Lords of Finance

By   /   January 3, 2014  /   12 Comments

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The system today is as unstable and as destabilising as the gold-standard system was in the 1920s. We saw a hint of that instability in the Global Financial Crisis of 2008. But only a hint.

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This week I have been reading Lords of Finance (Liaquat Ahamed, 2009), subtitled “1929, The Great Depression, and the bankers who broke the world”. The book spans the period from 1914, and the real villain of the piece is the monetary gold standard, rather than the four central bankers who are the very human protagonists of this story.

Indeed Ahamed tells a sympathetic tale about how the best financial brains in the world had no real idea how international capitalism actually worked, but nevertheless they (and everyone else) believed that they could manage the system by following a simple set of rules.

My comment here relates to the gold standard and its modern alternative (the system of floating exchange rates), and how both are self-defeating rather than self-regulating.

Money is both a thing that each of us thinks about most days, and a social technology that almost nobody understands. Money is so linked, and in different ways, to our actions, interests and values. It is hard to think in a disinterested (ie detached) way about money.

Our prevailing view of money dates back to the philosopher economists of the 1690s to the 1780s: especially John Locke, David Hume, and Adam Smith. Theirs was a simplistic view; that money is either gold or silver, and that the value of a thaler or a pound or a shilling was determined by how much gold or silver was in a coin of that denomination.

David Hume made a number of significant comments about money. He noted, correctly, that it was essentially the lubricant of commence, that works by circulating (and does not work when hoarded). He also suggested that money was a “veil”, meaning that it didn’t matter whether there was much money or little money in the world, because prices would always adjust to how much money there was. These two beliefs were somewhat contradictory, because we all understand that if a car has insufficient lubricant, then it will not go very far.

Hume described the putative self-regulating economic mechanism (like a thermostat) of the gold-standard, known as the “price-specie-flow mechanism”. Payments between countries would be made in gold coin or bullion. Countries with trade surpluses would accumulate gold, and countries with trade deficits would face diminished gold reserves. Inflation would be automatic in the surplus countries, and price deflation would be automatic in the deficit countries.

The result would be falling production costs in these deficit countries and rising costs in the surplus countries. So those deficit countries would run trade surpluses and the surplus countries would become deficit countries. (Although gold is today replaced by “fiat” currencies such as the Euro, this is precisely the reasoning behind austerity in the Eurozone; to create deflation and falling production costs in Greece, Spain and Portugal; and, implicitly, inflation and rising production costs in Germany.)

In the alternative floating-currency system, the inflation requirement for surplus countries is replaced by an appreciation requirement. And the deflation requirement for deficit countries is replaced by a currency depreciation requirement.

Neither system can work in its pure form, in part because individual countries’ authorities resist the key mechanisms: inflation; deflation; currency appreciation; currency depreciation. (While we note that Germany is not exactly promoting inflation as its part of resolving the Euro crisis, Japan is a surplus country that today is promoting inflation.) The gold standard also never worked because inflation and deflation are not automatic consequences of a country having more or less money.

The gold-standard, as a mechanism, was rescued in the nineteenth century by bankers. Debt is absent from the philosopher-economist version. Debt is reality, however. Humans tend to lend rather than spend their accumulations; a matter of money-love unforeseen by the economists.

The gold standard ideal morphed into a variant system whereby gold need not flow at all; rather gold would be lent back to deficit countries by surplus countries.

The debt-variant gold standard had no automatic mechanism to resolve the debt accumulations. Enter the central bank and the central banker. The new lords of banking would be required to set interest rates according to the following rule: interest rates would be raised in deficit countries (creating a “dear-money” environment) and would be reduced in surplus countries (creating a “cheap-money” environment). People in the cheap-money countries would be incentivised to save less, borrow more and spend more. People in the indebted dear-money countries would be incentivised to save more, borrow less and spend less. Thus the debt imbalances arising from unbalanced trade could be resolved.

It was widely believed that, in the heyday of the gold standard (1870-1914) this system worked as well as any system involving humans can possibly work, and that it was the single most important facilitator of world economic growth. So, after World War I, the big challenge of the 1920s was to reinstate this system. The result of this misplaced endeavour was the Great Depression. The world’s gold became concentrated in two countries – the USA and France – and neither had any intention of running the large trade deficits that the system required of them.

