, as a percent of the GDP. A strong currency is terrible for industry but great for those who lend out money, at interest. The stronger the currency, the lower the interest rate that can be offered, since a very strong currency is presumably protected from inflation.
There is, of course, the great puzzle that during the 1960s inflation was rising even though the trade deficit was increasing. This is difficult to explain. One possible explanation is that the over-valued dollar was super charging those economies, all over the world, that exported to the USA, and so it was all of those other, super charged economies, that were competing for resources on an increasingly integrated world market, such that the USA finally found that its dollar, even overvalued, was not overvalued enough to snuff out that inflation. The only way to get that inflation under control would be a worldwide recession deep enough to cool off all of the economies, all over the world, that exported to the USA, and that happened with the 1973 OPEC crisis.
But also, Nixon ended the Bretton Woods System in 1971:
https://en.wikipedia.org/wiki/Nixon_shock
He pushed through a 10% devaluation of the USA dollar, relative to all of the major currencies. This contributed to inflation in the USA, while slowing the growth of exports in some of the nations that had been exporting to the USA. This is especially noticeable in Germany.
In the 1980s, President Reagan advocated for a very strong dollar, but given how advanced Japan and Germany had become, this was a disaster of a decision. The USA no longer had the kind of huge technological lead that would have allowed USA industry to out-compete Japan and Germany, while also carrying the burden of a very strong currency. During the 1980s the USA lost 2 million industrial jobs, while the USA financial sector grew dramatically, as the strong currency delivered unexpected profits to the financial sector. But the financial sector was unable to generate the big exports that industry used to produce, and so the USA trade deficit got worse. The USA trade deficit, during the 1980s, was almost entirely with Japan, Germany, and those nations that sold oil to the USA. (China was not yet a factor.)
So it is worth asking, was this a mistake, or a set of deliberate decisions made by USA leadership? 1945-1992: None of the USA presidents seemed to have any intuitions about how the economy actually worked, and certainly none of them seemed to have any awareness of what the various complex side effects were of having an over-valued currency. Indeed, there was a wide spread sense that having a strong currency was always good, never bad -- there was a lack of awareness about how much this would damage American exports.
It is worth asking whether President Clinton was different. He was among the first to realize that the USA needed to invest in itself. He allowed the dollar to reach its all time low point against the Japanese yen, in April of 1995. But he lacked a political mandate to introduce a new world order, that might have allowed the USA to close its trade deficit, or re-industrialize. And after 1995, when the first Dot Com boom began, it seemed reasonable to do nothing, but simply enjoy the benefits of that boom.
Does this story also apply to Europe? On a smaller scale you can put together a similar case for the previously great imperial centers in Europe, that they tended to have overvalued currencies relative to their former colonies, who remained major trading partners.
So if you'd like to build an IR model that can explain why the United States and West de-industrialized, you'd first need to decide when and why you can determine if a leader is making a mistake, or if a leader is deliberately doing something that helps one domestic group, even if it hurts overall welfare. Did USA leaders deliberately sacrifice USA industry, because they wanted to help the financial sector? Or was it a huge and tragic mistake?
I've already written a lot, but of course, I've barely scratched the surface. This is a large and complex topic. I could also write about the establishment of petrodollars in 1973, and how that tended to again over-value the dollar in the long-term, while offering a quick fix for inflation in the short-term.
And of course, a focus on currencies won't explain some of the other big mysteries. If merely having a weak currency was the secret to success, why did Taiwan do so well, but Africa did not? Africa has some of the weakest currencies in the world, but this has not brought wealth to Africa.
Also, there is the great mystery of why, exactly, the USSR fell apart, even when it started to implement some of the same reforms that led to such success in China. I wrote about that issue here: