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Regional Integration Without Empire
By
Henry C.K. Liu
Presented at the 2015 Eurasian Workshop at IIASA, Luxemburg,
Austria – Sept 15-16
Regional integration is a multi-national political process in which
sovereign nation states within a region voluntarily agree to enhance
cooperation in regional affairs through participation in supranational
institutions governed by integrated regulatory regimes to facilitate the
region’s common goals and objectives in socio-economic development, while
retaining individual state sovereignty. It is important that regional
integration does not degenerate into empire structure dominated by any one
nation state, or one group of nation states.
As a political process, regional integration aims to achieve within a
region economic, social, cultural and political integration. This goal is
to be achieved through the promotion of international trade by reducing
trade barriers within a region, such as reduction or removal of tariffs to
create a single regional market, and to adopt unified rules on trade,
standards on goods quality and service performance, legal framework and a
common currency, or at least a free convertibility of currencies of member
states.
The process also orchestrates multilateral governmental support from
sovereign states in a region for tackling common regional problems that
transcend national borders, such as protection of the environment,
maintenance of public health, safeguard of cross-border water purity and
supply, setting standards for food safety, policing of transnational crime,
particularly illegal cross-border traffic of narcotic drugs and controlled
substances, undocumented immigration, violation of financial regulations
and fraudulent business practices, and illicit money laundering.
Regional integration as it has developed nowadays focuses primarily
on economic issues, particularly through market liberalization in
international trade and finance and concerted efforts to create a
region-wide single market, operating under the assumption that prosperity
can best be achieved through trade and that prosperity is a sine qua non
for achieving socio-cultural and political integration .
Yet many regional problems are not purely economic or financial, but
are social-political problems with economic and financial dimensions. Such
socio-economic-political problems cannot be understood, let alone solved,
through doctrinaire market fundamentalism. This is because the market is
only one narrow aspect of the economy and while the market can give a quick
fix on economic conditions at a specific moment, it is not informative to
view the market itself as the economy, particularly as an input in
socio-political policy deliberation.
Historically, the most effective venue for regional integration has
been the empire structure of the 19th century. As WWI brought
about the end of Age of Empire, it also gave life to a new Age of
Imperialism gamely practiced by democratic governments of new bourgeois
sovereign republics that followed the demise of imperial monarchies.
WWII ended the Age of Colonialism but gave a second life to
Neo-Colonialism as whitewashed by Winston Churchill’s fantasy propaganda of
the victorious Allies as “The Democracies” and “Defenders of Freedom”, and
because neocolonialism could be used as an effective program to stop the
spread of global communism, it deserved the support of the US as the
superpower of the capitalistic democratic camp.
It is particularly pathetic that Churchill himself was nor democratically
elected Prime Minister, but appointed by the King as an emergency
arrangement to form a war-time coalition government with the opposing Labor
Party without an election being held.
Predictably, lingering colonialism drove many national liberation
movements to turn toward communism in pursuit of self determination.
Post-war France
was consumed by civil war to suppress national liberation in Algeria
and Vietnam
seeking self determination.
Anti-communist fixation in the US
forced the guarantor of self-determination to support residual French
colonialism, dragging the country into a protracted Vietnam War that
instead of bringing peaceful unification in the small distant Asian
country, caused a deep split in US
public opinion, radicalizing US politics and exposing US
government to populist mass protests. The high cost of the no-win war in
Vietnam torpedoed LBJ’s grand vision of Great Society as massive resources
were siphoned off to fund foreign war to save French colonialism.
Real Politik
Han Morgenthau in his Politics among Nations: The Struggle for
Power and Peace (New York:
McGraw-Hill Education, 2005) sets forth six fundamental principles of real
politik. The first principle of political realism maintains that
politics are grounded in observable laws of human nature any idealistic
attempt to challenge these laws will only lead to failure. Therefore, the
project of political realists is “the testing of this rational hypothesis
against the actual acts and their consequences that gives theoretical
meaning to the reality of international relations. He describes US
post-war behavior as imperialistic.
Moegenthau’s second principle of political realism is the centrality
of power. Political realists believe that power is the main
articulation of political interest, a hypothesis that can be tested by the
observable actions of statesmen throughout history. By focusing on the
study of political power, realists create a continuity of analysis of
policy: each state can then be analyzed in terms of power politics.
However, Morgenthau warns against two common misconceptions: the
first, trying to understand the motives of statesmen, is faulty because
motives do not always align to actual policy or outcomes of policy; and the
second, the alignment of ideology with action, to which the realist
responds that a policy may be articulated in terms of popular ideologies,
but nevertheless remains a product of considerations of power. Only a
rational foreign policy built off a reasoned analysis of international
relations will be a successful foreign policy.
The third principle is that while power is a universally valid
concept, realism does not endow that concept with a meaning that is fixed
for once and all. While the focus of analysis remains power, the method and
articulation of power throughout centuries has changed and will continue to
change. It is possible for a shift in scalar units of analysis (away from
then nation-state), since the contemporary connection between interest and
the nation-state is a product of history and therefore bound to disappear
in the course of history. However, realists still disagree with their
idealist counterparts in believing that the transition away from the
nation-state system will occur as a product of the laws of international
relations not by the reasoned pleas of a utopian minority.
The fourth principle states: political realism is aware of the moral
significance of political action. However, the moral principles relevant to
a particular policy must be historicized and contextualized. Therefore,
ethics is incorporated into political realism through the calculation of
the political consequences of a particular policy or action.
The fifth principle holds that political realism refuses to identify
the moral aspirations of a particular nation with the moral laws that
govern the universe”. Since nations have and will continue to disguise
their particular ambitions within the language of universal morality, the
shrewd realist sees through their rhetorical maneuver. Instead, power
forms the basis for judging the actions of other countries and developing
appropriate reactions to those actions.
Lastly, the sixth principle is the acknowledgment of the primacy of
political analysis in the sphere of the political. Morgenthau warns that
policy repeatedly guided by legal and moral guidelines instead of strictly
political considerations endangers the power of a country and the welfare
of its citizens. Instead, realism advocates that policy must arise out of
purely political analysis: an analysis of power. In a world order of
sovereign state interacting in free trade financial capitalism operating
through markets with a price mechanism, policy must arise from an analysis
of market power, which can be defined as a participant’s ability to effect
price to his benefit in an open market without alienating other
participants to the extent of causing market failures.
Virtual Synthetic Empires
Even today, the formation of regional integration frameworks is at
constantly risk of dominant states exploiting the creation of ideologically
preferred integration frameworks in which preeminent states can exercise
exclusive imperialistic influence over other weaker member states in a
virtual form of synthetic empire building.
In this context, including and excluding of certain target countries
in regional integration schemes are essentially stealth empire building
measures by dominant states, as can be observed in the distinct feature of
the US
engineered Trans-Pacific Partnership (TPP) in its pointed exclusion of the
People’s Republic of China (PRC).
Boycotts or nonparticipation in regional integration initiatives is a
negative form of empire building as US
position of the China-proposed Asian Infrastructure Investment
Bank (AIIB), an international financial institution focused on
supporting infrastructure construction in the Asia-Pacific region.
AIIB was proposed as an initiative by the government of China and
was supported by 37 regional and 20 non-regional members as Prospective
Founding Members (PFM), 51 of which have signed the Articles of Agreement
that form the legal basis for the proposed bank. AIIB starts operation
after the agreement enters into force, which requires 10 ratifications,
holding a total number of 50% of the initial subscriptions of the Authorized
Capital Stock. Countries with a large GDP that did not become PFMs are the US,
Japan
(which dominated the ADB) and Canada. AIIB is regarded by some as a rival for
the IMF, the World Bank and the Asian Development Bank
(ADB), which are regarded as dominated by developed countries
AIIB is regarded by some as a rival for the IMF, the World
Bank and the Asian Development Bank (ADB), which are
regarded as dominated by developed countries like the United
States. The United Nations has
addressed the launch of AIIB as "scaling up financing for sustainable
development" for the concern of Global Economic Governance.
AIIB was proposed by China
in 2013 and the initiative was launched in Beijing
in October 2014. The Articles of Agreement (AOA) were signed by 50
PFMs on 29 June 2015,
which become a party to the agreement through ratification. As of July
2015, one member state (Myanmar)
has ratified the agreement, formally becoming a founding member.
Rise of China
Upsets US
Within US policy circles, the rapid rise of China
as a major force in the global economy is proving a reconsideration of
whether free trade is still in the US
national interest. The prospect that China
can be a major economic power is feeding wide-spread paranoia in the US. The fear is that developing
nations led by China
and India
may out-compete the advanced nations for high-tech jobs while keeping the
low-skill, labor-intensive manufacturing jobs they already won.
China
already is the world's biggest producer and exporter of consumer
electronics and it is a matter of time before it becomes a major player in
auto exports. Shipbuilding is now dominated by China
and aircraft manufacturing will follow. The US Navy is now dependant on Asia,
and eventually China,
to build its new ships and eventually the economics of trade will force the
US Air Force to procure planes assembled in China
from parts made in Asia.
The fear of China
by the US
dates back to almost two centuries of institutional racial prejudice, ever
since Western imperialism invaded Asia beginning in
early 19th century. Notwithstanding that it is natural,
ceteris paribus, that the country with the world’s largest population, an
ancient culture and long history would again be a big player in the world
economy in modern times as it modernizes, the fear that China might soon
gain advantages of labor, capital and even technology that would allow it
to dominate the world economy and gain the strategic advantages that go
along with such domination, is enough to push the world’s only superpower
to openly contemplate preemptive strikes against it.
Furthermore, Chinese culture commands close affinity with the
population in Asia, the main concentration of the
world’s population and a revived focal point of global geopolitics.
Suddenly, socio-economic Darwinism of survival of the fittest, celebrated
in the US
since its founding, is no longer welcome by US policymakers when the US
is no longer the fittest and the survival of US
hegemony is at stake. To many in the US,
particularly the militant neo-conservatives, international trends of
socio-economic Darwinism now need to be stopped by war.
China
has more than 1.3 billion people, a fifth of the world’s population, and a
work force of 700 million as against a US
work force of 147 million. This is a ratio of 5 to 1. To avoid being over
taken by China
in aggregate national income, US wages would have to maintain a gap of five
times over Chinese wages. Historically-based technological and economic
advantages currently give US workers a nominal wage gap of over 35 to 1
over Chinese workers, or 9 to 1 on purchasing power parity (PPP) basis.
This comfortable gap is not based on current productive differentials but
rather on unbalanced terms of trade and geopolitical incongruity left by
history. Yet until wage parity is attained, free trade will continue to be
driven by cross-border wage arbitrage in favor of China. But
with wage parity, the Chinese economy will be five times the size of the US
economy, a prospect not particularly welcomed by the US
geopolitical calculations. It was the superior US
economy that enabled the US
to emerge as victor in the two world wars and to prevail in the Cold War.
Free Trade leads to Unbalance Trade
The US
is waking up from its self delusion about free trade to the reality that
free trade never leads to balanced trade. Free trade always works
against the weaker trading partner, notwithstanding Ricardian principle of
comparative advantage. The British promoted free trade when it’s early
industrial economy was the strongest in the world.
Friedrich List, in his National System of Political
Economy (1841), asserts that political economy theory as espoused in England,
far from being a valid science universally, was merely British national
opinion, suited only to British historical conditions.
List’s school of institutional economics asserts that the
doctrine of free trade was devised to keep England
rich and powerful at the expense of its trading partners and such free
trade must be fought with protective tariffs and other protective measures
of economic nationalism by trading countries with weaker economies. Henry
Clay’s "American system" was a national system of political
economy.
The US
was happy to promote free trade when unbalanced trade was in favor of the
stronger US
economy. Balanced trade between unequal partners requires managed trade to
reduce market power of the stronger partner, which is achieved by the
weaker economy resorting to government interference on free trade for more
favorable terms of trade. Such government interference is driven
by the politics of trade. When managed trade is conducted
against the weaker partner, it is economic imperialism. When it
is conducted against the stronger partner, it is known as leveling the
playing field. Yet some in the US
are engaging in New Speak when they seek the perpetuation of economic
imperialism by demanding a leveling of the playing field in trade with
weak, less-developed economies with low wages.
Poor Economies Oppose US Farm Subsidies
As poor nations press the WTO to stop unfair US
farm subsidy, US
cotton growers try to defuse the mounting pressure by offering help to
growers in poor nations. The US
government spends $4.5 billion annually in subsidy on a cotton crop with a
market price of $5.9 billion, which otherwise must be priced more than
double in the world market. This subsidy enables US growers to profitably
export three quarters of their output and control 40% of world trade in
cotton. What the US
lost in textile manufacturing, it gains back in subsidized cotton export,
high returns on investment in overseas textile mills and low consumer
prices in cotton goods. Thus the current tariff war against Chinese textile
is merely the US
wanting its cake and eating it too. While $4.5 billion is a merely pittance
in the $2.4 trillion 2005 US
fiscal budget, the subsidy has the effect of ruining the economies of the
world’s poorest nations.
The National Cotton Council, a powerful trade group in US domestic
politics, while basking in the happy situation of seeing US cotton export
increase by 350% between 1999 and 2004, from 4 million bales of 480 pounds to 14 million
bales, explains that the goal of helping African growers is “not to make
Africa a big cotton producer, only to make the miserable lives of poor
Africans a little better. It is a strategy of protecting managed trade with
welfare trade.
On the other hand, simply doubling the market price of cotton will
not help African growers, whose competitive disadvantages go beyond market
price, and cannot be eliminated without fundamental changes in the terms of
global agriculture trade.
While China’s economy has grown by over 9% annually for the last
couple of decades and its GDP had soared from $147 billion in 1978 to $1.6
trillion in 2004, the US GDP, $11.75 trillion in 2004, was still far ahead
by 7.4 times over that of China. A
2% growth in the larger US GDP contributes to a widening GP gap over the 7%
growth in China’s
GDP.
Because of the difference in population size, US
2005 per capita GDP is $41,917 while that of China
is only $1,411, a gap of almost 30 times. The US
ranks 8th in the world in per capita GDP while China
ranks 111th. In 2004, US
per capita income was $35,400 while that of China
was $960, a 36.8 times gap. The per capita income gap between
the two economies, while growing at a dramatic rate in China,
is in fact widening, not closing.
Despite such wide per capita income disparity, the US
is apprehensive because it is this perpetual disparity that will continue
to drain jobs from the US
to China. While
a narrowing of the wage disparity is needed to slow the job drain to China,
the resultant rise in Chinese aggregate national wealth will threaten US
economic dominance in the world. In a neo-liberal free trade global regime,
the US has
a choice of losing jobs or losing economic dominance and geopolitical power
to China. That
is the key dilemma in US
economic policy towards China.
There is an economic basis behind US
antagonistic militancy towards China.
The US won
both previous world wars primarily by its war-time productive
power. This fact has not been forgotten by US policy-planners.
While US manufacturing base has been seriously eroded by neo-liberal global
trade in the last two decades, the prospect of a shooting war with China
will relocate much of the lost manufacturing back to the US
in short order.
Impressive US
War Production Record
In 1942, only weeks after Japanese attack on Pearl Harbor,
President Roosevelt called for an annual production of 60,000 military
planes, a near impossible demand considering that prewar annual production
was only 6,000, and working males were being taken into the war-time
military.
But in 1943, some 86,000 planes were produced by a work force that
recruited women, exceeding the president’s call by a third. In World War
II, the US
produced 31,000 B17 and B24 long-range bombers to support strategic
bombing, reaching a peak production rate of 50 per day. In 1941,
55,000 individual work hours were needed to turn out a B-17, and by 1944,
this had dropped to 19,000 hours. Strategic bombing crippled German war
production from ball bearings production to oil refineries for critically
needed gasoline. The shortage of gasoline stalled German resistance in both
the Eastern and Western fronts and crippled the Luftwaffe. Also, the time
it took for an aircraft carrier to be built in the US
dropped from 36 months in 1941, to 15 months in 1945. In all, 300,000 military
planes were produced in four years of war.
Because of the production prowess of the US,
Germany and
Japan simply
could not produce enough weaponry fast enough to keep up with battle
attrition the way the Allies could. It was only a matter of time before the
Axis powers would be defeated. A market economy is a feeble
weakling compared to a war-command economy. That a war in Asia
will relocate manufacturing jobs back to the US
in large scale to get the US
economy moving again must have occurred to the neo-con warriors who have
been controlling US
policy since 2000. The hawks in this group are betting on the
gamble that China’s nuclear deterrence against attacks from the US
can be neutralized by US strategic defense initiative (SDI), and that the US
mainland will continue to be safe from counter attack.
US Fear of Rising Chinese Economy
Notwithstanding irrational paranoia from US militarists, the fear of China
by the US
is not fundamentally based on military threat, albeit it has a military
dimension. On June 13, 2005,
a period of fatalist talk on the need for preemptive strike against China
by some normally responsible politicians, Henry Kissinger, arguably the
greatest living guru of contemporary geo-realpolitik, wrote in the
Washington Post: “Military imperialism is not the Chinese style.
Clausewitz, the leading Western strategic theoretician, addresses the preparation
and conduct of a central battle. Sun Tzu, his Chinese counterpart, focuses
on the psychological weakening of the adversary. China
seeks its objectives by careful study, patience and the accumulation of
nuances -- only rarely does China
risk a winner-take-all showdown.”
US fear of China
is a reaction to the destabilizing effect on existing, established
geo-economics from the natural rise in economic power of a modernizing
nation with a large population. It was this natural advantage of a large
population that permitted the US
and the USSR
to exploit geopolitical opportunities to capitulate themselves into
superpowers status after WWII.
The British Empire was first and foremost a quest
for population, and the wealth associated with it, albeit without the
benefit of equality, the lack of which became the central weakness that
deprived the empire of longevity. The lack of equality within the USSR
was the main cause of its dissolution, not perverted communist doctrine.
The large aggregate population of the EU is now driving its new economic
aspirations, but inequality will be the main stumbling block. Japan
will never be a contender for superpower status because of its small
population and its exclusionary national culture.