The gold standard came to an end in 1971, but, since the 1980s, the central banks of the world have been playing essentially the same game as they played in the 1920s. Today’s lords of finance manage interest rates in ways that, in practice, exacerbate rather than resolve the debt imbalances between countries. Thus the world is awash with financial assets (ie debt), whereas the economic model says that deficit countries like New Zealand and the United Kingdom should have depreciating currencies, and surplus countries like China and Germany should have appreciating currencies.

In the world today, much additional debt flows into debtor countries (with higher interest rates), adding to their debts, and much additional credit accumulates in creditor countries (with lower interest rates), adding to their credits.

The system today is as unstable and as destabilising as the gold-standard system was in the 1920s. We saw a hint of that instability in the Global Financial Crisis of 2008. But only a hint.

The reality is that, whatever the global monetary system, capitalism must always feature endemic lenders and endemic borrowers, and that imbalances simply grow until either a debt crisis or a debt amnesty takes place. When inequality and miserliness are pervasive, the pace of destabilisation tends to be much faster than when incomes are more equally distributed.

Our financial lords – the men and woman whose jobs are to promote systemic balance in the global financial system – need to attend more to the actual problem of inequality, and less to the hypothetical problem of inflation. Indeed inflation is sometimes part of the solution.

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12 Comments

  1. Marc says:

    “The result would be falling production costs in these deficit countries and rising costs in the surplus countries. So those deficit countries would run trade surpluses and the surplus countries would become deficit countries. (Although gold is today replaced by “fiat” currencies such as the Euro, this is precisely the reasoning behind austerity in the Eurozone; to create deflation and falling production costs in Greece, Spain and Portugal; and, implicitly, inflation and rising production costs in Germany.)”

    Good grief, have another look at what you wrote there, Keith Rankin.

    Is that not somewhat contradictory?

    As for the rest, I prefer to read Krugman or other experts, rather than this poorly put together “analysis” of what?

    Gold standard or fiat money, they are not the major problems in themselves, and many currencies are these days not as freely traded as some believe. The whole finance and currency business is much more complex than presented here, same as trade and trading terms.

    It is true of course, that those that have accumulated wealth, have the means to potentially grow this quite fast, while poverty tends to be a state for those that suffer from it, that is damned hard to ever get out of.

    But we have the “American Dream”, have we not, or the “Kiwi Dream” for all those aspiring migrants.

    • Draco T Bastard says:

      Good grief, have another look at what you wrote there, Keith Rankin.
      Is that not somewhat contradictory?

      Nope, it isn’t. It’s quoted out of context.

  2. Marc says:

    Inflation or deflation in the European Union, Eurozone countries and some leading economies:

    http://www.inflation.eu/inflation-rates/cpi-inflation.aspx

    Inflation and deflation are hardly that substantial in the Eurozone, and the existence of one currency takes out the exchange issues. Debt of course is an issue to those with low growth and deflation, but interest rates and other measures can be used to address that to certain degrees.

    ‘Deflation’ as explained on Wikipedia:

    http://en.wikipedia.org/wiki/Deflation

    “Economists generally believe that deflation is a problem in a modern economy because it increases the real value of debt, and may aggravate recessions and lead to a deflationary spiral. Historically not all episodes of deflation correspond with periods of poor economic growth. Deflation occurred in the U.S. during most of the 19th century (the most important exception was during the Civil War). This deflation was caused by technological progress that created significant economic growth. This deflationary period of considerable economic progress preceded the establishment of the U.S. Federal Reserve System and its active management of monetary matters.”

    There is more to it all than there appears at first sight.

  3. Marc says:

    “The reality is that, whatever the global monetary system, capitalism must always feature endemic lenders and endemic borrowers, and that imbalances simply grow until either a debt crisis or a debt amnesty takes place. When inequality and miserliness are pervasive, the pace of destabilisation tends to be much faster than when incomes are more equally distributed.”

    This is part of the core problem, and it goes back to human behaviour. Those that accumulate wealth will tend to only spend it on personal use to smaller degrees, and “invest” most to create yet more wealth. That happens amongst individuals, shareholders, corporations, private equity investors, banks, states that lend money to others and so forth.