Immigration Good for Economies
Immigration is the fountainhead of economic development and sustained
prosperity. The developmental history of the US
is a story of immigration. The US
owed its economic rise to immigrants. Throughout Chinese history,
immigration from distant lands and foreign cultures enriched Chinese
civilization and contributed to long periods of prosperity. Germany
benefited greatly from the immigration of Jews and lost much from Nazi
prosecution of its Jewish citizens. The current anti-immigration
phobia in the US
and in the EU will put self-inflicted roadblocks in the path of these
economies toward a new age of prosperity.
Still the history of the US
in its process in becoming an economic superpower is
instructive. As a prosperous, internationally-engaged US evolved
into a huge open market for the world’s developing economies, so will a
prosperous, internationally engaged China.
China,
similar to historical US
experience, will go through several series of historic policy debates over
the choice between isolationism and international engagement as its economy
develops.
Isolation Bad for Economies
US trade embargo on Communist China after WWII caused the failure of the
Pax Americana until the Nixon-Kissinger opening to China
in 1973. The embargo effectively delayed development in China
for half a century, and radicalized Chinese both domestic politics and
foreign policy.
Developing countries should not misconstrue isolationism as an effective
strategy of anti-imperialism. Quarantine is a strategy that deprives the
subject of any chance of developing effective immunity against invading
viruses that eventually exposes it to more serious
vulnerability. Yet US
policy on China
will continue to impact the outcome of China’s policy debates with serious
consequences. Hostility breeds counter hostility and
protectionism breeds counter protectionism. Isolation between hostile
nations leads inevitably to war.
Kissinger went on in the same article: “With respect to the overall
balance, China’s large and educated population, its vast markets, its
growing role in the world economy and global financial system foreshadow an
increasing capacity to pose an array of incentives and risks, the currency
of international influence. Short of seeking to destroy China
as a functioning entity, however, this capacity is inherent in the global
economic and financial processes that the United
States has been preeminent in
fostering.” Unfortunately, Kissinger’s influence on US
foreign policy was cut short by the Watergate scandal.
A China
forced defensively by hostile US
policy into isolationism, a recurring tendency throughout its long history,
ironically would lead to regional decline and instability that would
quickly turn global in this interconnected world. The decline of China
that began in early 19th century was traceable in part to Chinese
self-imposed isolationism, in contrast to Japan’s forced opening to the
then more technologically advanced West that led to the Meiji Reformation.
The modern history of China
might have been totally different if Chinese isolationism had not prevailed
in Chinese politics in the early 1800s, and modernization had been allowed
to proceed with needed stimulation from mutually beneficial contacts with
the West before Western imperialism had a chance to take shape.
An internationally-engaged China
will be a positive force for world peace and prosperity. As the enormous China
market becomes reality from rising income, it will impact traditional
international economic relations to restructure residual prejudicial racial
enmity and Cold War geopolitical alliances and give rise to a new mode of
world order free of residual racial phobia and obsolete ideological
conflicts.
US
hostility and pre-emptive strategy toward a peacefully-rising China
may be forced to fall back on ineffective US
unilateralism, devoid of willing partners even from among its residual Cold
War allies. Trade protectionism will lead to US isolationism, a
movement with a significant past in US
history. Yet, as a superpower, the US
cannot isolate itself from the rest of the world without severe penalties.
Or to put it another way, the cost of US
isolationism is the forfeiture of US
superpower status.
Kissinger observed correctly in the same recent article that “in a US
confrontation with China,
the vast majority of nations will seek to avoid choosing sides.” Already,
normally dependable US
allies such as the UK,
the EU (particularly France and Germany),
Japan, Australia
and even Israel,
are experiencing rising conflicts with US policy on China. These
nations are beginning to see US demands for unquestioning support of its
hostile policy on China
as not being congruent with their separate national interests.
Everywhere else in the world, from Asia to Latin
America, from the Middle East to Africa,
sympathy for China’s effort to regain its natural prominence in the world
and positive response to its effective development strategy are mounting
while appreciation for unilateral US
security and economic policies is falling. While the US
is still a juggernaut in its coercive ability to commandeer much of the
world’s wealth, its ability to produce wealth appears to have visibly
declined. It is becoming increasingly obvious to some in Washington
that a military option is the answer to arresting US
economic decline that threatens US
superpower status.
Eleven of the 16 countries surveyed in June 2005 by the US-based Pew
Research Center:
Britain, France,
Germany, Spain,
the Netherlands,
Russia, Turkey,
Pakistan, Lebanon,
Jordan and Indonesia,
had a more favorable view of China
than of the US.
The survey on global attitude finds that while China
is well-regarded in both Europe and Asia,
its burgeoning economic power elicits mixed reactions. Majorities or
pluralities in France
and Spain
believe that China's
growing economy has a negative impact on their own economies. Respondents
in the Netherlands
and Great Britain,
traditionally free trade nations, have much more positive reactions to China's
economic growth. Public opinion in the US
on this issue is divided; 49% view China’s economic emergence as a good
thing, while 40% say it has a negative impact on the US.
Whatever their views on China's
increasing economic power, European publics are opposed to the idea of China
becoming a military rival to the US,
despite their deep reservations over US policies and hegemony. Solid
majorities in every European nation except Turkey
regard China’s emergence as a military superpower as undesirable. In Turkey
and most other predominantly Muslim countries, where antagonism toward the US
runs much deeper at this time in history, most people think a Chinese
challenge to US military power would be a good thing.
Nonetheless, there is considerable support across every country
surveyed, other than the US,
for some other country or group of countries to rival the US
militarily. In France,
85% of respondents believe it would be good if the EU or another country
emerged as a military rival to the US.
Most Western Europeans want their countries to take a more independent
approach from the US
on diplomatic and security affairs than it has in the past. The European
desire for greater autonomy from the US
is increasingly shared by the Canadian public; 57% of Canadians favor Canada
taking a more independent approach from the US,
up from 43% two years ago. The US
public, by contrast, increasingly favors closer ties with US allies in Western
Europe, a continuation of traditional US
Eurocentric attitude, while the center of world affairs is shifting toward Asia.
China’s Dilemma: Growth and Equality
Chinese President Hu Jintao laid out China’s economic goals through 2020 in a May 16, 2005 address in Beijing.
He vowed to quadruple to $4 trillion the nation’s 2000 GDP of $1
trillion. This would still be only about one-third the size of
the US
economy in 2005, which itself will surely grow significantly by
2020. Even if China’s economy quadruples, the average Chinese
will remain poor. If China
succeeds in her goal, per capita income would rise only to $3,000. In
contrast, US
per capita income was $40,100 in 2004. Thus all the talk of China
overtaking the US
in the near future is misleading.
Yet China
is paying a heavy social price for fast GDP growth. A recent survey by China’s
National Bureau of Statistics found that earners in the highest-income
bracket in cities earned 11.8 times more than those at the low end of the
scale in the first quarter of 2005. The figures were 4.16 times
in 1996 and 5.7 times in 2000. Statistics from the Ministry of Labor and
Social Security also indicate that the richest 10% of households own 45% of
private urban wealth. The poorest 10% of urban households have less than
1.4% of the private wealth in Chinese cities. Urban poverty has been
increasing since the mid-1990s although the Chinese Government has been
more successful in reducing rural poverty. Urban poverty is concentrated in
three groups: the disabled and elderly without family, the unemployed and
migrant workers. Given the absence of a sound social security system in the
country’s move toward socialist market economy, the rich-poor gap among
Chinese urbanites may become threatening to social stability. Popular
resentment towards the rich is approaching seismic dimensions, unlike in
the US
where the rich enjoy the enviable status of adored celebrities. The
business newspaper, China Daily, identified government policies as mainly
to blame for their failure to ensure equal opportunity and fair wealth
distribution and to give enough help on a timely basis to the urban needy.”
To the government;s credit, Premier Wen Jiabao in a press conference on March 14, 2005 referred to Nobel
laureate economist Theodore Schultz (1979) who maintained that rural
poverty in poor countries persists because government policy in those
countries is biased in favor of urban residents at the expense of rural
dwellers. Schultz visits to farms and interviews of farmers led to new
ideas, such as human capital (Investment in Human Capital, American
Economic Review 51 - March 1961). So if we knew the economics of the
poor, we would know much of the economics that really matter. Most of the
world's poor people earn their living from agriculture. So if we knew the
economics of agriculture, we would know much of the economics of being
poor,said the premier. Yet free trade prevents government
subsidy to agriculture. China Daily suggested that the government should
also be concerned with the urban poor. This disparity of wealth
naturally accompanies market liberalization and deregulation in all
economies. For the Chinese economy to remain a socialist market economy,
income and wealth disparity is the biggest obstacle that must be tackled as
a top priority. Socialism does not reject wealth, only the
mal-distribution of it.
US
Rethinks China
Trade Policy
For a decade now, debate in US
policy circles has swirled over whether China
- a “socialist market economy” according to its constitution - is a
strategic partner, a strategic competitor or a rising military rival. What
makes China
unacceptable to the US
is that it is still a communist country, albeit the neo-communism being put
in place in China
is increasingly free of authoritarian effects of a garrison mentality that
has resulted from US
hostility and containment during the Cold War. Neo-communism in China
is largely a strategic response to and the resultant consequence of
expanding global neo-liberalism. Yet while the policy debate between
orthodox communism and neo-communism has yet to be definitively settled in China,
free trade and market fundamentalism are under reconsideration in US policy
circles. If neo-liberalism should fail and the global trading system
freezes, the future of Chinese neo-communism will also be put in
jeopardy. Thus US
isolationism is the unwitting ally of Chinese orthodox communism.
Paul Samuelson, a Nobel laureate economist, famed author of the standard
economics textbook and an ardent supporter of free trade, in an article in
the Journal of Economic Perspectives (2004) suggested that China’s growing
economic might calls into question whether free trade is a win-win game for
the US. Samuelson
said open trade helped the US
economy grow since World War II, but that competition from abroad drove
down wages in lower-skill jobs. Over time, China
and India
could displace US high-tech jobs as well and more US
wages could be forced further down to sustain competitiveness. Even though
US consumers get cheaper Chinese-made goods, many US
citizens could be net losers from such trade, Samuelson wrote. Consumer
gains from lower prices are offset by worker income losses. If
globalization causes enough US
citizens to suffer lower wages, the US
as a whole loses. “It is going to become so big a problem that some slowing
down is going to be politically popular - and has some merits,” says
Samuelson, who estimates that from World War II to the early 1980s,
increased trade with a revived Europe and the Pacific Basin accounted for
30% of the rise in the standard of living in the US, as a result of the law
of comparative advantage.
But Samuelson expects the US
to gain less from trade, outsourcing, investment, and other aspects of
globalization in the coming 30 years, possibly even lose out on a net
basis. In such case, a minority of the US
population would gain, but more would suffer lower living standards. “The
general dogma that anything that expands globalization is good for everyone
isn't right,” Samuelson says. And as all political scientists know, when
the majority loses, the politics turns ugly in a democracy. Even
for free-trade guru Samuelson, free trade in a global market economy is
only desirable if its serves US
national interest. When it does not, free trade needs to be replaced by
managed trade, directed by a domestic command economy.
One difference between free trade then, when it was good for the US,
and now is that greater inequality has become institutionalized in the US,
Samuelson argues. Neither the political establishment nor the electorate is
any longer willing to spread around the benefits of freer trade to help
those in the US
hurt by globalization, as they did in the aftermath of the Great Depression
after World War II, through a progressive tax structure, government social
spending, and transfer payments. Those harmed are usually at the lower end
of the income and wealth ladder. This is true of individuals within the US
as well as those in other trading nations. Free trade has worsened the fair
distribution of income for the working class and emasculated the ability
trade unions to command pricing power for labor, while the more educated
professional classes, particularly those in management and finance, have
gotten most of the financial gain. Warren Buffet, one of the
most successful investing capitalists in the world, has also been saying
that the current US
tax regime favors the rich unfairly. Inequality of wealth and disparity of
income during the 1920s, coupled with easy credit to fuel a speculative
debt bubble, led to the 1929 stock market crash. But it was the resultant
pain that disproportionately fell on the unemployed and the working poor
that led to the politics of protectionism that prolonged the Great
Depression. A repeat of similar economic-political dynamics seems to be
evolving in the first decade of the 21st century in the US.
Political philosophers in the past worried that in a democracy,
lower-income classes would elect politicians who would confiscate much of
the riches of the wealthy. Proponents of democracy then guard against this
tendency by promoting the concept of minority rights. The US
version of representative democracy has turned that worry on its head. The
cost of getting a representative elected in a US
election has escalated so much that the rich minority has been excessively
able to protect and enhance its interests through campaign contributions to
sympathetic if not captured politicians.
Trade was kept from emerging as an important issue in the 2004 presidential
campaign. The Bush administration had taken protective measures during its
first term in areas where key political constituencies faced competitive
pressures, such as steel, agriculture, and lumber, but the president
remained solidly a free trader. The AFL-CIO has been pushing for trade with
the poor nations to be “fair,” by forcing them to adopt international labor
and environmental standards. Fair trade has become the slogan for both
labor and conservatives, but the practical effect of fair trade as defined
by US labor would be no trade, as the poor country are not allowed any
pricing power, particularly in wages and environmental protection, by the
unfair and unequal terms of trade set by their more powerful trading
partners in the on-going trade regime.
US
Labor Opposes Free Trade
The labor movement in the US
has been the main victim of neo-liberal global trade. Union
membership has fallen from 31.8% of the workforce in 1948 to 12.5% in
2004. Unions have been increasingly ineffective in protecting
worker interests as US domestic politics turns conservative in favor of
management. Yet US
labor had been in the forefront in the support for US
global anti-communist policy and was among the most fervent supporters of
every unpopular war, from Vietnam
to Iraq,
wars waged to lay the ground for a world of neo-liberalism that eventually
came to undermine the economic interests of US
labor. Traditionally, union pay and benefits helped lift even
non-union worker pay as employers had to match or better union pay scale to
keep employees from joining unions. While union membership of government
workers increased from 25% in 1975 to 36% in 2004, the total number of
government workers has been declining as a direct result of
anti-big-government trends since the Reagan era.
Membership in the private sector where most of the jobs are, union
membership has dropped from 21.5% in 1975 to 8% in 2004. The industries
that have the largest declines are: manufacturing (from 36% in 1975 to 13%
in 2004); transportation (from 47% in 1975 to 27% in 2004); and
construction (from 35% in 1975 to 16% in 2004).
Manufacturing workers unions suffer from both sector-wide aggregate job
loss and a drastic drop in membership percentage of the remaining work
force, as the first waves of outsourcing were concentrated in union plants
where labor cost was highest. While wage arbitrage has been the driving
force behind the decline of labor unions, the US
bankruptcy regime had been the legal venue for the wholesale abrogation of
labor contracts and employee pension obligations.
Disparity of Income
The growing disparity of income in the US
translates into low pay for place-related service jobs that cannot be
outsourced. Yet the disproportionate concentration of women,
minorities, new immigrants, both legal and illegal, in these jobs presents
opportunities for union organization. The emergence of large
employers such as Wal-Mart, Home Depot, FedEx, major national cleaning and
telecommunication companies, and labor-intensive food packaging companies
such as Tyson, presents identifiable organizing targets. There
is a trend in union strategy to shift from improving the pricing power of
labor in vibrant sectors of the economy, to resistance against inhumane
oppression in a structurally unfair economy.
This trend will move the labor movement increasing out of progressive
economics into radical political confrontation. The first signs
of such a shift came from the withdrawal from the AFL-CIO by the service
workers union and the Teamsters on July 16, 2005 at the opening of its
annual convention in Chicago, followed by the United Food and Commercial
workers and United Here which represents hotel, restaurant and apparel
workers. These dissident unions aim to cooperate with other unions of
laborers, farm workers and carpenters to develop multi-union drives against
Cintas, the big nation-wide laundry company, as well as Wal-Mart and FedEx.
In the 2004 presidential campaign, Democratic challenger John Kerry was
careful not to disappoint US organized labor, traditionally a key political
constituent. But labor is a captured constituent for the Democrats, with no
alternative champions in US politics. In a tight race, the
strategy was to woe the undecided who otherwise would vote for the
opponent. The opposing presidential candidates of both political parties
proclaimed support for trade liberalization, while they make protectionist
concessions separately to their traditional constituents for purely
tactical reasons of election politics rather than as strategic reforms in
national trade policy, with Bush favoring big business such as steel and
Kerry opposing outsourcing. Samuelson of course warns that just because
free trade sometimes hurts does not mean that trade barriers in the form of
tariffs can help. Most efforts at protectionism are self-defeating,
Samuelson says. Nonetheless, a slowdown in globalization might be “more
comfortable,” allows the guru of free trade.
US Politicians
Critical of Chinese Trade Posture
Many politicians whose
own fates are dependent on voter sentiments, are less sanguine. Liberal
Senator Charles Schumer (D - New York), and Conservative Senator Lindsey
Graham (R - South Carolina), with broad-based bi-partisan support
reflective of popular sentiment, introduced the China Currency Bill (S.
295) in April 2005, calling for 27.5% tariffs on all Chinese products sold
in the US if China does not revalue its currency by 27.5% within 180 days
of the passage of the bill. The bill was “attached” as an amendment
to the Foreign Affairs Authorization Act (S. 600) -- the umbrella
legislative authority for the $34 billion foreign aid program.
The pro-free-trade
Senate leadership attempted to have the amendment struck down, but was
defeated by an overwhelming margin of 67-33. After that, Senator Schumer agreed to
withdraw his amendment only with the quid pro quo compromise of
being allowed to hold a full-blown Senate Finance Committee hearing on the
Chinese currency issue and the guarantee of a vote on S. 295 before the end
of this summer. Similar bi-partisan legislation was also introduced in
the US House of Representatives by Reps. Duncan Hunter (R - CA) and Tim
Ryan (D - OH).
Chinese Export
Revenue Goes
To Foreign Investors
In the past decade,
Chinese exports have increased 6.5 times, from US$91.7 billion in 1993 to
US$593.4 billion in 2004. Yet 62% of that increase has been driven by
foreign direct investment as offshore Chinese outposts of foreign companies
and investors from the US, Europe, Japan and elsewhere in Asia. For every dollar China retains as a trade surplus,
another $4 goes to returns on foreign investment. And even that
dollar goes to the Chinese central bank to buy US Treasuries to finance the
US debt economy, and cannot be spent inside China. This is why economists say
Chinese GDP growth is supporting the global economy, which is dominated by
the dollar economy.
China is
significant not only because it is the most populous nation with the
fastest growing economy, but also because it is one of the poorest and thus
has much prospect and room for basic growth with a huge appetite for
imports. Blessed with a long history of a rich culture, the economic
revival of China
can proceed at lightning speed and bring with it a new world of plentitude.
The whole world now wants to trade and interact with the Chinese economy
because under the current trade regime, trade with China
benefits the foreign trading partners more than its does China
itself.
Exchange Rates
It does not matter what the exchange rate of the Chinese currency is;
China is totally free to set the exchange rate as long as trade is
ultimately denominated in Chinese currency and Chinese prices are
competitively adjusted according to the exchange value of the Chinese
currency, even if the dollar remains the world’s main reserve currency for
global trade for a long time.
The question of the exchange value of the Chinese yuan in relation to
the US dollar is a minor technical issue within the peculiar regime of
dollar hegemony. It has no fundamental macroeconomic
significance. The day will come when this technical issue will
become mute, when the Chinese yuan will naturally become a reserve currency
for trade with China,
reflecting the reality of changing global trade patterns.
As the attempt of a Chinese state-owned oil company to merge with
US-based Unocal Corporation fanned protectionist passion in the US
Congress, Federal Reserve Chairman Alan Greenspan warned senators in public
testimony not to let their misguided frustrations with China’s economic
policies breed reactions that would do the US economy more harm than good.
What is not generally recognized is the fact that Chinese monetary and
trade policies are defensively driven by US policy. Proposed tariffs
against Chinese goods and other forms of protectionism would significantly
lower US living standards and would not save jobs in the US,
Greenspan told members of the Senate Finance Committee.
Greenspan testified that he was aware of no credible evidence that
revaluing the Chinese currency would significantly increase manufacturing
activity and jobs in the US. Many
of the goods sold in the U.S.
with a “Made in China” label are merely assembled in China
from parts made elsewhere in Asia. If the yuan, and
therefore Chinese labor, were more expensive in dollar terms, those goods
would be assembled elsewhere in Asia, at no net
benefit to the US,
Greenspan said. He said that Senator Schumer’s proposed tariffs
on Chinese goods “would significantly lower US imports from China
but would comparably raise US
imports from other low-cost sources of supply in Asia
and perhaps Latin America as well. Few, if any, jobs
in the US
would be protected. In this respect, CAFTA (Central America Free Trade
Agreement) is linked to the China
trade issue.
Greenspan credited the relatively free flow of goods and services across
national borders with enabling the global prosperity of the last six
decades. “A return to protectionism would threaten the continuation of much
of the extraordinary growth in living standards worldwide, but especially
in the United States,
that is due importantly to the post-World War II opening of global
markets,” he said. For lawmakers worried about US
job losses, Greenspan recommended that they bolster job retraining programs
and improve education in middle and high schools. Nevertheless,
Congress introduced political obstacles that successfully blocked the
proposed CNOOC/Unocal merger, forcing CNOOC to withdraw on August 4.
US False Hope on Yuan Revaluation
The People’s Bank of China
announced on July 20 that effective immediately the Renminbi (RMB) exchange
rate will go up by 2.1% to 8.11 yuan to the dollar and that China
will drop the dollar peg to its currency. Instead, China
will move to a managed float of the RMB, pegging the currency's exchange
value to a basket of currencies. In an effort to limit the amount of
volatility, China
will not allow the currency to fluctuate by more than .3% in any one
trading day. Linking the yuan to a basket of currencies means China’s
currency is relatively free from market forces acting on the dollar,
shifting to market forces acting on a basket of currencies of China’s key
trading partners. The basket will be composed of the euro, yen
and other Asian currencies as well as the dollar. Though the precise
composition of the basket is not disclosed, it can nevertheless be deduced
by China’s
trade volume with key trading partners and by mathematic calculation from
the set-daily exchange rate.
The valuation shift to a basket of currencies is only a superficial move
because the exchange rate of the dollar in an efficient foreign exchange
market already reflects the equilibrium of the exchange rates of major
currencies around the dollar. This equilibrium is the function of the
market by definition, sustained by the complex workings of hedging through
derivative trading with the dollar as the base. By a managed
float for its currency, China will enjoy the flexibility of leading the
market, but it cannot go against the market as soon as the yuan becomes
freely convertible, which according to current policy intention, may not
become reality for some years.
Even when the yuan is not freely convertible under China’s strict
capital control regime, hedge funds and other speculators have been trading
yuan for years in the derivative market and through the trading in the
equities of companies with large operations in China,
and through trading of Asian currencies with flexible but close links to
the Chinese yuan. Companies such as Wal-Mart and Motorola, which
buy from China,
and LVMH Moet Hennessy Louis Vitton, which sells to China,
face opposite impacts from a stronger yuan, with Wal-Mart losing on higher
import cost and LVMH gaining on more Chinese purchasing power for foreign
goods.
Non-deliverable forwards (NDF) have been an instrument of choice for
professional currency traders. The NDF market allows traders to speculate
on the value of currencies whose fluctuation is restricted by government
fiat. In recent years, the NFD market has grown from $3 to $5 billion a
day. Despite the huge size of China’s $1.4 trillion-a-year economy,
the volume of currency traded in Shanghai
is tiny, averaging just under $1 billion per day.
By comparison, daily currency trading on the Chicago Mercantile Exchange
averages about $43 billion and worldwide around $2 trillion, with most of
it transacted in London. Following
the news of the yuan revaluation, NDF traders were taking bets for further
revaluation ranging from 2.5% to 6% for 12-month contracts. In Singapore,
one day after the news, one-year RMB NDF rose to about 7.64 yuan per
dollar, a level that predicts further revaluation of more than 6% by the
middle of next year. Big international banks routinely act as
counterparties between opposing bets to generate risk-free
fees. Merrill Lynch forecast that the renminbi would rise to 7.5
yuan to the dollar by the end of this year. Other analysts were more
conservative. Bank of America saw the reminbi being held at 8.11 yuan to
the dollar until the year-end, while BNP Paribas believed Beijing
would allow the renminbi to firm to 7.9 yuan to the dollar by the year-end.
When market participants disagree, the market becomes active.
Xia Bin, director general of the Financial Research Institute under the
State Council, China’s cabinet, warned speculators against harboring
“illusions” about further revaluation, saying Beijing
was likely to move carefully and slowly. Xia said no “clear” appreciation
was likely in the remainder of this year. China Daily warned that expectation
of a revaluation bigger than the 2.1% announced on July 20 “was, and will
be, unrealistic.” Yu Yongding, a member of the monetary policy committee of
the People’s Bank of China,
the central bank, and a long-standing supporter of revaluation, was reported
to have said he did not think China
would allow dramatic changes in the exchange rate. “The principle is
stability as well as flexibility,” Prof Yu said. “We don't want to
encourage speculative capital inflows.” Gradualism has always been the hallmark
Chinese economic policy. As this article is being written, the
flood of hot money into China
and Hong Kong, which had begun some two years
earlier when the market was anticipating eventual adjustments, has
continued to accelerate.
RMB Revaluation
China’s central bank repeatedly insisted with strongly phrased
announcements that there would be no more government-led revaluation of the
renminbi, saying that the currency’s exchange rate was already reflecting
market forces. Zhou Xiaochuan, People’s Bank governor, unintentionally
fuelled market expectations by describing the revaluation move as “an
initial adjustment to the exchange rate level”. The central bank later
clarified that the remark did not mean there might be more adjustments to
come. “Some foreign people have tried to create misunderstanding by saying
this adjustment is an initial move and there will be more to come,” the
bank said, adding that such foreigners had come up with such explanation
"to suit their own purposes". In fact, the bank said, the
renminbi rate was being set “according to objective rules”. “These
movements will be created by the floating mechanism and there will be no
more official adjustments of the renminbi level,” it said, and that “in
trading since revaluation, the renminbi had been reflecting market forces
and movements in international currency exchange rates.” Yet the
more China
stresses its determination to resist further evaluation, the more such
announcements would induce stronger US
pressure to push the yuan higher.
China is
caught between market pressure and US
political pressure in that moves to quell market pressure to push up the
yuan will increase political pressure from the US
to push up the yuan. China
should stay quiet to avoid agitating more US
political reaction and let actions deliver the message to the
market. The most effective way to manage the market is to make
speculators lose money.
Despite its recent rhetoric, the Chinese central bank itself is widely
seen in Beijing as favoring a more substantial revaluation than was
announced, and is suspected of accepting the 2.1% move with open
reluctance, only under pressure from other government departments.
Yuan credit and interest rates are mostly administered by Chinese
government policy which is normal for a national banking regime. In such a
regime, state-owned enterprises are not affected by the short-term market
cost of loans. That means the People’s Bank of China
(PBoC), the central bank, does not have as much leverage over the economy
as the US Federal Reserve does. Also, the large foreign-exchange inflows
into China
affect the flexibility of PBoC to set interest rates to manage the credit
needs of the domestic economy.
A stable currency has macroeconomic merits, but a currency kept below
market expectations produces inflationary fallouts. In a central
banking regime, it is the central bank’s responsibility to fight inflation
with interest rate policies. But China
is still in a transition stage between national banking and central
banking.
The PBoC is working feverishly on building the finance infrastructure of
monetary policy needed for changing China’s previous national banking
regime to a new central banking regime. Shifting the yuan’s peg to the
dollar to crawling rates pegged to a basket of currencies will help
facilitate structural reforms that will enable monetary policy to act as a
key tool for managing China’s economy in a central banking
regime.
Whether a shift to a central banking regime in the context of global
dollar hegemony is good for an economy that cannot print dollars at will is
another question. A central banking regime for China
serves only the interest of foreign capital denominated in dollars.
In market economies operating under central banking, interest rate is
the main means by which central bankers manage aggregate demand, fight
inflation and reining in unruly financial markets when the economy
overheats, and fighting deflation and stimulating economic activities when
the economy slows. This approach remains controversial as it can lead to
liquidity traps under certain conditions, as in Japan
in the last decade, or debt bubbles as in the US
in recent years. Yet most neo-liberal monetary economists continue to view
interest rate policy as the best tool for managing aggregate demand in
market economies.
In the late 1990s, China
used fiscal policy to stimulate the stalled economy and to fight deflation.
Treasury-bond issuance rose, and in 2001 the central bank encouraged
Chinese banks to lend more, leading to huge credit expansion and an
investment boom that the government now is trying to slow down. Fiscal
stimulant worked in China
and not in Japan
because the Chinese economy had not yet been saturated with built
infrastructure, as was the case in Japan
where new unneeded expressways were built that led to points of no economic
significance. Fiscal spending in China,
even if indiscriminately applied, while suffering from less than optimum
effectiveness, still produced positive impacts on the vastly underdeveloped
Chinese economy.
Year-on-year annual M2 growth in China
hit 21.6% in August 2003, overall bank credit grew at 23.9%, and annual
fixed-asset investment was booming at 30% to 40%. By 2004, the government
was compelled to curb over-investment and speculation, particularly in the
real-estate sector. Over-investment was creating overcapacity, causing a
new wave of nonperforming loans for the banks. As monetary policy had
repeatedly proved ineffective in directing market trends, raising rates was
decidedly not a policy option, as such broad-brush measures would hurt the
healthy sectors along with the speculative sectors. Instead, the government
administratively managed its fiscal stimulus and imposed planned-economy
measures.
In April 2004, a
“macro-economic adjustment” program was launched targeting over-investment
in key heavy industries, including steel, cement and coal. National
Development Reform Commission (NDRC) approval was required for all new
investment, with some on-going projects suspended in midstream. Control
over land development rights was tightened, and banks were instructed to
curb their lending selectively, instead of responding to market demand by
lending only to borrowers who were prepared to pay high interests. Instead
of raising interest rates which would put all projects in distress, the
government chose to selectively turn off the funding source for undesirable
projects. By June 2004, M2
growth was back below 16% year on year, domestic credit growth had fallen
back, and consumer price inflation was heading downward. The PBoC was
allowed to raise bank rates just once, in October 2004, by 27 basis points,
perhaps just enough to signal rates could rise. Apart from that, it has
played a subsidiary role in macro-policy over the past 18 months.
National Baning vs Central Banking
With that experience, one would think that Chinese policymakers would
learn the lesson of the ineffectiveness of central banking with its
fixation on keeping banks profitable at the expense of the economy, and
revert back to a national banking regime to support industrial policy for
effective development of the Chinese economy. Yet the central
banking movement in China,
urged on by neo-liberal economists both inside and outside of China,
is adopting a “damn the torpedoes, full steam ahead” mentality.
Ongoing structural changes towards a central banking regime are leading
China’s economy towards being increasingly more sensitive to interest
rates. State-owned enterprises will be forced to manage their operations
with an eye on quarterly earnings for repayment of short-term loans,
preventing them from making long-range plans for growth. They are subjected
to the unpredictable short-term fluctuation of the market cost of funds,
while they are still at a stage of undercapitalization which puts them at
structural disadvantage in the global arena of market capitalism.
As more state-owned enterprises are privatized and sold off at fire sale
prices to foreign competitors, political pressure to keep rates low for the
remaining state-owned enterprises wanes, making them more vulnerable to
foreign takeovers. More private companies are accessing credit in the open
market and be rate sensitive in the business decisions. Chinese banks now
lend 11% of their outstanding loans to consumers who are sensitive to rate
changes. Recent upstream imported raw materials inflation is pushing
interest rates up and slowing economic expansion generally, rather just in
overheated sectors. In a global regime of financial
liberalization based on dollar hegemony, it is not wise for a nation such
as China, which lacks capital denominated in dollars, to expose its economy
to market capitalism, a game in which those with less capital always loses.
As the yuan is not a freely convertible currency, there is no market
basis to judge if the yuan is undervalued or overvalued. The trade
imbalance, as many economists has pointed out, is a complex phenomenon of
which exchange rate is only a last resort compensating
factor. Besides, the US-China trade imbalance is only nominally
in favor of China,
with China
earning a foreign fiat currency that can only be spent in the dollar
economy and not the yuan economy. Even then, Chinese held
dollars are not fungible as they can only be spent under political
constraints imposed by the issuer of the dollar, as the failed CNOOC/Unocal
merger has shown.
And for a currency that is not freely convertible, fixed exchange rate
has no basic effect on trade balance except as a positive stabilizing force
against price volatility. Usually, undervalued currencies, even if nor
freely convertible, cause domestic inflation, thus making export prices
higher even if the exchange rate remains unchanged. This is because a cheap
currency means more exports than imports, and the resulting current account
surplus causes net inflows of money from overseas. These inflows add to the
monetary base, allowing banks to lend the added money out to new customers.
Prices will rise as a result of more money chasing goods and services which
expand at a slower rate than money supply expansion. Domestic inflation
translates into higher export prices. But for China,
the bulk of the profit from higher export prices goes to pay unlimited
returns on foreign capital, not to higher domestic wages.
The Poor Financing the Rich
Even then, there are domestic economic benefits from this inflow of
funds if it goes to facilitating domestic economic expansion beyond the
export sector. But with dollar hegemony, these economic benefits of China’s
trade surplus are blocked from domestic economic expansion, with all the
dollars from the Chinese trade surplus going back into US Treasuries to
finance the US
debt bubble with which to incur more US
trade deficits. It is a classic example of the poor lending
their meager wages received from the rich back to the rich to enable the
rich to make the next pay day, with the rich demanding that the money they
pay the poor should buy less in the neighborhood where the poor live. The US
is confusing the spread of freedom with an expanding collection of
freebies.
Dollar inflows into China
were $206 billion in 2004. This came on an accelerated basis, meaning the
rate of inflow increased toward the end of the year. Some $101 billion
flowed into China
in the first half of 2005, a
50% year-on-year growth rate for first halves. The PBoC uses open market
operations, mainly selling PBoC bills, to deal with these inflows. These
bills allow the PBoC to take high-power money from the commercial banks in
exchange for bills that the banks cannot re-lend to customers, thus
stopping the creation of new money by banks issuing loans on partial
reserve requirements. Net bill issuance accelerated in late 2004 to cope
with dollar inflows of up to $30 billion a month, and remained at high
levels. During 2004, the PBoC withdrew a total of 616 billion yuan ($74.5
billion) from the monetary base through bill issuance in the interbank
market. This was the equivalent of 36.1% of forex inflows for the year.
In addition, the PBoC issued 196.6 billion yuan ($23.8 billion) in PBoC
bills in May 2004 to the four major state-owned banks. In total, the PBoC
sterilized 812.6 billion yuan ($98.3 billion) during the year, equivalent
to 47.5% of forex inflows during 2004.
In the first half of 2005, there was an estimated
increase in outstanding PBoC bills of 645 billion to 672 billion yuan,
soaking up the equivalent of $78 billion to $81 billion worth of the forex
inflows. In other words, the PBoC sterilized 68% to 71% of the
inflows. Still, some 30% of the forex inflows went into the
expansion of the yuan money supply.
China
Raises Banks Reserve Ratio
Another tactic the PBoC used to control forex reserve inflows was higher
required reserve ratios, (RRR) which banks are required to place with the
central bank in proportion to their deposits. On September 21, 2003, RRR was raised to 7% from
6%, and to 7.5% on April 25, 2004.
These moves had the effect of withdrawing 203 billion yuan ($24.5 billion)
and 111.2 billion yuan ($13.4 billion) from the banking system.
The PBoC also issues guidance to banks on which sectors and regions to
lend and which to restrict credit, less to cement plants and real estate,
and more to agriculture and small- and medium-sized enterprises and less to
the coastal regions and more to the interior west.