    Hence those that are poor as people or nations, they tend to end up remaining dependent on the “investment”, bail out or other “assistance”, of those that have accrued monetary and other wealth, to keep paying their debts, to survive and try to “shape up” and “perform” somehow, in this geopolitical economic and fiscal system, to perhaps move “ahead”.

    But few ever manage to improve their situations, and everything else is relative anyway, hence we have the scenarios we are confronted with.

    So the state and interstate organisations must play a vital role to address these injustices and tendencies, as otherwise we will not only continue with booms and busts, but also economic busts in the form of economic crisis on national and global scales.

    What can be done within New Zealand may address certain local issues, but it will hardly change the global situation, and will not take New Zealand out of it’s trade and other dependencies. Before that can even be considered (a solid change, even just nationally), the public must be convinced and vote for it. Will they though, under present circumstances? It starts with being properly informed and educated about all these matters, most are not.

    • Draco T Bastard says:

      Those that accumulate wealth will tend to only spend it on personal use to smaller degrees, and “invest” most to create yet more wealth.

      And that is the biggest load of BS ever.

      As the rich get richer they look for ways to guarantee their wealth. The solutions that they seek out are government borrowing and large assets where they get a government guaranteed income such as state assets in power and telecommunications which are vital to the prosperity of the nation and so the government can’t allow them to fail. Also, because state assets are usually a demand monopoly (everyone needs it) they get to boost charges, and thus profits, as much as they like.

      Government borrowing is especially evil. The government is sovereign and thus can create its own currency removing any need to borrow. The rich oppose this and they even come up with valid sounding reasons. All those reasons are invalid. The only reason why the rich oppose the government creating its own money is because it removes their government guaranteed income from the rest of the population.

      • Marc says:

        Yes, they certainly tried to solve fiscal problems in the Waimar Republic, resorting to simply issuing more and more money, which in the end became more and more worthless.

        While that is an extreme, not that appropriate example, the quantitative easing, government bonds issues, and other such measures, can only work, if done in a measured and timely way.

        The problem with just focusing on a government’s own “reserve” to issue it’s own “money” in the present global economy, with open trading and exchange boarders, is that it does not work as intended. We are tied into international monetary systems and banking systems, that are also directly linked to the world trade going on.

        Issuing cash by printing money as the government wants or pleases within NZ, while the country trades in other currencies, and needs to exchange its own currency for such currencies, will quickly lead to the NZ currency losing it’s value and imports becoming unaffordable. Yes, the currency trading, the exchange systems and credit ratings are sadly a curse or chain around our neck, that are not so easily and conveniently disposed of. If you opt out and set your own rules, the systems and players involved will simply shun and punish you as a nation, and that happens again and again.

        Only on an international scale can such challenges as mentioned above be resolved, not by individual countries simply printing money and issuing bonds to pay for what they want to spend it on.

        Unless you want to create a country that tries to be self dependent on most commodities, products and services, and therefore does not need or want to exchange and trade these for other goods from elsewhere, you will stuff up a fair bit, I am afraid. Bilateral or multilateral agreements with like minded countries may work, but they would do so in cumbersome ways, causing other issues.

        First of all you will also need people to vote for such a system and approach, and then you may need to tell people that they should perhaps stop importing cars, fuels, machinery, of which too little or none is made here, so that no trade imbalances occur, that could harm fiscal policies and planning.

        I bet you, you will not get more than 5 per cent of the vote, proposing what you do.

        Investing in government bonds is not what the richest of the rich are known for, they invest in shares, directly owned assets and businesses or in certain high yield financial instruments, that is, when they know what they are doing. Government bonds are preferred by small time investors and only as parts of investment portfolios for most. Yes, of course also governments and certain banks buy such bonds, but only to pass them on at some stage.

        Also once a government or state is heavily leveraged, you will find few wealthy investors wanting to invest in such environments, as it is considered too high risk. Yet there are some exceptions, like an ideal debtor nation as New Zealand, as here the populace have traditionally been ripped off with being charged high interest, and putting up with it, working hard, saving and paying that interest to others, mostly off-shore, to have a nice, secure income.

        The NZ Dollar is also one of a few currencies highly speculated with. But all this is only possible as despite of all problems, New Zealand maintains a stable political and social environment, keeping people quiet, obedient, slaving and thus maintaining a functioning capitalist system.