China’s commercial banks are trying to meet the new capital-adequacy
ratios of 8% by January 2007 that bank regulators have imposed. Investments
in PBoC paper and most other forms of debt, which carry no capital
requirement, are now preferable to loans to corporate borrowers. This is
causing banks to draw back lending. China
had to pay a price to defend the yuan’s peg to the dollar. Faced with
massive forex inflows, fast-growing bank deposits and limited profitable
investment options, commercial banks are eager buyers of PBoC paper. The
ample liquidity in China’s money markets drove yields low. The overnight
borrowing rate in the market is now hovering around 1.2%, and one-year PBoC
bills sold for 2% in late May, down from an average in 2004 of
3.2%.
For a more in-depth analysis of the exchange rate issue, see: China steady
on the peg.
The revaluation move by China
is basically a political gesture to appease US
pressure on an allegedly over-valued Chinese currency against the dollar.
The market was expecting a lot more from China.
Key Asian currencies will now float with the RMB yuan. As global trading
began after the initial news of the yuan revaluation, the dollar was
falling against other major currencies. The dollar dropped to 110.97 yen
from 113.06 in
New York at the end of the
day of the news, while the 12-nation euro jumped to US$1.2196 from
US$1.2108. Minutes after China
announced its decision on the evening news, Malaysia
said it was also un-pegging its currency, the ringgit, from the dollar,
replacing it with a managed float in a move similar to that of China.
That left Hong Kong as the only major economy in Asia
that pegs its currency to the U.S. dollar. As long as the yuan is still not
freely convertible, Hong Kong can keep its currency
peg to the dollar, albeit at a high cost. Eventually, as the
yuan fluctuates against the dollar, the HK peg to the dollar will create
transactional inefficiencies and instabilities and possibly new
manipulative attacks from hedge funds. In South
Korea, the news was received in stride,
and government officials said they didn't expect it to have a big impact on
the nation's economy, the third largest in Asia
following Japan
and China.
Philippine central bank Governor Amando Tetangco said the move was expected
to strengthen all regional currencies, including the Philippine peso.
The yuan will now be allowed to trade in a tight 0.3 percent band
against an undisclosed basket of foreign currencies. Under the new system,
the yuan immediately jumps to 8.11 to the dollar. But once off this
starting block, it could, in theory anyway, rise (or fall) as much as 0.03
percent a day, since each day’s closing price against a basket of currencies
becomes the center of the next day's trading band. Each step is tiny, but
over time they add up. Yet gradualism is a key to stability.
China
Revalue RMB to Appease US Pressure
The yuan revaluation move is a response to the Schumer-Graham China Currency Bill (S.
295), calling for 27.5% tariffs on all Chinese products sold in the US if
China does not revalue its currency by 27.5% within 180 days of the passage
of the bill, which had been slated to pass before the end of the summer. A
deal was worked out months ago to postpone a vote in exchange for a Senate
hearing to be followed by a token gesture by China, so everyone could claim
they won something without any real changes. The desire to ease
tension in preparation for President Hu Jintao’s planned visit to
the Washington in September
2005 and the pending US Treasury ruling, also due in the Fall, on whether China
is a “currency manipulator” also played a role in the timing of the
move. The 2.1% upward revaluation of the yuan against the dollar was
immediately neutralized by readjustments by other Asian currencies.<>
Managed Float
China
has now officially adopted the Singapore
manage float model rather than the HK currency-board model. This is a significant
move. It shows that the HK tycoons are losing their myopic influence on
Chinese economic/monetary policy. The smug Hong Kong Monetary
Authority has been emanating false pride of superior monetary wisdom by
stubbornly hanging on to its currency board arrangement pegged to a
volatile dollar mistaken as a stable currency. The blind error left by
the parting British colonial rulers launched Hong Kong
into a bubble economy when the dollar was undervalued throughout much of
the 1990s that burst with unprecedented disaster in 1997 as part of the
Asian financial crisis a day after the British left Hong Kong. The
same currency board regime kept the Hong Kong
economy from recovering for more than seven years after 1997 when Hong
Kong was returned to China,
until the dollar began to fall in 2004. During that painful
period, , the Hong Kong equity market was exposed to manipulative attacks
by hedge funds in 1998 that required massive government incursion in the
market to foil.
By contrast, Singapore
has used what is known as the “basket, band and crawl”, or BBC, system
since the early 1980s. The Singapore
dollar is managed against an undisclosed basket of currencies of its main
trading partners and competitors. It allowed Singapore
to devalue its currency immediately after the Asian financial crisis to
moderate unnecessary pain on its economy. John Williamson, the
neo-liberal economist who coined the term Washington Consensus, is credited
with developing the BBC model in the 1970s. The Monetary Authority of
Singapore asserts that the BBC policy has given it flexibility in
responding to changes in local, regional and global conditions to maintain
export competitiveness and control inflation. The composition of the
currency basket is revised periodically to take into account changes in
trade patterns. The secret policy band is also regularly reviewed to ensure
it remains consistent with economic changes, with adjustments every six
months if needed. Singapore,
whose currency was first pegged to the US dollar and then floated in the
1970s, chose the BBC regime because of a close link between exchange rates
and interest rates in a small and open economy. Whether the BBC system will
work for a gigantic, relative closed economy like China
remains an open question.
The city-state of Singapore
has since guided monetary policy through exchange rates instead of directly
adjusting interest rates. This in theory has the advantage of insulating
borrowers from interest rate risks. But for an international finance
center, exchange rate risks are equally problematic. In recent
years, derivatives have been the instruments of choice in hedging both
interest rate and foreign exchange rates. Inflation has been
relatively low at 2% a year since the early 1980s. Under the BBC managed
float, the Singapore
dollar has appreciated by about 20% against the US dollar as the dollar
fell against other key currencies, although its strong currency policy has
eased since the Asian financial crisis in 1997. In contrast, the currency
has fallen 40% against the levitating Japanese yen.
Both China’s and Malaysia’s managed float exchange rate systems appear
broadly similar to that of Singapore,
although details remain sketchy on their operations. But there are several
obvious differences. The most significant is that the yuan is not freely
convertible. The currency trading bands in China
and Malaysia
are narrower than in Singapore,
which means smaller currency movements. China’s trading band is also
adjusted on a daily basis. The fundamental difference for China
lies in the option of administrative measures to manage both interest rates
and exchange rates, with consistency between the two less critical because
the yuan remains not freely convertible.
The International Monetary Fund has listed about 40 countries that use
some type of managed float system. But Singapore
officials say their system is in some ways unique since it is used also to
control monetary policy, while policy statements provide a clear indication
to the markets of where the currency is headed. Some neo-liberal economists
have argued that a BBC regime could provide the basis for the eventual
adoption of a common Asian currency. Others suggest the system is not
widely applicable in spite of Singapore’s success. Supporters of
floating exchange rates argue that Singapore
has strengths, such as a well regulated banking and financial system and
large fiscal reserves that many other countries do not have to support a
BBC system. A managed float system for a freely convertible currency largely
rests on gaining the confidence of the markets. Only if other macroeconomic
policies are consistent with a managed float will it be a
success. Many economists and market participants believe China
faces a potential challenge in introducing a managed float since a small
revaluation would continue to attract speculative foreign capital in
anticipation of further currency appreciation. As a result, China
may have to widen its currency trading band eventually to gain market
acceptance. This problem will be magnified if and
when the yuan becomes freely convertible, which is not likely to happen
until China’s banking system is brought up to BIS standards, in which case,
the problem shifts from exchange rates to interest rates.
A Strong Yuan Not Good for US Economy
The US has been saying that the Chinese yuan is between 20-40% undervalued
against the dollar and this undervaluation is a key factor in recurring
US-China trade imbalance. Reality shows a very different picture.
Let us examine the economic impacts on the US
economy of a yuan suddenly trading at 20% higher against the dollar. The
first impact will be that prices of US imports from China
will rise some 20%, significantly pushing up US
inflation rate and dollar interest rates. High dollar interest rates will
lift the exchange value of the dollar, pushing to problem back to square
one. Since the bulk of US consumer goods are imported from China,
a sudden and drastic rise in import prices of 20% will dampen US
consumption of Chinese imports at a time when consumer spending is holding
up the US
economy.
There is a possibility that US consumer spending will hold in dollar terms,
but the actually amount of goods sold will be reduced, lowering US living
standards while not reducing the US trade deficit. The dollar value of
US-China trade may remain the same, with more Chinese goods available for
export to other countries or staying in the Chinese domestic market,
raising Chinese living standards, and shrinking the relative size of the US
economy. And if the US Federal Reserve further accommodates
consumer credit to absorb the rise in import prices to prevent a real
reduction in consumer product sales, the US
trade deficit may actual increase while US
standard of living remains unchanged. Even if US
trade deficit with China
should moderate, it would only lead to a corresponding reduction in US
capital account surplus with China. With
a slower growth of Chinese holdings of dollars, China
will buy less US sovereign debt, pushing US
interest rates higher, possibly bursting the already precarious US
debt bubble.
With a yuan pegged to a basket of currencies of which the dollar is only
one among several, China
will have less of a need to hold dollars. With a drop in Chinese
export to the US,
China may
see its ability to buy US
sovereign debt reduced. And with the uncertainty of the exchange values of
the dollar against the other volatile currencies in the Chinese basket, the
market price of the yuan may at times fall as well as rise against the
dollar. If market forces should act against the yuan and push
the dollar higher against the yuan, US political pressure on letting the
market determine the value of the yuan would have proved to be
counterproductive toward its goal of a stronger yuan against the dollar. And
the adverse consequences the misguided cure can be significantly worse than
the current malady. For one thing, with a stronger dollar, US assets
not directly related to import prices, such as real estate, will suffer a
price collapse, adding a last straw effect to the already precarious
housing bubble. A strong yuan may not be a blessing for the US
economy.
On the Chinese side, a stronger yuan will have to be compensated with lower
Chinese wages, or a slowdown of rising wages, in order that Chinese exports
remain price competitive and profitable. Lower Chinese wages will slow the
development of a vibrant Chinese domestic market for US exports to China. The
better option would be to let the peg stand, and push China
to raise wages.
In a global market dominated by dollar hegemony, it is idiotic to expect
that the complex problems of the US
economy can be solved by the exchange value of one single foreign
currency. Dollar hegemony by definition eliminates the impact of
the exchange value of the dollar on the dollar economy.
Hostile, ill-considered US
political pressure on China’s economic/monetary policies has opened a can
of currency worms with highly unpredictable and possibly negative
consequences for the US
and the whole world. Just as the 1985 Plaza Accord on the
Japanese yen destroyed the Japanese export economy and brought stagflation
to the US
that led to the 1987 crash, forcing the yuan off its decade-old dollar peg
now may well be the spark that will ignite a raging forest fire in the US
debt-infested economy in the coming years.
The Danger of Trade Wars
US
geopolitical hostility toward China
will manifest itself first in trade friction, which will lead to a mutually
recriminatory trade war between the two major economies that will attract
opportunistic trade realignments among the traditional allies of the US. US
multinational corporations, unable to steer US domestic politics, will
increasingly trade with China through their foreign subsidiaries, leaving
the US economy with even less jobs, and a condition that will further
exacerbate anti-China popular sentiments that translate into more
anti-free-trade policies generally and anti-China policies specifically.
The resultant global economic depression from a trade war between the
world’s two largest economies will in turn heighten further mutual
recriminations. An external curb from the US of Chinese export
trade will accelerate a redirection of Chinese growth momentum inwards,
increasing Chinese power, including military power, while further encouraging
anti-US sentiment in Chinese policy circles. This in turn will
validate US
apprehension of a China
threat, increasing the prospect for inevitable armed conflict.
Problem of Overcapacity
A war between the US
and China
can have no winners, particularly on the political front. Even if the US
were to prevail militarily through its technological superiority, the
political cost of military victory will be so severe that the US
as it currently exists will not be recognizable after the conflict and the
original geopolitical aim behind the conflict would remain elusive, as the
Vietnam War and the Iraq War have demonstrated. By comparison,
the Vietnam
and Iraq
conflicts, destructive as they have been on US
social fabric, are mere minor scrimmages compared to a war with China.
US
policymakers have an option to make China
a friend and partner in a peaceful world for the benefit of all nations. To
do so, they must first recognize that the world can operate on the
principle of plentitude and that prosperity is not something to be fought
over by killing consumers in a world plagued with overcapacity.
Virtual Synthetic Empires
Even today, the formation of regional integration frameworks is at
constantly risk of dominant states exploiting the creation of ideologically
preferred regional frameworks in which preeminent powers can exercise
exclusive imperialistic influence over other weaker member states in a
virtual form of synthetic empire building.
In this context, including and excluding of certain target countries in
regional integration schemes are essentially stealth empire building
measures by dominant powers, as can be observed in the distinct feature of
the US
engineered Trans-Pacific Partnership (TPP) in its pointed exclusion of the
People’s Republic of China (PRC).
Exclusion of a particular country does not mean that the excluded
country will perpetually remain outside the framework. In fact, TPP holds
the door ajar for positive engagement with China,
shifting from the current balancing strategy to purposeful engagement,
holding better behavior as admission requirement.
The beginning step of such imperialistic policy is the establishment of
a neoliberal regional framework from which a target country is
conditionally engaged and proactively encouraged to reform in the direction
preferred by the hegemonic power. Regional integration can be a trap for
creeping ideological empire building by dominant member states.
Trade War Fought With Dollar Hegemony
Through international trade denominated in dollars, the US
has been waging an imperialistic trade war on its trading partners, using
dollar hegemony as weapon. The productivity boom in the US
in the past three decades was as much a mirage as the money that drove the
apparent boom. There was no productivity boom in the US
in the final two decades of the 20th century; only an import boom. What's
more, this boom was driven not by the spectacular growth in productive
activities in the American economy; it was driven by debt borrowed from the
low-wage countries producing wealth for export to US markets, paid for with
unlimited supply of fiat dollars that the US can print at will with no
adverse consequence because these fiat dollars has no place to go except
return to the US to buy US sovereign debt instruments, i.e. Treasury bonds.
Thus the US
current account deficit caused by imports is extinguished by capital
account surplus bulging with returned trade deficit dollars.
Empire in the Age of Free Trade
This economic boom made possible US
currency hegemony, fueled by payments of tribute from vassal states kept
perpetually at the level of subsistence poverty by their own addiction to
exports for paper money. It is the economics of empire in the Age of Free
Trade.
For the exporting nations, globalized “Free Trade” has installed export
as the only path to national development in a trade regime of market
fundamentalism, which is the belief that the only route to prosperity is
through free trading markets, and the optimum societal interest can only be
served through free market equilibrium reached through interactions of
countless individual decisions made independently by self-centered market
participants, each freely seeking to maximize his/her/its own private gain.
Such market equilibrium, if distorted by regulatory regimes in the name of
the common good of society, will in fact be harmful to economy, causing it
to fail in its function of allocation resources efficiently. This fanatic
view is summed up by Margaret Thatcher's infamous declaration that there is
no such thing as society in a market economy.
Exclusion of a particular country does not mean that the excluded
country will perpetually remain outside the framework. In fact, TPP holds
the door ajar for positive engagement with China,
shifting from the current balancing strategy to purposeful engagement,
holding better behavior as admission requirement.
The beginning step of such imperialistic policy is the establishment of
a neoliberal regional framework from which a target country is
conditionally engaged and proactively encouraged to reform in the direction
preferred by the hegemonic power. Regional integration can be a trap for
creeping ideological empire building by dominant member states.
Import Boom mistaken as Productivity Boom
Through international trade denominated in dollars, the US
has been waging an imperialistic trade war on its trading partners, using
dollar hegemony as weapon. The productivity boom in the US
in the past three decades was as much a mirage as the money that drove the
apparent boom.
There was no productivity boom in the US
in the final two decades of the 20th century; only an import boom. What's
more, this boom was driven not by the spectacular growth in productive
activities in the American economy; it was driven by debt borrowed from the
low-wage countries producing wealth for export to US markets, paid for with
unlimited supply of fiat dollars that the US can print at will with no
adverse consequence because these fiat dollars has no place to go except
return to the US to buy US sovereign debt instruments, i.e. Treasury bonds.
Thus the US
current account deficit caused by imports is extinguished by capital
account surplus bulging with returned trade deficit dollars.
This economic boom made possible US
currency hegemony, fueled by payments of tribute from vassal states kept
perpetually at the level of subsistence poverty by their own addiction to
exports for paper money. It is the economics of empire in the Age of Free
Trade.
For the exporting nations, globalized “Free Trade” has installed export
as the only path to national development in a trade regime of market
fundamentalism, which is the belief that the only route to prosperity is
through free trading markets, and the optimum societal interest can only be
served through free market equilibrium reached through interactions of
countless individual decisions made independently by self-centered market
participants, each freely seeking to maximize his/her/its own private gain.
Such market equilibrium, if distorted by regulatory regimes in the name of
the common good of society, will in fact be harmful to economy, causing it
to fail in its function of allocation resources efficiently. This fanatic
view is summed up by Margaret Thatcher's infamous declaration that there is
no such thing as society in a market economy.
National Sovereignty in the Pease of Westphalia
The fact is that in a Westphalian World Order of sovereign states that
has been functioning since its creation in 1648, all sovereign nations have
managed to retain their sovereign prerogative of command on their own
economies until economic globalization through international trade driven
by the integration of markets that all nations must develop trading
economies to remain prosperous and strong. The United
States, the Mecca of
market fundamentalism, commands its alleged free market economy in the name
of national security.
As a process, regional integration aims to reduce barriers of
international trade within a region, such as removal or reduction of
tariffs and adoption of a common currency for trade. The process also
orchestrates multilateral governmental support from all sovereign states in
a region for joint tackling of common regional problems that transcend
national borders, such as protection of the environment, maintenance of
public health, safeguard of cross-border water purity and supply, setting
standards for food safety, policing of transnational crime, particularly
illegal cross-border traffic of narcotic drugs, undocumented immigration,
financial fraud and illicit money laundering.
Free Trade as Diplomatic Weapon
While the US tirelessly
advocates free trade, denial of trade to another country is a declared
instrument of war in US foreign
policy. President George W Bush declares that "open trade is a moral
imperative" to spread democracy around the world. Administratively,
the White House Council of Economic Advisers is organizationally
subservient to the National Security Council. National-security concerns dictate
trade policies the US adopts
for its economic relations with different foreign countries. The
exchange rate policy of the dollar is set by the US Treasury, not the
Federal Reserve, the central bank, and certainly not set by the market
beyond a safe range.
Phyllis Schlafly, syndicated conservative columnist, responded to the
President three weeks later in an WSJ op-ed article: Free Trade is
an Economic Issue, Not a Moral One. In it, she notes while
conservatives should be happy to finally have a president who adds a moral
dimension to his actions, “the Bible does not instruct us on free trade and
it’s not one of the Ten Commandments. Jesus did not tell us to follow Him
along the road to free trade. … Nor is there anything in the U.S.
Constitution that requires us to support free trade and to abhor
protectionism. In fact, protectionism was the economic system believed in
and practiced by the framers of our Constitution. Protective tariffs were
the principal source of revenue for our federal government from its beginning
in 1789 until the passage of the 16th Amendment, which created the federal
income tax, in 1913. Were all those public officials during those
hundred-plus years remiss in not adhering to a “moral obligation” of free
trade?” Hardly, argues Schlafly whose views are noteworthy
because US
politics is currently enmeshed in a struggle between strict-constructionist
paleo-conservatives and moral-imperialist
neo-conservatives. Despite the ascendance of neo-imperialism in US
foreign policy, protectionism remains strong in US
political culture, particularly among conservatives and in the labor
movement.
World trade today is free only to the extent of being free to
support US unilateralism.
For the US imperia,
the line between foreign policy and domestic policy is merged to make room
for new global policy. The sole superpower views the world as its oyster,
and global trade is to replace foreign trade in a global economy the rules
for which are set by a World Trade Organization dominated in the hegemonic
dollar as reserve currency freely printed at will by the sole
superpower.
FreeTrade under Market Fundamentalism
Market fundamentalism as the term is generally used in macroeconomics as
a key component of neoliberal globalization of trade, in the same sense
that the British, through Adam Smith, promoted British opinion of
"free trade" as universal truth in the 18th -19th
centuries.
The difference between Smithian free trade doctrine and 21st
century neoliberal market fundamentalism is that British free trade was limited
to the sphere of political influence within the British
Empire, whereas neoliberal market fundamentalism aims to be
universally global in a new form of economic empire building.
Market fundamentalism helps no economy. It helps only gangs of select elites
in economies that subscribe to it. Since the segment most
favored by market economy is in control of the US polity,
market fundamentalism is officially billed as being the appropriate
doctrine for the US and
the world order it dominates.
Washington Consensus
Washington Consensus is a “conditionality” for inclusion into global
market fundamentalism through supranational intervention on national
sovereignty prerogative over monetary and fiscal policies. It is
another tool for building a new form of empire.
Washington Consensus is a term coined in 1990 by John Williamson of the
Institute for International Economics to summarize the synchronized
ideology of Washington-based establishment neoliberal economists,
reverberated around the world for a quarter of a century as the true gospel
of reform indispensable for achieving growth in a globalized market
economy. Economic neoliberalism has turned most trade-dependent nations
into failed states. (Please see my AToL article: World
Order, Failed States and Terrorism - PART 1: The failed-state cancer)
Initially applied to Latin America and
eventually to all developing economies, the term neoliberal has come to be
synonymous with globalized universal policy prescriptions based on
capitalistic free-market principles and a hegemonic monetarist regime
within narrow ideological limits. It promotes macroeconomic control, trade
openness, pro-market microeconomic measures, privatization and deregulation
in support of a dogmatic ideological faith in the market's ability to solve
all socio-economic problems more efficiently, and to assert a blanket
denial of an obvious contradiction between market efficiency and poverty
eradication.
Under monetarism, financial capital growth is to be achieved at the
expense of human capital growth. Sound money, undiluted by inflation,
imposed on all by US monetarists who ironically are the most flagrant
violators of the sound money principle, is to be maintained by keeping
wages low through structural unemployment and cross-border wage arbitrage.
Pockets of poverty in the periphery are the necessary price for prosperous
centers in the global economy. All economic activities are to be governed
by profit incentive. Such dogmas grant unemployment and poverty, conditions
of economic failure, undeserved conceptual respectability. Structural
unemployment then becomes the vaccine against inflation that would lead to
massive unemployment. Pockets of poverty become the venue to contain the
systemic spread of poverty in the whole economy. State intervention has
come to focus mainly on reducing the market power of labor in favor of
market power of capital in a blatantly predatory market mechanism.
The set of policy reforms prescribed by the Washington Consensus is
composed of 10 propositions:
1) fiscal discipline;
2) redirection of public-expenditure priorities toward fields
offering high financial returns;
3) tax reform to lower marginal rates and broaden the tax base;
4) interest-rate liberalization;
5) competitive exchange rates;
6) trade liberalization;
7) liberalization of foreign direct investment (FDI) inflows;
8) privatization;
9) deregulation and
10) secure private-property rights.
These propositions landed the world economy in recurring economic and
financial crises every decade, each crisis bigger than the previous one,
until the current crisis that began in mid 2007 which is now being
described as the crisis of a century.
Creation of WTO
The creation of the World Trade Organization (WTO) on January 1, 1995 was a crucial
reform landmark in international trade since the end of Second World War.
It also reversed the failed attempt in 1948 to create an International
Trade Organization (ITO).
In December 1945, representatives of 15 sovereign nations held talks
to reduce and set customs tariffs in the post-war era. With the Second
World War only recently ended, these sovereign nations wanted to give a
timely boost to liberalization of international trade, and to erase the
lingering legacy of counter-productive protectionist measures of the early
1930 which remained in place at the end of the war.
GATT
This first round of negotiations resulted in a package of trade rules
and 45,000 tariff concessions affecting $10 billion of trade, about one
fifth of the world’s total at the time. The group had expanded to 23
sovereign states by the time the deal was signed on October 30, 1947. The tariff concessions
came into effect by June 30, 1948
through a “Protocol of Provisional Application”, creating the new General
Agreement on Tariffs and Trade (GATT), with the 23 founding members,
officially known as “contracting parties”.
The 23, part of the larger group negotiating the ITO Charter,
accepted some of the trade rules of the draft Protocol of Provisional
Application in order to safeguard the result of the tariff concessions they
had negotiated. They spelled out how they envisaged the relationship
between the new GATT and the ITO Charter, but they also allowed for the
possibility that the ITO might not be created, which turned out to be the
case.
The Havana conference
began on November 21, 1947,
less than a month after GATT came into existence. The ITO Charter was
finally agreed to in Havana in
March 1948, but ratification in many of the 23 national legislatures proved
impossible. The fatal blow came from most serious opposition in the US
Congress, even though the Truman Administration had been one of the driving
forces behind the effort to form ITO.
In 1950, the US
government announced that it would not continue to seek Congressional
ratification of the Havana Charter, rendering the ITO was effectively dead.
GATT then was left to be the only multilateral; instrument governing
international trade from 1948 until the WTO was established in 1995.
The WTO governs global rules of trade between nations. Its main
function is supposed to ensure that trade flows as smoothly, predictably
and freely as possible. In fact, the effect of WTO rules can be manipulated
by the dominant member to misuse as empire building algorithms.
Negotiation sessions were held in Geneva
in 1947, Havana (Cuba
1948), Annecy (France
1949), Torquay (UK
1951), Geneva (1956), the
Dillion Round (1960-61), the Kennedy round (1964-67), Tokyo
(Japan 1973-79), Punta del Este (Uruguay 1986-94), Montreal
(Canada), Brussels
(Belgium)
and finally to Marrakesh (Morocco)
in 1994.
During that period of 47 years, the world trading system operated
under GATT, salvaged from the aborted attempt to create the ITO.
GATT facilitated the establishment of a strong and prosperous
multilateral trading system that became increasingly liberal
through several rounds of trade negotiations.
From 1948 to 1994, the General Agreement on Tariffs and Trade (GATT),
a provisional agreement and organization, provided rules for world trade
and presided over periods of high growth rates in international commerce.
The original intention was to create a third institution to handle
the trade side of international economic cooperation, joining the two
“Bretton Woods” created institutions: the World Bank and the International
Monetary Fund.
IMF
The mandate of the IMF is to promote international monetary
cooperation and provides policy advice and technical
assistance to help countries build and maintain strong economies
through a sound monetary regime. It also makes loans and helps
countries design policy programs to solve balance of payments problems when
sufficient financing on affordable terms cannot be obtained in credit markets
to meet net international payments. IMF loans are short and medium term and
funded mainly by the pool of quota contributions that its members provide.
IMF staff are primarily economists with wide experience in macroeconomic
and financial policies.
World Bank
The mandate of the World Bank is to promote long-term economic
development and poverty reduction by providing technical and financial
support to help countries reform particular sectors or implement specific
projects, such as building schools and health clinics, providing clean
water and electricity, fighting disease, and protecting the environment.
World Bank assistance is generally long term and is funded both by member
country contributions and through development bond issuance in the credit
market. World Bank staff are generally specialists in particular issues,
sectors, or techniques in development. The staffs of the two institutions
also cooperate on the conditionality involved in their respective
lending programs.
The IMF and World Bank also work together to reduce the external debt
burdens of the most heavily indebted poor countries under the Heavily
Indebted Poor Countries (HIPC) Initiative and the Multilateral
Debt Relief Initiative (MDRI). The objective is to help low-income
countries achieve their development goals without creating future debt
problems. IMF and Bank staff jointly prepare country debt sustainability
analyses under the Debt Sustainability Framework (DSF) developed
by the two institutions.
In 1999, the IMF and the World Bank launched the Poverty
Reduction Strategy Paper (PRSP) approach as a key component in the
process leading to debt relief under the HIPC Initiative and an important
anchor in concessional lending by the Fund and the Bank.
While PRSPs continue to underpin the HIPC Initiative, the World Bank
adopted in July 2014 a
new approach to country engagement that no longer requires PRSPs while
focusing on the elimination of extreme poverty and promotion of shared
prosperity. The Fund continues to rely on the PRSP to provide the link
between a Fund-supported program and the poverty reduction and growth
objectives of a member country.
Monitoring progress on the MDGs
Since 2004, the Fund and the Bank have worked together on the Global
Monitoring Report (GMR), which assesses progress towards the 2015
UN Millennium Development Goals (MDGs).
According to the final MDG report launched on July 6, 2015 by United
Nations Secretary-General Ban Ki-moon, the MDGs have produced the most
successful anti-poverty movement in history and will serve as the
jumping-off point for the new sustainable development agenda to be adopted
this year. The Millennium Development Goals Report 2015 found that the
15-year effort to achieve the eight aspirational goals set out in the Millennium
Declaration in 2000 was largely successful across the globe, while
acknowledging shortfalls that remain. The data and analysis presented in
the report show that with targeted interventions, sound strategies,
adequate resources and political will, even the poorest can make progress.
“Following profound and consistent gains, we now know that extreme
poverty can be eradicated within one more generation”, said Ban Ki-moon.
“The MDGs have greatly contributed to this progress and have taught us how
governments, business and civil society can work together to achieve
transformational breakthroughs”.
Goals and targets work
The MDG report confirms that goal-setting can lift millions of people
out of poverty, empower women and girls, improve health and well-being, and
provide vast new opportunities for better lives. Only two short decades
ago, nearly half of the developing world lived in extreme poverty. The
number of people now living in extreme poverty has declined by more than
half, falling from 1.9 billion in 1990 to 836 million in 2015. The world
has also witnessed dramatic improvement in gender equality in schooling
since the MDGs, and gender parity in primary school has been achieved in
the majority of countries. More girls are now in school, and women have
gained ground in parliamentary representation over the past 20 years in
nearly 90 per cent of the 174 countries with data. The average proportion
of women in parliament has nearly doubled during the same period. The rate
of children dying before their fifth birthday has declined by more than
half, dropping from 90 to 43 deaths per 1,000 live births since 1990. The
maternal mortality ratio shows a decline of 45 per cent worldwide, with
most of the reduction occurring since 2000.
Targeted investments in fighting diseases, such as HIV/AIDS and
malaria, have brought unprecedented results. Over 6.2 million malaria
deaths were averted between 2000 and 2015, while tuberculosis prevention,
diagnosis and treatment interventions saved an estimated 37 million lives
between 2000 and 2013. Worldwide, 2.1 billion have gained access to
improved sanitation and the proportion of people practicing open defecation
has fallen almost by half since 1990.
Official development assistance from developed countries saw an increase
of 66 per cent in real terms from 2000 and 2014, reaching $135.2 billion.
Inequalities persist The report highlighted that significant gains
have been made for many of the MDG targets worldwide, but progress has been
uneven across regions and countries, leaving significant gaps. Conflicts
remain the biggest threat to human development, with fragile and
conflict-affected countries typically experiencing the highest poverty
rates.
New Sustainable Development Goals (SDGs) will replace the MDGs in
2015 as the basis for the post-2015 development agenda. The Fund and the
Bank will support the implementation of the new SDGs and contribute to
monitoring progress toward their achievement.
The IMF and the World Bank are also working together to make
financial sectors in member sovereign states resilient and well regulated.
The Financial Sector Assessment Program (FSAP) was introduced in
1999 to identify the strengths and vulnerabilities of a country's financial
system and recommend appropriate policy responses.
Free market reform policies promoted by the World Bank are often
harmful to economic development, particularly if implemented badly, by
"shock therapy"), in the wrong sequence or in weak, uncompetitive
economies.
Failed ITO
Over 50 countries participated in the failed negotiations to create
an International Trade Organization (ITO) as a specialized agency of the
United Nations. The draft ITO Charter was ambitious. It extended beyond
world trade disciplines, to include rules on employment, commodity
agreements, restrictive business practices, international investment, and
services. The aim was to create the ITO at a UN Conference on Trade and
Employment in Havana, Cuba
in 1947.
But by the 1980s the GATT system needed a thorough overhaul. This led
to the Uruguay Round (1986-94), and ultimately to the WTO.
The Final Act of the Uruguay Round was signed by participants in Marrakesh,
Morocco, on April 15, 1994, marking the
formal end of the most far-reaching liberalization in world trade history.
It lasted 2,643 days, cutting tariffs, opening markets and bringing new
areas of cross-border economic activity under international rules for the
first time.
For almost half a century, the GATT’s basic legal principles remained
much as they were in 1948. There were additions in the form of a section on
development added in the 1960s and “plurilateral” agreements (i.e. with
voluntary membership) in the 1970s, and efforts to reduce tariffs further
continued. Much of this was achieved through a series of multilateral
negotiations known as “trade rounds” — the biggest leaps forward in
international trade liberalization have come through these rounds which
were held under GATT auspices.
In the early years, the GATT trade rounds concentrated on further
reducing tariffs. Then, the Kennedy Round in the mid-sixties brought about
a GATT Anti-Dumping Agreement and a section on development. The Tokyo Round
during the seventies was the first major attempt to tackle trade barriers
that do not take the form of tariffs, and to improve the system. The
eighth, the Uruguay Round of 1986-94, was the last and most extensive of
all. It led to the WTO and a new set of agreements.
The Tokyo
Round: a first try to reform the system
The Tokyo Round lasted from 1973 to 1979, with 102 countries
participating. It continued GATT’s efforts to progressively reduce tariffs.
The results included an average one-third cut in customs duties in the
world’s nine major industrial markets, bringing the average tariff on
industrial products down to 4.7%. The tariff reductions, phased in over a
period of eight years, involved an element of “harmonization” — the higher
the tariff, the larger the cut, proportionally.
In other issues, the Tokyo Round had mixed results. It failed to come
to grips with the fundamental problems affecting agriculture trade and also
stopped short of providing a modified agreement on “safeguards” (emergency
import measures). Nevertheless, a series of agreements on non-tariff
barriers did emerge from the negotiations, in some cases interpreting existing
GATT rules, in others breaking entirely new ground. In most cases, only a
relatively small number of (mainly industrialized) GATT members subscribed
to these agreements and arrangements. Because they were not accepted by the
full GATT membership, they were often informally called “codes”.
Codes were not multilateral, but they were a beginning. Several codes
were eventually amended in the Uruguay Round and turned into multilateral
commitments accepted by all WTO member states. Only four remained “plurilateral”
— those on government procurement, bovine meat, civil aircraft and dairy
products. In 1997, WTO members agreed to terminate the bovine meat and
dairy agreements, leaving only two.
GATT was provisional with a limited field of action, but its success
over 47 years in promoting and securing the liberalization of much of world
trade is incontestable. Continual reductions in tariffs alone helped spur
very high rates of world trade growth during the 1950s and 1960s — around
8% a year on average. And the momentum of trade liberalization helped
ensure that trade growth consistently out-paced production growth
throughout the GATT era, a measure of countries’ increasing ability to
trade with each other and to reap the benefits of trade. The rush of new
members during the Uruguay Round demonstrated that the multilateral trading
system was recognized as an anchor for development and an instrument of
economic and trade reform.
But all was not well. As time passed new problems arose. The Tokyo
Round in the 1970s was an attempt to tackle some of these new problems, but
achievements were limited. This was a sign of difficult times to come in
the global trade system.
GATT’s success in reducing tariffs to a low level, combined with a
series of economic recessions in the 1970s and early 1980s, drove
governments to devise other forms of protection for domestic sectors facing
increasingly inasive foreign competition. High rates of unemployment and
constant factory closures led governments in Western Europe
and North America to seek bilateral market-sharing
arrangements with competitors and to embark on a subsidies race to maintain
their holds on agricultural trade. Both these changes undermined GATT’s
credibility and effectiveness and in the case of strong nations, they were
stealth empire-building measures..