        But this all would not apply to countries like Paraguay, Bolivia, Nicaragua, Bangla Desh, Papua New Guinea or other countries, where few would bother investing. Apart from mining or low cost production of low value goods, not much else happens there. Poor infrastructure, insecurity, social and other issues, with low education, skills and also higher incidents of crime and corruption, that would only invite the most ruthless or desperate wild west investors.

        Borrowing or printing money actions – both must bring results and pay for themselves, so naturally most governments do both, trying to achieve the best balance amongst both actions.

        • Draco T Bastard says:

          Yes, they certainly tried to solve fiscal problems in the Waimar Republic, resorting to simply issuing more and more money, which in the end became more and more worthless.

          Ah, the old Wiemar Republic scare. I suggest you read this. The problem that the Wiemar Republic had was the same problem we have now – private banks creating money.

          While that is an extreme, not that appropriate example, the quantitative easing, government bonds issues, and other such measures, can only work, if done in a measured and timely way.

          The problem is that the private banks create money without controls. Yes, I’m quite aware of the Basel accords and what they say but they fail to control the amount of money actually being created which is why the amount of money in the system is growing exponentially and faster than the growth in the economy (I’ve read estimates that there’s already four times more money in circulation than there is productivity).

          Issuing cash by printing money as the government wants or pleases within NZ, while the country trades in other currencies, and needs to exchange its own currency for such currencies, will quickly lead to the NZ currency losing it’s value and imports becoming unaffordable.

          And thus we’ll be incentivised to make stuff here – which was the whole point. If we have the resources, which we do, then it’s actually cheaper in real terms (i.e, use of resources) to make stuff here because doing so removes the added costs of shipping it thousands of kilometers.

          Yes, the currency trading, the exchange systems and credit ratings are sadly a curse or chain around our neck, that are not so easily and conveniently disposed of.If you opt out and set your own rules, the systems and players involved will simply shun and punish you as a nation, and that happens again and again.

          Actually, it is very easy and sticking to the present corrupt system because other nations (really, just the bankers) want it that way isn’t a viable option.

          Only on an international scale can such challenges as mentioned above be resolved,

          Believing that prevents the problem being solved. Especially when all indications are that no other country will move. We need a country to break the mold and NZ is perfectly situated to do so as we can provide everything we require.

          Unless you want to create a country that tries to be self dependent on most commodities, products and services, and therefore does not need or want to exchange and trade these for other goods from elsewhere, you will stuff up a fair bit, I am afraid. Bilateral or multilateral agreements with like minded countries may work, but they would do so in cumbersome ways, causing other issues.

          I see that you’re stuck in the delusional belief that we need trade. We don’t as we have all the resources we need to provide everything we want.

          Oh, and international trade will actually work better because it will be minimised rather than maximised with the result that the country will be better off.

          First of all you will also need people to vote for such a system and approach, and then you may need to tell people that they should perhaps stop importing cars, fuels, machinery, of which too little or none is made here, so that no trade imbalances occur, that could harm fiscal policies and planning.
          I bet you, you will not get more than 5 per cent of the vote, proposing what you do.

          Yes, people need to be educated about the present corrupt practices before they’ll change.

          Investing in government bonds is not what the richest of the rich are known for, they invest in shares, directly owned assets and businesses or in certain high yield financial instruments, that is, when they know what they are doing.

          Well, that’s what they tell you – but this government did just sell our state owned power companies and are borrowing millions of dollars per day resulting in a massive overall loss to NZ and a gain for the new owners as they get to be parasites on the rest of NZ.

          But this all would not apply to countries like Paraguay, Bolivia, Nicaragua, Bangla Desh, Papua New Guinea or other countries, where few would bother investing. Apart from mining or low cost production of low value goods, not much else happens there.

          Considering that they have the capabilities that every other people has why would that be? IMO, it’s because the governments of those countries are too busy kowtowing to international finance than helping build their own countries which they could easily do if they created their own money and spent it in to their countries economy to build up schools and industry.

          Borrowing or printing money actions – both must bring results and pay for themselves, so naturally most governments do both, trying to achieve the best balance amongst both actions.