The problem was not just a deteriorating trade policy environment. By
the early 1980s the General Agreement was clearly no longer as relevant to
the realities of world trade as it had been in the 1940s. For a start,
world trade had become far more complex and important than four decades
before. The globalization of the world economy was underway, trade in
services, not covered by GATT rules, was of major concern to increasing
more countries, and international investment had expanded. The expansion of
services trade was also closely tied to further increases in world
merchandise trade.
GATT was ill equipped to handle trade in agriculture Loopholes in the
multilateral system were heavily exploited, and efforts at liberalizing agricultural
trade were unsuccessful. In the textiles and clothing sector, an exception
to GATT’s normal disciplines was negotiated in the 1960s and early 1970s,
leading to the Multifibre Arrangement. Even GATT’s institutional
structure and its dispute settlement system were causing concern.
An example of transnational convention in regional development is
the Agreement on the Application of Sanitary and Phyto-sanitary
Measures (SPS Agreement). The SPS Agreement is an international
treaties of the World Trade Organization (WTO) regarding the
application of standard food safety and regulation on animal and
plant health regulation. It was negotiated during the Uruguay Round of
GATT, and entered into force with the establishment of the WTO on January 1, 1995.
GATT originated with a meeting of 22 nations meeting in 1947 in Geneva,
Switzerland. By 2000,
there were 142 member nations, with another 30 countries seeking admission.
The detailed commitments by each country to limit tariffs on particular
items by the amount negotiated and specified in its tariff schedule is the
central core of the GATT system of international obligation.
The obligations relating to the tariff schedules are contained in
Article II of GATT. For each commodity listed on the schedule of a country,
that country agrees to charge a tariff that will not exceed an amount
specified in the schedule. It can, if it wishes, charge a lower tariff.
The WTO heavily influences the workings of the GATT treaties through
the efforts of various committees. Representatives of member countries of
the WTO comprise the Council for the Trade in Goods (Goods Council), which
oversees the work of 11 committees responsible for overseeing the various
sectors of GATT. The committees focus on such issues as agriculture, sanitary
measures, subsidies, customs valuation, and rules of origin.
SPS measures aim at the protection of human, animal and plant life
and health from preventable risks. The WTO sets constraints on policies of
member-states relating to food safety (bacterial contaminants, pesticides,
inspection and labeling of products ) as well as animal and plant health
(phyto-sanitation) with respect to of pests and contagious diseases.
Three organizations set standards that WTO members states are obliged
to adopt for SPS methodologies. As provided for in Article 3, the three
are:
the Codex Alimentarius Commission (Codex),
World Organization for Animal Health (OIE) and
Secretariat of the International Plant Protection Convention (IPPC).
SPS standards target ‘scientifically unfounded’ barriers to trade disguised
as health and safety regulations.
The Agreement on Technical Barriers to Trade (TBT), signed in
the same year as the SPS, with similar goals. The TBT emerged from the
Tokyo Round and was negotiated with the aim of ensuring non-discrimination
in the adoption and implementation of technical regulations and standards.
The TBT exists to ensure that technical regulations, standards,
testing, and certification procedures do not create unnecessary obstacles
to trade. The agreement prohibits technical requirements created in order
to limit trade, as opposed to technical requirements created for legitimate
purposes such as consumer or environmental protection.
In fact, its purpose is to avoid unnecessary obstacles to international
trade and to give recognition to all WTO members to protect legitimate
interests according to own regulatory autonomy, although promoting the use
of international standards. The list of legitimate interests that can
justify a restriction in trade is not exhaustive and it includes protection
of environment, human and animal health and safety.
The General Agreement on Trade in Services (GATS)
is a treaty of the WTO that entered into force in January
1995 as a result of the Uruguay Round negotiations. The treaty was
created to extend the multilateral trading system to service sector,
in the same way GATT provides such a system for merchandise trade. All
members of the WTO are signatories to the GATS. The basic WTO principle
of most favoured nation (MFN) applies to GATS as well. However,
upon accession, Members may introduce temporary exemptions to this rule.
While the overall goal of GATS is to remove barriers to trade,
members are free to choose which sectors are to be progressively
"liberalised", i.e. marketised and privatised, which mode of
supply would apply to a particular sector, and to what extent
liberalisation will occur over a given period of time. Members' commitments
are governed by a "ratchet effect", meaning that commitments are
one-way and are not to be wound back once entered into. The reason for this
rule is to create a stable trading climate. However, Article XXI does allow
Members to withdraw commitments, and so far two members have exercised this
option (USA
and EU). In November 2008, Bolivia
gave a notification that it will withdraw its health services commitments.
Some activist groups consider that GATS risks undermining the ability
and authority of governments to regulate commercial activities within their
own boundaries, with the effect of ceding power to business interests ahead
of the interests of citizens. In 2003 the GATSwatch network
published a critical statement which was supported by over 500
organisations in 60 countries.[1] At
the same time, countries are not under any obligation to enter
international agreements such as GATS. For countries that like to attract
trade and investment, GATS adds a measure of transparency and legal
predictability. Legal obstacles to services trade can have legitimate
policy reasons, but can also be an effective tool for large scale
corruption
The GATS agreement has been criticized for tending to substitute the
authority of national legislation and judiciary with that of
a GATS Disputes Panel conducting closed hearings. WTO member-government
spokespersons are obliged to dismiss such criticism because of prior
commitment to perceived benefits of prevailing commercial principles of
competition and 'liberalization'.
While national governments have the option to exclude any specific
service from liberalization under GATS, they are also under pressure from
international business interests to refrain from excluding any service
"provided on a commercial basis". Important public utilities such
as water and electricity most commonly involve purchase by consumers and
are thus demonstrably "provided on a commercial basis". The same
may be said of many health and education services which are sought to be
'exported' by some countries as profitable industries.
This definition defines virtually any public service as being
"provided on a commercial basis" and is already extending into
such areas as police, the military, prisons, the justice system, public
administration, and government. Over a fairly short time perspective, this
could open up for the privatization or marketization of large parts,
and possibly all, of what today are considered public
services currently available for the whole population of a country as
a social entitlement, to be restructured, marketized, contracted out to
for-profit providers, and eventually fully privatized and available only to
those who can pay for them. This process is currently far advanced in most
countries, usually (and intentionally) without properly informing or
consulting the public as to whether or not this is what they desire.
When a WTO member enters into a regional integration arrangement
through which it grants more favorable conditions to its trade with other
parties to that arrangement than to other WTO members’ trade, it departs
from the guiding principle of non-discrimination defined in Article I
of GATT, Article II of GATS, and elsewhere.
WTO Members are however permitted to enter into such arrangements
under specific conditions which are spelled out in three sets of rules:
Paragraphs 4 to 10 of Article XXIV of GATT(as
clarified in the Understanding on the Interpretation of Article XXIV of the
GATT 1994) provide for the formation and operation of customs unions and
free-trade areas covering trade in goods; the so-called Enabling
Clause (i.e., the 1979 Decision on Differential and More Favorable
Treatment, Reciprocity and Fuller Participation of Developing Countries)
refers to preferential trade arrangements in trade in goods between
developing country Members; and Article V of GATS governs the
conclusion of RTAs in the area of trade in services, for both developed and
developing countries.
Other non-generalized preferential schemes, for example
non-reciprocal preferential agreements involving developing and developed
countries, require Members to seek a waiver from WTO rules. Such waivers
require the approval of three quarters of WTO Members. Examples of such
agreements which are currently in force include the US
— Caribbean Basin Economic Recovery Act (CBERA), the CARIBCAN agreement
whereby Canada
offers duty-free non-reciprocal access to most Caribbean
countries, Turkey-Preferential treatment for Bosnia-Herzegovina and the
EC-ACP Partnership Agreement.
Financial Markets Globalization
Inequality of income has been widening with the top 1% gaining
spectacularly against workers’ wages. This is attributable to the
financialization of the economy, a term the describes not just expanding
monetary value of the financial sector relative to the rest of the economy,
but also the increasing central role of finance in economic activities,
particularly the use of high leverage to create high returns on equity and
the securitization of debt, turning liability into tradable asset as collateralized
debt obligations (CDO) with steady flow of debt service payments
legitimized by deregulation. This has led to under-pricing of risk in the
financial system.
The success or failure of the financial sector has a disproportionate
impact on the rest of the economy, especially when the combination of too
much speculation and too little regulation starts inflating and bursting
bubbles. And its returns flow almost exclusively to high earners. Please
see my June 24, 2009
article: Mark-to-Market vs
Mark-to-Model.
US
Plunge Protection Team saving Free Market
Plunge Protection Team (PPT), the moniker given in 1997 to the then
just-established President’s Working Group on Financial Markets (PWG)
by The Washington Post, was created by Executive
order 12631, signed on March 18, 1988 by President Ronald Reagan in
response to the 1987 market crash to give recommendations for legislative
and private sector solutions for “enhancing the integrity, efficiency,
orderliness, and competitiveness of [United States] financial markets and
maintaining investor confidence.” Many perceive it as having been created
solely to shore up crashing markets or even to manipulate the market to
reverse free-falling stock indices.
PPT, officially created to make urgent financial and economic
recommendations to various sectors of the economy in times of extreme
market turbulence, consists a team of top policymakers and market
regulators that include the Secretary of the Treasury, the Chairman of the
Board of Governors of the Federal Reserve, the Chairman of the SEC and the
Chairman of the Commodity Futures Trading Commission.
In April 1999, the PWG issued a report on the lessons of the pending
collapse of Long-Term Capital Management (LTCM) in May 1998 and six
months after the subsequent bailout of LTCM by creditors arranged by the
New York Fed on September 23, 1998.
The PWG Report raised alarm over excessive leverage and the opaque risks
of the Over the Counter (OTC) derivatives market that trade outside of
exchanges, but called for only one legislative change -- a recommendation
that unregulated affiliates of brokerages be required to assess and report
their financial risk to government regulators. Fed Chairman
Greenspan dissented even on that vague recommendation on the ground that
self regulation was preferred in financial markets.
Traces of PPT market intervention are discernable regularly
since its creation. Forbes Magazine in its August 24, 2015 issue headlined an article: U.S.
Plunge Protection Team Out In Force This Morning, by Jay Somanev: "It
sure looks like the U.S.
plunge protection team is out in full force this morning. Our indices are
off the lows made from the open and a lot of stocks that were
down to absolutely ridiculous levels have also bounced back and some are
even trying to go green amidst the carnage. One of the most important
things in this sort of market environment is capital preservation. So, if
you are buying or adding do it in small increments and save your firepower
for the days and weeks ahead where you might see better prices than what we
are seeing right now. I don’t think we will see the prices that we saw at
the open again but I am fairly confident that better prices than what we
see right now will be available in the upcoming days. There is no way we
don’t have an off-the-cuff comment from a Fed head soon.More importantly,
China is not just going to reverse and bounce back from here on out.I have
covered a lot of my hedges and have added in smallish increments, leaving
plenty of cash should we get better prices in the coming
days/weeks."
Four persons as appointed members of PPT can control all US
financial markets through the use of dangerous and explosive derivatives.
They are empowered to risk the assets and retirement funds of all US
citizens. Because of their manipulations, especially since 2001, US
financial markets are now based on speculative whims of a special
fraternity of Federal Government derivatives dealers.
PPT works closely with all US
exchanges and Wall Street banks, including large derivative risk players
such as Citibank and JP Morgan Chase.
Few are aware of Executive Order 12631 signed by Ronald Reagan on
March 18, 1988 which delegates "authority" to four individuals to
trade derivatives since 2001.
Executive Order 12631 - Working Group on Financial Markets - Mar. 18,
1988; 53 FR 9421, 3 CFR, 1988 Comp., p. 559: "By virtue of the
authority vested in me as President by the Constitution and laws of the
United States of America, and in order to establish a Working Group on
Financial Markets, it is hereby ordered as follows:
Section 1. Establishment. (a) There is hereby established a Working
Group on Financial Markets (Working Group). The Working Group shall be
composed of:
(1) the Secretary of the Treasury, or his designee;
(2) the Chairman of the Board of Governors of the Federal Reserve
System, or his designee;
(3) the Chairman of the Securities and Exchange Commission, or his
designee; and
(4) the Chairman of the Commodity Futures Trading Commission, or her
designee.
Section 2. Purposes and Functions. (a) Recognizing the goals of
enhancing the integrity, efficiency, orderliness, and competitiveness of
our Nation's financial markets and maintaining investor confidence, the
Working Group shall identify and consider: the actions, including
governmental actions under existing laws and regulations (such as policy
coordination and contingency planning), that are appropriate to carry out these
recommendations. The Working Group shall consult, as appropriate, with
representatives of the various exchanges, clearinghouses, self-regulatory
bodies, and with major market participants to determine private sector
solutions wherever possible.
Section 3. Administration. (c) To the extent permitted by law and
subject to the availability of funds therefore, the Department of the
Treasury shall provide the Working Group with such administrative and
support services as may be necessary for the performance of its functions.
US financial markets showed an astounding - yet confounding and
puzzling - rise for the 4 months proceeding the 911 terrorist attack. US
media dubbed it a "patriotic rally". The European Press called it
a "PPT rally".
Obviously, US markets were manipulated and rigged to an inflated
value in advance of the 911 disaster, after which there were at least three
major long-term stock market rallies. In all 3 instances, when the markets
opened, all the indices began to quickly plunge. In each incidence, by
early afternoon the markets were brought back from the brink of collapse to
the surprise of everyone, including historical analysts.
On September 16, 2001,
The Guardian reported "that a secretive committee... dubbed 'the
plunge protection team'... is ready to coordinate intervention by the
Federal Reserve on an unprecedented scale. The Fed, supported by the banks
it regulates, will buy equities from mutual funds and other institutional
sellers..."
At the Fed Open Market Committee (FOMC) meeting on Jan 29-30, 2002, Fed
Chairman Alan Greenspan openly discussed the use of
"unconventional methods" to stimulate the economy. The Financial
Times of London quoted an anonymous US Fed official who stated that one of
the extraordinary measures "considered" in January 2004 was
"buying US equities".
On Feb 21, 2002,
the Financial Times featured an article about Japan's
Stock Buying Body. The article stated that "...government backed
equity markets, as Japan
has recently become aware, do not work... Plunge protecting the world's
markets may be a hazardous pursuit."
Another event that should have sent markets spiraling downward was
the Enron corporate accounting scandals. Here is the timeline on Eron
collapse:
December 2000 - Enron announces that Skilling, then president and
chief operating officer, will succeed Kenneth Lay as CEO in February 2001.
Lay will remain as chairman. Stock hits 52-week high of $84.87.
2001:
Aug. 14 - Skilling resigns; Lay named CEO again.
Aug. 22 - Finance executive Sherron Watkins meets privately with Lay
to discuss concerns of murky finance and accounting that could ruin the
company.
Oct. 16 - Enron announces $638 million in third-quarter losses and a
$1.2 billion reduction in shareholder equity stemming from writeoffs
related to failed broadband and water trading ventures as well as unwinding
of so-called Raptors, or fragile entities backed by falling Enron stock
created to hedge inflated asset values and keep hundreds of millions of
dollars in debt off the energy company's books.
Oct. 19 - Securities and Exchange Commission launches inquiry into
Enron finances.
Oct. 22 - Enron acknowledges SEC inquiry into a possible conflict of
interest related to the company's dealings with Fastow's partnerships. Lay
says, "We will cooperate fully with the SEC and look forward to the
opportunity to put any concern about these transactions to rest."
Oct. 23 - Lay professes confidence in Fastow to analysts.
Oct. 24 - Fastow ousted.
Nov. 5 - Enron treasurer Ben Glisan Jr. and in-house attorney
Kristina Mordaunt fired for investing in Fastow-run partnership.
Each invested $5,800 in 2001 and received a $1 million return a few
weeks later.
Nov. 8 - Enron files documents with SEC revising its financial
statements for previous five years to account for $586 million in losses.
Nov. 9 - Dynegy Inc. announces an agreement to buy Enron for more
than $8 billion in stock.
Nov. 19 - Enron restates its third-quarter earnings and discloses a
$690 million debt is due Nov. 27.
Nov. 28 - Enron stock plunges below $1 as Dynegy Inc. aborts its plan
to buy its former rival.
Dec. 2 - Enron goes bankrupt, thousands of workers laid off.
2002:
Jan. 9 - Justice Department confirms it has begun a criminal
investigation of Enron.
Jan. 10 - The White House discloses Lay sought help from two Cabinet
members shortly before the company collapsed, but neither offered aid. The
company's auditor, Arthur Andersen LLP, says it has destroyed tons of Enron
documents.
Jan. 23 - Lay resigns as chairman and CEO.
Jan. 25 - Cliff Baxter, former head of Enron's trading unit and later
vice president before his resignation in May 2001, found dead of a
self-inflicted gunshot wound.
Feb. 4 - Lay resigns from the board.
Feb. 7 - Skilling, Fastow, Michael Kopper appear at Congress with
McMahon and in-house Enron lawyer Jordan Mintz. Skilling testifies; Fastow
and Kopper invoke Fifth Amendment rights.
Feb. 12 - Lay invokes Fifth Amendment at a Senate hearing after
expressing "profound sadness" at Enron's collapse.
March 14 - Former Enron auditor Arthur Andersen LLP indicted for
destroying Enron-related documents to thwart investigators.
April 9 - David Duncan, Andersen's former top Enron auditor, pleads
guilty to obstruction for instructing his staff to destroy documents as per
company policy.
June 15 - Andersen convicted.
Aug. 21 - Former top Fastow aide Michael Kopper pleads guilty to
money laundering and conspiracy, the first ex-Enron executive to strike a
deal with prosecutors. He identifies a string of partnerships designed to
falsely portray Enron as financially healthy while enriching him, Fastow
and others.
Sept. 12 - Three former National Westminster Bank bankers indicted
for wire fraud for siphoning off millions of dollars in income intended for
their employer through investments in a Fastow partnership. They are
fighting extradition.
Oct. 16 - Andersen sentenced to probation and fined $500,000; firm
was already banned from auditing public companies and had only a few
hundred employees left after its conviction.
Oct. 17 - Former top Enron trader Timothy Belden pleads guilty to
wire fraud for participating in schemes to game California's
power markets during the state's energy crisis in 2000 and 2001.
Oct. 31 - Fastow indicted on 78 charges of conspiracy, fraud, money
laundering and other counts.
Yet an unprecedented across-the-board markets rally began on July 24, 2002. Once again, the
European Press called it a "PPT rally".
In each of these events, a large "no-name" buyer in the
futures market secretly plunged in and bought up massive quantities of
derivatives through big banking groups such as JP Morgan. These were trades
that were prepared to suffer losses not sustainable by the average market
participant, neutralizing Keynes famous warning that market can stay
irrational longer than investors can stay solvent. As unlimited funds were
buying to support S&P's rise, in each instance, the market's free-fall
was quickly reversed.
PPT successfully brought the markets back each time from sharp
correction despite the inflated financial realities that existed. Each
time, the large purchase of derivatives at a huge loss transformed
developing market crises into a irrational rallies. Each time, such
manipulation of the derivative market further inflated highly overvalued
market indices to set up the next more severe crisis .
Supranational Institutions in Regional Integration
The EU is the most prominent operating supranational
union in which negotiated power is delegated to a super authority by
the national governments of all its member sovereign states. It is the only
entity which provides for international popular elections, going beyond the
level of political integration generally afforded by international
treaty.
The hierarchical term "supranational" is sometimes used
in a loosely defined sense in different contexts, as a substitute for
non-hierarchical “international”, or for transgressing “transnational”
or for geographical “global”.
Intergovernmentalism refers to a theory of regional
integration originally formulated by Stanley Hoffmann of Harvard in his
influential book: The New European Community: Decisionmaking and
Institutional Change, co-edited with Robert O. Keohane, (Westview
Press, 1991).
As a broad political concept, Intergovernmentalism sees
semi-autonomous state governments and their national governments in
particular, as the primary actors in the integration process of a region.
Intergovernmentalists explain periods of radical
transformation in the EU as being driven by converging governmental
preferences, and periods of inertia as being outcome of diverging national
interests.
Intergovernmentalism is distinguishable from
realism and neorealiam neorealism because of its recognition of
both the significance of institutionalization in international politics and
the impact of domestic politics upon governmental preferences.
European Integration
The best-known, most far-reaching and most studied operating example
of regional integration is the European Union (EU),
an economic and political intergovernmental organization of 28
member sovereign states, all in Europe.
The EU operates through a system of supranational independent
institutions and intergovernmental negotiated decisions by the member
sovereign states. Supranational institutions of the EU include
the European Commission, the Council of the European Union,
the European Council, the Court of Justice of the European Union,
the European Central Bank, the Court of Auditors, and
the European Parliament. The European Parliament is elected every five
years by EU citizens.
EU's de facto capital is Brussels.
The EU has developed a single market through a standardized
system of laws that apply in all member states. Within the Schengen
Area (which includes 22 EU and 4 non-EU European states) passport
controls have been abolished. EU policies favor the free movement
of people, goods, services, and capital within its multination
boundaries, enact legislation in justice and home affairs, and maintain
common policies on
trade, agriculture, fisheries and regional development.
A monetary union, the eurozone, was established in 1999 and is
composed of 17 member states. Through the Common Foreign and Security
Policy the EU has developed a role in external relations and
defense. Permanent diplomatic missions have been established
around the world. The EU is represented at the United Nations,
the World Trade Organization, the G8 and the G-20.
Intergovernmentalism represents a way for limiting the conferral of
powers upon supranational institutions, halting the emergence of common
policies. in the current institutional system of the EU, the European
Council and the Council play the role of the institutions which have the
last word about decisions and policies of the EU, institutionalizing a de
facto intergovernmental control over the EU as a whole, with the
possibility to give more power to a small group of states. This extreme
consequence can create the condition of supremacy of someone over someone
else violating the principle of a “Union of Equals”.
A common method of decision-making in international
organizations is intergovernnmentalism, in which sovereign state
governments play a more prominent role.
Council of Europe
The Council of Europe has created a system based
on human rights and rule of law in its founding Statute
and its Convention of Human Rights and Fundamental Freedoms. Robert
Schuman, French Foreign minister, initiated the debate on supranational
democracy in his speeches at the United Nations, at the signing of the
Council's Statutes and at a series of other speeches across Europe
and North America.[3]
The term "supranational" occurs in an international treaty
for the first time (twice) in the Treaty of Paris, 18 April 1951. This new legal term defined
the Community method in creating the European Coal and Steel
Community and the beginning of the democratic re-organization of Europe.
It defines the relationship between the High Authority or European
Commission and the other four institutions. In the treaty, it relates
to a new democratic and legal concept.
The Founding Fathers of the European Community and the
present European Union said that supranationalism was the cornerstone of the
governmental system. This is enshrined in the Europe Declaration made
on 18 April 1951, the
same day as the European Founding Fathers signed the Treaty of
Paris.
"By the signature of this Treaty, the participating Parties
give proof of their determination to create the first supranational
institution and that thus they are laying the true foundation of
an organised Europe. This Europe
remains open to all nations. We profoundly hope that other nations will
join us in our common endeavour."
This declaration of principles that included their judgment for the
necessary future developments was signed by Konrad Adenauer (West
Germany), Paul van Zeeland and Joseph Meurice
(Belgium), Robert Schuman (France), Count Sforza (Italy), Joseph
Bech (Luxembourg), and Dirk Stikker and Jan van den
Brink (The Netherlands). It was made to recall future generations to
their historic duty of uniting Europe based on
liberty and democracy under the rule of law. Thus, they viewed the creation
of a wider and deeper Europe as intimately bound to
the healthy development of the supranational or Community system.
This Europe was open to all nations who were
free to decide – a reference, or rather an invitation and encouragement of
liberty to the Iron Curtain countries. The term supranational
does not occur in succeeding treaties such as the Treaties of Rome, officially the Treaty establishing the
European Economic Community (TEEC), is an international agreement that
led to the founding of the European Economic Community (EEC) on 1
January 1958.
It was signed on 25 March 1957 by
Belgium, France, Italy, Luxembourg, the Netherlands and
West Germany; the Maastricht Treaty, (formally, the Treaty on European Union
or TEU) undertaken to integrate Europe was signed on 7 February 1992 by the
members of the European Community in Maastricht, Netherlands.
On December 9-10,
1991, the same city hosted the European Council which drafted the
treaty; the Treaty of Nice, signed by European leaders on February 26, 2001 and came into force on
February 1, 2003. It amended the Maastricht Treaty (or the Treaty on
European Union) and the Treaty of Rome (or the Treaty establishing the
European Community which, before the Maastricht Treaty, was the
Treaty establishing the European Economic Community); or
the Constitutional Treaty,
an unratified international treaty intended to create a consolidated
constitution for the European Union (EU). It would have replaced the
existing European Union treaties with a single text, given legal force to
the Charter of Fundamental Rights, and expanded Qualified Majority Voting
into policy areas which had previously been decided by unanimity among
member states. The Treaty was signed on 29 October 2004 by representatives
of the then 25 member states of the European Union. It was later ratified
by 18 member states, which included referendums endorsing it in Spain and
Luxembourg. However the rejection of the document by French and Dutch
voters in May and June 2005 brought the ratification process to an end.
Following a period of
reflection, the Treaty of Lisbon was created to replace the Constitutional
Treaty. This contained many of the changes that were originally placed in
the Constitutional Treaty but was formulated as amendments to the existing
treaties. Signed on 13 December 2007, the Lisbon Treaty entered into force
on 1 December 2009.
A supranational union is a supranational polity which lies
somewhere between a confederation that is an association of
states, and a federation that is a state.
The European Economic Community was described
by its founder Robert Schuman as midway between confederalism
which recognizes the complete independence of States in an association
and federalism which seeks to fuse them in a
super-state. The EU has supranational competences, but it possesses these
competences only to the extent that they are conferred on it by its member
states (Kompetenz-Kompetenz). Within the scope of these
competences, the union exercises its powers in
a sovereign manner, having its own legislative, executive,
and judicial authorities. The supranational Community also
has a chamber for organized civil society including economic and social
associations and regional bodies.
Unlike states in a federal super-state, member states in a
supranational Community retain ultimate sovereignty, although some
sovereignty is shared with, or ceded to, the supranational body.
Supranational agreements encourage stability and trust, because governments
cannot break international accords at a whim. The supranational action may
be time-limited. This was the case with the European Coal and Steel
Community, which was agreed for 50 years with the possibility of renewal.
Supranational accords may be permanent, such as an agreement to outlaw war
between the partners. Full sovereignty can be reclaimed by withdrawing from
the supranational arrangements but the member state would also lose the
great advantages offered by mutualities, economies of scale, common
external tariffs and other commonly agreed standards such as improved
international trust and democracy and the increased weight of common
external positions.
A supranational union, because it is an agreement between sovereign
states, is based on international treaties. The European treaties in
general are different from classical treaties as they are constitutionalizing
treaties, that is, they provide the basis for a European level of democracy
and European rule of law. They have something in the nature of a
constitution and like the British constitution, not necessarily a
single document. They are based on treaties between its member
governments but have normally to undergo a closer democratic scrutiny than
other treaties because they are more far-ranging, affecting many areas of
citizens' lives and livelihoods. This is why citizens often demand referendums.
Decision-making is partly intergovernmental and partly
supranational within the Community areas. The latter provides a higher
degree of institutional scrutiny both via the Parliament and through the
Consultative Committees. Intergovernmentalism provides for less democratic
oversight, especially where the institution such as the Council of
Ministers or the European Council takes place behind closed
doors, rather than in a parliamentary chamber.
A supranational authority can have some independence from member
state governments in specific areas, although not as much independence as
with a federal government. Supranational institutions, like
federal governments, imply the possibility of pursuing agendas in ways that
the delegating states did not initially envision. Democratic supranational
Communities, however, are defined by treaty and by law. Their activity is
controlled by a Court, democratic institutions and the rule of law.
The union has legal supremacy over its member states (only)
to the extent that its member state governments have conferred competences
on the union. It is up to the individual governments to assure that they
have full democratic backing in each of the member states. The citizens of
the member states, though retaining their nationality and
national citizenship, additionally become citizens of the union.
The European Union
The European Union, the only clear example of a supranational union,
has a parliament with legislative oversight, elected by its
citizens. To this extent, a supranational union like the European
Union has characteristics that are not entirely dissimilar to the
characteristics of a federal state like the United
States of America. However, the
differences in scale become apparent if one compares the United
States federal budget with
the budget of the European Union (which amounts only to about one
percent of combined GDP) or the size of the federal civil service of the United
States with the Civil Service of
the European Union.
Because decisions in some EU structures are taken by majority votes,
it is possible for a member state to be obliged by the other members to
implement a decision. The states retain the competence for adding this
additional supranational competence.
European Integration originates from Trade Integration. Historically
the concept was introduced and made a concrete reality by Robert
Schuman when the French Government agreed to the principle in
the Schuman Declaration and accepted the Schuman
Plan confined to specific sectors of vital interest of peace and war.
Thus commenced the European Community system beginning with
the European Coal and Steel Community. The six founder States, (France,
Italy, Germany,
The Netherlands, Belgium,
Luxembourg)
agreed on the goal: making 'war not only unthinkable but materially
impossible'. They agreed about the means: putting the vital interests,
namely coal and steel production, under a common High Authority, subject to
common democratic and legal institutions. They agreed on the European rule
of law and a new democratic procedure.
The five institutions (besides the High Authority) were a
Consultative Committee (a chamber representing civil society interests of
enterprises, workers and consumers), a parliament, and a Council of
government ministers. A Court of Justice would decide disputes coming from
governments, public or private enterprises, consumer groups, any other
group interests or even an individual. A complaint could be lodged in a local
tribunal or national courts, where appropriate. Member states have yet to
fulfil and develop the articles in the Paris
and Rome treaties for full
democracy in the European Parliament and other institutions such as the
Economic and Social Committee and the Committee of Regions.
Schuman described supranational unions as a new stage in human
development. It contrasted with destructive nationalisms of the nineteenth
and twentieth centuries that began in a glorious patriotism and ended in
wars. He traced the beginning concept of supranationality back to the
nineteenth century, such as the Postal Union, and the term supranational is
used around the time of the First World War. Democracy, which he defined as
'in the service of the people and acting in agreement with it,' was a
fundamental part of a supranational community. However, governments only
began to hold direct elections to the European Parliament in 1979, and then
not according to the treaties. A single electoral statute was specified in
the treaty for Europe's first community of coal and
steel in 1951. Civil society (largely non-political) was to have its own
elected chamber in the Consultative Committees specific to each Community
as democratically agreed, but the process was frozen (as were Europe's parliamentary
elections) by Charles de Gaulle and other politicians who opposed
the Community method.
Trade Origin of the EU
Today supranationalism only exists in the two European Communities
inside the EU: the Economic Community (often called the European Community
although it does not legally cover all State activities) and Euratom (the
European Atomic Energy Community, a non-proliferation community, in which
certain potentialities have been frozen or blocked.) Supranational
Communities provide powerful but generally unexploited and innovatory means
for democratic foreign policy, by mobilizing civil society to the
democratically agreed goals of the Community.
The first Community of Coal and Steel was agreed only for fifty
years. Opposition, mainly by enterprises which had to pay a small European
tax of less than one percent and government ministers in the Council, led
to its democratic mandate not being renewed. Its jurisprudence and heritage
remains part of the European Community system.
De Gaulle attempted to turn the European Commission into a political
secretariat under his control in the Fouchet Plan but this move
was thwarted by such democrats in the Benelux countries
as Paul-Henri Spaak, Joseph Luns and Joseph Bech as
well as a large wave of other pro-Europeans in all the Community countries.
The supranational Community method came under attack, not only from
de Gaulle but also from other nationalists and Communists. In the post-de
Gaulle period, rather than holding pan-European elections under a single statute
as specified in all the treaties, governments held and continue to hold
separate national elections for the European Parliament. These often favour
the major parties and discriminate against smaller, regional
parties. Rather than granting elections to organised civil society in
the consultative committees, governments created a three-pillar system
under the Amsterdam Treaty and Maastricht Treaty, mixing
intergovernmental and supranational systems. Two pillars governing External
policy and Justice and Home affairs are not subject to the same democratic
controls as the Community system.
In the Lisbon Treaty and the earlier nearly identical Constitutional
Treaty, the democratic independence of the five key institutions is further
blurred. This moves the project from full democratic supranationalism in
the direction of not just intergovernmentalism but the politicization of
the institutions, and control by two or three major party political
organizations. The Commission defines key legal aspects of the supranational
system because its members must be independent of commercial, labor,
consumer, political or lobby interests (Article 9 of the Paris Treaty). The
Commission was to be composed of a small number of experienced
personalities, whose impartiality was beyond question. As such, the early
presidents of the Commission and the High
Authority were strong defenders of European democracy against
national, autocratic practice or the rule of the strong over the weak.
The idea in the Constitutional and Lisbon Treaties is to run the
European Commission as a political office. Governments would prefer to have
a national member in the Commission, although this is
against the principle of supranational democracy. (The original concept was
that the Commission should act as a single impartial college of
independent, experienced personalities having public confidence. One of the
Communities was defined in the treaty with a Commission with fewer members
than the number of its member states.) Thus, the members of the Commission
are becoming predominantly party-political, and composed of sometimes
rejected, disgraced or unwanted national politicians.
The first president of the High Authority was Jean
Monnet who never joined a political party, as was the case with most
of the other members of the Commissions. They came from diverse liberal
professions, having made recognized European contributions.
Governments also wish to retain the secrecy of their deliberations in
the Council of Ministers or the European Council, which discusses matters
of the most vital interest to European citizens. While some institutions
such as the European Parliament have their debates open to the public,
others such as the Council of Ministers and numerous committees are not.
Schuman wrote in his book, 'Pour l'Europe' (For Europe) that in a
democratic supranational Community the Councils, committees and
other organs should be placed under the control of public opinion that was
effectual without paralyzing their activity nor useful initiatives.
The European Union, the North American Free Trade Agreement, the
Association of Southeast Asian Nations, the South Asian Association for
Regional Cooperation, the Common Market of the South (MERCOSUR), the
Australia-New Zealand Closer Economic Relations Agreement, and so on.
By July 2005, Mongolia
was the only WTO member state not party to a regional trade agreement.
The surge in these agreements has continued unabated since the early 1990s.
By July 2005, a
total of 330 had been notified to the WTO and its predecessor, GATT. Of
these: 206 were notified after the WTO was created in January 1995; 180 are
currently in force; several others are believed to be operational although
not yet notified.
One of the most frequently asked questions is whether these regional
groups help or hinder the WTO’s multilateral trading system. A committee is
keeping an eye on developments.
Regional Trading Arrangements
They seem to be contradictory, but regional trade agreements can
actually support the WTO’s multilateral trading system. Regional agreements
have allowed groups of countries to negotiate rules and commitments that go
beyond what was possible at the time multilaterally. In turn, some of these
rules have paved the way for agreement in the WTO. Services, intellectual
property, environmental standards, investment and competition
policies are all issues that were raised in regional negotiations and later
developed into agreements or topics of discussion in the WTO.
The groupings that are important for the WTO are those that abolish
or reduce barriers on trade within the group. The WTO agreements recognize
that regional arrangements and closer economic integration can benefit
countries. It also recognizes that under some circumstances regional
trading arrangements could hurt the trade interests of other countries.
Normally, setting up a customs union or free trade area would violate the
WTO’s principle of equal treatment for all trading partners
(“most-favoured-nation”). But GATT’s Article 24 allows regional
trading arrangements to be set up as a special exception, provided certain
strict criteria are met.
In particular, the arrangements should help trade flow more freely
among the countries in the group without barriers being raised on trade
with the outside world. In other words, regional integration should
complement the multilateral trading system and not threaten it.
Article 24 says if a free trade area or customs union is created,
duties and other trade barriers should be reduced or removed on
substantially all sectors of trade in the group. Non-members should not
find trade with the group any more restrictive than before the group was
set up.