          A government should never, ever borrow money as it adds costs that it just doesn’t need.

          • Marc says:

            Sorry Draco, but rather than your choice of resource to explain the Weimar Republic’s inflation problems, I prefer to stick to the explanations stated in ‘Wikipedia’:

            http://en.wikipedia.org/wiki/Hyperinflation_in_the_Weimar_Republic

            See also the quote under ‘Analysis’:

            “John Maynard Keynes described the situation in The Economic Consequences of the Peace: “The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance.”

            So where does “short selling” of the Mark come in there? Maybe some of that also happened, I am sure, but that does not explain the high amount of printed notes brought into circulation, as that would not be necessary to meet currency trading requirements.

            And re your comment:
            “And thus we’ll be incentivised to make stuff here – which was the whole point. If we have the resources, which we do, then it’s actually cheaper in real terms (i.e, use of resources) to make stuff here because doing so removes the added costs of shipping it thousands of kilometers.”

            While I totally agree that more “stuff” should be made in New Zealand, I reassert, that it will be impossible to produce certain machinery and other technical products here, at least impossible in “economical”, affordable ways, which are also needed to continue agricultural production, to maintain traffic and various infrastructure, to use in hospitals and research units, and so forth.

            Or are you suggesting we produce trains, truck, tractors, buses and planes, same as computers, highly sophisticated medical and scientific equipment here in New Zealand? Such things are mass produced overseas, and it requires large scale production of much, to make it economical.

            The assets part sold here in New Zealand would be of interest to some investors, but what has that do do with the rich or wealthy to gain control over governments, while the government renders control to nearly half of the shares? Selling former state assets means they will be privatised, so become part of the privately run economy, but the MOM is of course a special case scenario.

            As for the many poorer countries, there have always been some that snubbed at the IMF and World Bank, like Venezuela leaving both years ago, but such countries get punished, as they are gradually being isolated and victimised, and have credit withdrawn and end up with currency issues, as a result of credit agencies downgrading them.

            It has nothing much to do with kowtowing. Then you can also call the WINZ beneficiaries as being persons kowtowing, or workers in low paid jobs. If they dare stand up and take a stand, they will be punished. The same happens to the countries that have only population and few resources to offer, who challenge the system. Only collective effort can change that. That is why I insist, the economic proposals you make, can only be implemented in the framework of international agreements, and only to certain degrees.

            What you propose for New Zealand will not bring the result you claim, I am afraid. Sorry, but I continue to disagree with your comments, although you are of course well intending.

            • Draco T Bastard says:

              So where does “short selling” of the Mark come in there? Maybe some of that also happened, I am sure, but that does not explain the high amount of printed notes brought into circulation, as that would not be necessary to meet currency trading requirements.

              I’m sure that’s actually backwards – it was the unregulated printing of money by the private banks that drove the speculation which fed the printing making it a spiral.

              Also, I have a tendency to believe someone who was there, Hjalmar Schacht, than someone speculating from abroad, Keynes. There’s also the seeming fact that financial history has been written to support the status quo. I’ve come across several contradictory accounts which have been used to support the status quo. Further research into those accounts often shows that something completely different actually happened. That seems to be the case with the hyper-inflation of the Wiemar Republic.

              I reassert, that it will be impossible to produce certain machinery and other technical products here, at least impossible in “economical”, affordable ways,

              Such things are mass produced overseas, and it requires large scale production of much, to make it economical.

              Which is an unfounded and illogical assertion. We have the resources and capability to produce most, if not all, of what we use here. You also seem to be confusing financial with economical. Believe me, the two are quite different. Making a profit is not proof that the work is being done economically (actually, IMO, these days making a profit is proof that it isn’t).

              A factory is a factory is a factory. It really doesn’t matter where it is or its size anymore. Engineering has progressed enough that a small factory is just as efficient as a large one removing economies of scale.

              Or are you suggesting we produce trains, truck, tractors, buses and planes

              We already do produce those or have produced them in the past and quite efficiently as well. There’s Kwiwbus for starters, the ancestors of Kiwirail produced trains, SafeAir for planes.

              The assets part sold here in New Zealand would be of interest to some investors, but what has that do do with the rich or wealthy to gain control over governments, while the government renders control to nearly half of the shares?

              Ah, I see your ignorance.

              Selling the shares means that ownership went from 100% of NZers to ~2.3% for those shares and it was only the rich that bought them. Then there’s the fact that NZ law requires that the majority shareholder not act in a way detrimental to the minor shareholders which means that the majority shareholders, us, have just lost control of the power companies as we can no longer direct them to work for the best interests of NZ.

              It has nothing much to do with kowtowing.

              It has everything to do with kowtowing and being afraid that we will be punished by the rich – punishment that you seem to agree with. It really shouldn’t matter to us what other nations and people think of what we do to ensure that our people are well looked after by using our resources. If they don’t want to buy anything from us that’s fine as we shouldn’t need to buy anything from them.

        • Mike S says:

          “While that is an extreme, not that appropriate example, the quantitative easing, government bonds issues, and other such measures, can only work, if done in a measured and timely way.”

          Marc, these measures are not examples of a government issuing it’s own, interest and debt free money. They are just other names for government borrowing money from private banks. In terms of the quantitative easing, remember, the Federal Reserve system is a private, run for profit banking cartel, not a government system. All money is created as a debt, having to be borrowed into existence, that is the only way new money can be created (other than notes and coins) All of the money in the entire world is owed, somewhere along the line, to a private bank. This is the core of our problems.

          If the government needs to borrow say $500 million. What is the difference in terms of inflation of the government creating that money itself debt free, or borrowing it off a private bank?

          Why should we allow private banks which exist to make profits, to create our entire money supply out of thin air and then charge us vast amounts of interest for the privilege of using it??

  4. Marc says:

    Draco – H. Schacht was in charge at that time, and many people have a habit of “reviewing” their own past decisions and actions, and thus “rewriting” history, when they write books decades later.

    So I take his claims with a bit of a grain of salt, wanting perhaps, to distract from own failings.

    The Weimar Republic governments saw themselves between a rock and a hard place, and when the repayments for war damage and penalties were due to commence, they threw on, or rather authorised the banks, to throw on the printing presses. Remember that it was an extremely unstable period in German history, with very weak, even desperate governments, lacking firm support by voters (i.e. due to fractured governments).

    They realised later, that the problems could not be fixed that way, so made the readjustments soon after.

    Re your defence for most being made here, Kiwibus do not produce the kinds of buses that impress me, as they lack certain technical knowhow and resources. They are ok, but hardly on the cutting edge side of bus vehicle manufacturing. The same applies to other industrial production. Well, if there was more production for the Australian market also, things may look a bit better, but look at Holden going to stop producing there, so we again see the present forces at play, where the international competition for low cost production continues.

    I do not agree, that a lot of such high end machinery and so forth can be made here in an efficient enough manner. The investment needed would tie up a lot of finance for decades, and it would be missing somewhere else. Ahem, I forgot, that you believe that just issuing more finance would solve all this, which again leads us to what I stated before about that.

    While I strongly opposed the partial asset sales of the energy companies, one has to be fair and concede, that still over half of the ownership remains in the hands of the state and New Zealanders, eventhough of the 49 per cent of shares only 1 to 2.5 percent of locals will own those shares.

    And also be honest, that the earning capacity of the SOEs was not always used for the benefit of New Zealanders. Hes it was money in the state’s coffers, but therefore people also put up with high electricity prices, likely higher than they needed to be.

    Solid Energy is a special case, and while I disagree with the government’s position on their failings, they appear to have made some rather poor decisions.

    And this sentence says it about all, Draco:
    “It really shouldn’t matter to us what other nations and people think of what we do to ensure that our people are well looked after by using our resources.”

    In all honesty, it has been tried by various countries, to be self sufficient, but this is often by paying for this in foregoing certain benefits that trade may offer. If every country’s government and people would think so, we would have even more injustice in the world than we already have, as the resource rich and advantaged countries would simply look after only themselves, and let others linger in backward, poor conditions.

    Some exchange of goods and services is inevitable and under fair trading all can benefit. Some places have an abundance or over-abundance of resources, while others lack such, so exchanging these for services or goods in return is common sense.

    Hence I do believe in producing more in New Zealand, particularly value added goods, like high quality agricultural, forestry, seafood and other goods, but also in continuing to trade, on fair basis, with other nations.