Similarly, Article 5 of the General Agreement on Trade in
Services provides for economic integration agreements in services. Other
provisions in the WTO agreements allow developing countries to enter into
regional or global agreements that include the reduction or elimination of
tariffs and non-tariff barriers on trade among themselves.
On February 6, 1996,
the WTO General Council created the Regional Trade
Agreements Committee. Its purpose is to examine regional groups and to
assess whether they are consistent with WTO rules. The committee is also
examining how regional arrangements might affect the multilateral trading
system, and what the relationship between regional and multilateral
arrangements might be.
Eurozone Sovereign Debt
Crisis
The Eurozone sovereign
debt crisis is rooted in the dysfunction of a monetary union without
political union. The fundamental cause for the crisis lies in the
arrangement under which the euro is legal tender for all member states in
the eurozone, yet monetary policy for the eurozone is the exclusive
responsibility of the European Central Bank, for which common
representation of all member states, governance and fiscal policy union in
support of currency union does not formally exist. This essentially makes
sovereign debt of eurozone member states denominated in euro foreign
currency debts. Since individual eurozone member states do not have
sovereign authority over their common currency, they are deprived of the
option of solving their sovereign debt problem with monetary measures, such
as devaluing their common currency or lowering interest rates.
The eurozone, also known
as euro area (EA17), is an economic and monetary union (EMU) of 17
out of the 27 member states of European
Union (EU27) that have adopted the euro (€) as their common currency and
sole legal tender that is freely convertible at market exchange rates. The
euro is also legal tender in a five other non-EMU European political
entities (Montenegro, Andorra, Monaco, San Marino and Vatican City) and the
disputed territory of Kosovo.
The euro is the common
currency used daily by some 332 million Europeans and their separate governments.
Additionally, over 175 million people worldwide use currencies which are
pegged to the euro, including more than 150 million people in Africa.
A Political Crisis with
Financial Dimensions
The European sovereign
debt crisis is at its base a intergovernmental political crisis in the
eurozone-17 with financial and economic dimensions that reaches beyond the
eurozone to all its trading partner regions as well as financial and
trading markets in the entire world. The crisis is centered around the difficulty
in achieving policy consensus among all eurozone member states and the
inability of any eurozone member state under financial distress from
sovereign debt difficulties to employ monetary measures individually, such
a currency devaluation or interest rate measures, to solve its euro
denominated sovereign debt problems, since no member state has individual
authority to set or revise monetary policy or exchange rate value for the
euro to address its public finance problems. Furthermore, the economic and
public finance problems of eurozone member states are not congruent, thus
giving rise to varying and often contradicting political incentives in
different member states, pitting the political dynamics of richer economies
against those of poorer economies.
Debt Crisis of a Rich
Economy
On many levels, the
eurozone (EA17) is a very rich economy. It has a population of 320 million
with a 2010 GDP of €9.2 trillion ($12.2 trillion), albeit with an wide range of per capita GDP, ranging
from €30,600 in Austria to €19,700 in Romania. Little Luxembourg's
per capita GDP was €70,000 in 2010. Despite of the fact that eurozone membership involves only 17 of the
27 member state of the EU27, the eurozone is essentially the economic and
financial core of the EU, which has the highest GDP ($16.2 trillion in
2010) in the world, larger that the US GDP ($14.7 trillion). A sovereign
default in any eurozone member state will put in doubt the continuance of
the euro as a common currency in the eurozone and as prime reserve currency
for international trade.
Collapse of Aggregate
Demand
The reason why a rich
economy like that of the eurozone suffers such a sudden collapses in
aggregate demand caused by a banking sector and sovereign debt crisis
around a common currency lies squarely on a breakdown of political
consensus among eurozone member state governments. The sovereign debt
crisis in the eurozone began with the global economic recession that began
in mid 2007 in New York, caused by a massive
meltdown in electronically linked credit markets in all major open
economies due to excessive private and public debts to compensated for
decades of low wages.
This global
recession has thus far stubbornly resisted all coordinated efforts by
governments and central banks of trading economies around the world to
stimulate a quick economic recovery through the injection of liquidity via
aggressive central bank interest rate policy and massive quantitative
easing. The penalty for direct government bailout of too-big-to-fail financial
entities to defuse a market meltdown will be a decade of slow growth for
the world economy, because the debt crisis that had been caused by low
wages is being solved with government austerity measures that will push
wages further down. Slow economic growth is highly problematic for
countries with high levels of sovereign debt. And for any country whose
sovereign debt is denominated in currency not subject to the monetary
authority of its central bank, the problem can be fatal.
Anemic Recovery
The reason for the long
and weak recovery in global economy is that the excessive debt in the
global economy has not been extinguished by government bailouts. The debt
has only been shifted from the private sector to the public sector, from
the balance sheets of distressed commercial and investment banks to the
balance sheets of central banks. The penalty for this liquidity play on the
part of central banks to save insolvent financial institutions from
collapse will be an extended anemic global economy in which banks,
companies and households are all trying to deleverage from undistinguished
debt with the new liquidity of no economic substance released by central
bank quantitative easing. Also, government austerity programs needed to
secure more debt will further reduce wage income and exacerbate further
fall in aggregate demand in a downward vicious cycle.
The Coming Trade War and Global Depression
Many economic historians have suggested that the 1929 stock market
crash was not the cause of the Great Depression. If anything, the 1929
crash was the technical reflection of the inevitable fate of an overblown
bubble economy. Yet, stock market crashes can recover within a relatively
short time with the help of effective government monetary measures, as
demonstrated by the crashes of 1987 (23% drop, recovered in 9 months), 1998
(36% drop, recovered in 3 months) and 2000-2 (37% drop, recovered in 2
months).
Structurally, the real cause of the Great Depression, which lasted
more than a decade, from 1929 till the beginning of the Second World War in
1941, was the 1930 Smoot-Hawley tariffs that put world trade into a
tailspin from which it did not recover until World War II began.
While the US
economy finally recovered from war mobilization after the Japanese attack
on Pearl Harbor on December 7, 1940, most of the world’s market
economies sunk deeper into war-torn distress and never fully recovered
until the Korea War boom in 1951.
Barely five years into the 21st century, with a globalized
neo-liberal trade regime firmly in place in a world where market economy
has become the norm, trade protectionism appears to be fast re-emerging and
developing into a new global trade war of complex dimensions.
The irony is that this new trade war is being launched not by the
poor economies that have been receiving the short end of the trade stick,
but by the US
which has been winning more than it has been losing on all counts from
globalized neo-liberal trade, with the EU following suit in locked steps. Japan
of course has never let up on protectionism and never taken competition
policy seriously. The rich nations needs to recognize that in
their effort to squeeze every last drop of advantage out of already unfair
trade will only plunge the world into deep depression. History has shown
that while the poor suffer more in economic depressions, the rich, even as
they are fianancially cushioned by their wealth, are hurt by political
repercussions in the form of either war or revolution or both.
Post Cold War Global Trade
During the Cold War, there was no international free trade. The
economies of the two contending ideology blocks were completely
disconnected. Within each block, economies interact through
foreign aid and memorandum trade from their respective superpowers. The
competition was not for profit but for the hearts and minds of the people
in the two opposing blocks as well as those in the non-aligned nations in
the Third World. The competition between the two
superpowers was to give rather than to take from their separate fraternal
economies.
The population of the superpowers worked hard to help the poorer
people within their separate blocks and convergence toward equality was the
policy aim even if not always the practice.
The Cold War era of foreign aid and memorandum trade had a better
record of poverty reduction in either camps than post-Cold War globalized
neo-liberal trade dominated by one single superpower.
The aim was not only to raise income and increase wealth, but also to
close income and wealth disparity between and within economies. Today,
income and wealth disparity is rationalized as a necessity for capital
formation. The New York Time reports that from 1980 to 2002, the total
income earned by the top 0.1% of earners in the US
more than doubled, while the share earned by everyone else in the top 10%
rose far less and the share of the bottom 90% declined.
For all its ill effects, the Cold War achieved two formidable ends:
it prevented nuclear war and it introduced development as a moral
imperative into superpower geo-political competition with rising economic
equality within each block. In the years since the end of the
Cold War, nuclear terrorism has emerged as a serious threat and domestic
development is pre-empted by global trade even in the rich economies while
income and wealth disparity has widened everywhere.
Since the end of the Cold War some three decacds ago, world economic
growth has shifted to rely exclusively on globalized neo-liberal trade
engineered and led by the US as the sole remaining superpower, financed with
the US dollar as the main reserve currency for trade and anchored by the
huge US consumer market made possible by the high wages of US
workers. This growth has been sustained by knocking down
national tariffs everywhere around the world through supranational
institutions such as the World Trade Organization (WTO), and financed by a
deregulated foreign exchange market working in concert with a global
central banking regime independent of local political pressure, lorded over
by the supranational Bank of International Settlement (BIS) and the
International Monetary Fund (IMF).
The Washington Consensus is a “conditionality” for inclusion into
global market fundamentalism through supranational intervention on national
sovereignty prerogative over monetary and fiscal policies. It is
another tool for building a new form of Empire.
US-China Trade
Bush said China,
which had reached a trade agreement with the US
at the close of the Clinton
administration, and had became a member of the WTO in late 2001, would benefit
from political changes as a result of liberalized trade
policies. This pronouncement gives clear evidence to those in China
who see foreign trade as part of an anti-China “peaceful evolution”
strategy first envisioned by John Forster Dulles, US
Secretary of State under President Eisenhower in the 1950s. It is a
strategy of inducing through peaceful trade the Communist Party of China
(CPC) to reform itself out of power and to eliminate the dictatorship of
the proletariat in favor of bourgeois liberalization.
Almost four decades later, Deng Xiaoping criticized CPC Chairman Hu
Yaobang and Premier Zhao Ziyang for having failed to contain bourgeois
liberalization in their implementation of China’s modernization policy.
Deng warned in November 1989, five months after the Tiananmen incident:
“The Western imperialist countries are staging a third world war without
guns. They want to bring about the peaceful evolution of socialist
countries towards capitalism.” Deng’s handling of the Tiananmen
incident prevented China
from going the catastrophic route of the USSR
which dissolved two years later in 1991.
Yet it is clear that political freedom is often the first casualty of
a garrison state mentality and such mentality inevitably results from
hostile US economic and security policy toward any country the US
deems as not free. Whenever the US
pronounces a nation to be not free, that nation will become less free as a
result of US
policy. This has been repeatedly evident in China
and elsewhere in the Third World. Whenever
US policy
toward China
turns hostile, as it currently appears to be heading, political and press
freedom inevitably face stricter curbs in China.
Reforming the Terms of Trade
For trade to mutually and truly benefit the trading economies, three conditions
are necessary:
1) the de-linking of trade from ideological/political objectives,
2) equality must be maintained in the terms of trade and
3) recognition that global full employment at rising, living wages is
the prerequisite for true comparative advantage in global trade.
The developing rupture between the sole superpower and its habitually
deferential Cold War allies lies in mounting trade conflicts. The US
has benefited from a post-Bretton Woods international financial
architecture that gives the US
economy a structural monetary advantage over those of the EU and Japan,
not to mention the rest of the world. This advantage is derived
from dollar hegemony.
Dollar hegemony is detrimental even to the US domestic
economy, as it is only good for the global dollar economy of which
the US economy
is but one component, albeit a key major one. Through globalization and the
growth of euro-dollars (the name given to all offshore dollars and has no
direct relation to the euro or the EU), the global dollar economy is
increasingly detached from the US domestic
economy. What is good for the global dollar economy is not necessarily good
for the US domestic
economy. Economic nationalists in the US are
beginning to understand the threat of internationalist dollar hegemony to
the US economy
itself.
Trade issues range from government subsidies disputes between Airbus
and Boeing, on banana, sugar, beef, oranges, steel, as well as disputes
over fair competition associated with mergers and acquisition and financial
services. If either government is found to be in breach of WTO rules when
these disputes wind through long processes of judgment, the other will be
authorized to retaliate.
The US
could put tariffs on other European goods if the WTO rules against Airbus
and vice versa. So if both governments are found in breach, both could
retaliate, leading to a cycle of offensive protectionism. When the US
was ruled to have unfairly supported its steel industry, tariffs were
slapped by the EU on Florida
oranges to make a political point in a politically important state in US
politics.
Trade competition between the EU and the US
is spilling over into national security areas, allowing economic interests
to conflict with ideological sympathy. Both of these highly
proficient national production engines, saddled with serious overcapacity,
are desperately seeking new markets, which inevitably leads them to Asia in
general and China in particular, with its phenomenal growth rate and its
1.2 billion eager consumers bulging with rapidly rising disposable income.
The growth of the Chinese economy will lift all other economies in Asia,
including Australia
which has only recently begun to understand that its future cannot be
separated from its geographic location and that its prosperity is
interdependent with those of other Asian economies.
Australian iron ores, beef and dairy products are destined for China,
not the British Isles. The EU is eager to lift its
15-year-old arms embargo on China,
much to the displeasure of the US.
Israel faces
similar dilemma, with its close relations with the US,
on military sales to China.
Isreal must export arms to help reduce high arms production cost to its
small economy. Even the US
defense establishment has largely come around to the view that US
arms industry must export, even to China,
to remain on top form with technical innovation that needs huge revenue.
The Bangkok Post reported that Secretary Rumsfeld tried to sell to
Thailand F-16 warplanes capable of firing advanced medium-range air-to-air
missiles (AMRAAMs) two days after he lashed out in Singapore
at China
for upgrading its own military when no neighboring nations are threatening
it. The sales pitch was in competition with Russian-made Sukhoi SU-30s and
Swedish JAS-39s.
The open competition in arms export had been spelled out for Congress
years earlier by Donald Hicks, a leading Pentagon technologist in the
Reagan administration. “Globalization is not a policy option, but a fact to
which policymakers must adapt,” Hick said. “The emerging reality is that
all nations’ militaries are sharing essentially the same global
commercial-defense industrial base.” The boots and uniforms worn
by US soldiers in Afghanistan
and Iraq
were made in China.
The WTO is the only global international organization dealing with
the rules of trade between its 148 member nations. At its heart are the WTO
agreements, known as the multilateral trading system, negotiated and signed
by the majority of the world’s trading nations and ratified in their
parliaments. The stated goal is to help producers of goods and services,
exporters, and importers conduct their business, with the dubious
assumption that trade automatically brings equal benefits to all
participants. The welfare of the people is viewed only as a collateral
aim based on the doctrinal fantasy that “balanced” trade inevitably brings
prosperity equally to all, a claim that has been contradicted by facts
produced by the very terms of trade promoted by the WTO itself.
Trade and Inequality in Wealth Distribution
Two decades of neo-liberal globalized trade have widened income and
wealth disparity within and between nations. Free trade has turned out not
to be the win-win game promised by neo-liberals. It is very much
a win-lose game, with heads, the rich economies win, and tails, the poor
economies lose.
Domestic development has been marginalized as a hapless victim of
foreign trade, dependent on trade surplus for capital. Foreign
trade and foreign direct investment have become the prerequisite engines
for domestic development. This trade model condemns those economies with
trade deficits to perpetual underdevelopment. Because of dollar
hegemony, all foreign investment goes only to the export sector where
dollars can be earned. Even the economies with trade surpluses
cannot use their dollar trade earnings for domestic development, as they
are forced to hold huge dollar reserves to support the exchange rate of
their currencies.
In the fifth WTO Ministerial Conference held in Cancun
in September 2003, the richer countries rejected the demands of poorer
nations for radical reform of agricultural subsidies that have decimated Third
World agriculture. Failure to get the Doha
round back on track after the collapse of Cancun
runs the danger of a global resurgence of protectionism, with the US
leading the way.
Larry Elliott reported on October
13, 2003 in The Guardian on the failed 2003
Cancun Ministerial meeting: “The language of globalization is all about
democracy, free trade and sharing the benefits of technological advance.
The reality is about rule by elites, mercantilism and selfishness.” Elliot
noted that the process is full of paradoxes: why is it that in a world
where human capital is supposed to be the new wealth of nations, labor is
treated with such contempt?
Sam Mpasu, Malawi’s commerce and industry minister, asked at Cancun
for his comments about the benefits of trade liberalization, replied dryly:
“We have opened our economy. That’s why we are flat on our back.” Mpasu’s
comments summarize the wide chasm that divides the perspectives of those
who write the rules of globalization and those who are powerless to resist
them.
Exports of manufactures by low-wage developing countries have
increased rapidly over the last 3 decades due in part to falling tariffs
and declining transport costs that enable outsourcing based on wage
arbitrage. It grew from 25% in 1965 to nearly 75% over three decades, while
agriculture’s share of developing country exports has fallen from 50% to
under 10%.
Many developing countries have gained relatively little from
increased manufactures trade, with most of the profit going to foreign
capital. Market access for their most competitive manufactured export, such
as textile and apparel, remains highly restricted and recent trade disputes
threaten further restrictions. Still, the key cause of unemployment in all
developing economies is the trade-related collapse of agriculture,
exacerbated by the massive government subsidies provided to farmers in rich
economies. Many poor economies are predominantly agriculturally
based and a collapse of agriculture means a general collapse of the whole
economy.
The Doha Development Agenda (DDA) negotiations, sponsored by the WTO,
collapsed in Cancun, Mexico
over the question of government support for agriculture in rich economies
and its potential impacts on causing more poverty in developing countries.
The Doha negotiations since Cancun
are focused on the need to better understand the linkages between trade
policies, particularly those of the rich economies, and poverty in the
developing world.
While poverty reduction is now more widely accepted by establishment
economists as a necessary central focus for development efforts and has
become the main mission of the World Bank and other supranational
development institutions, very little effective measures have been
forthcoming.
The UN Millennium Development Goals (UNMDG) of 1990 commits the
international community to halve world poverty by 2015, a quarter of a century
hence. With then current trends, that goal is likely to be achievable
only through death of half of the poor by starvation, disease and local
conflicts. The UN Development Program warns that
3 million children will die in sub-Saharan Africa alone by 2015 if the world continues on its then current path of
failing to meet the UNMDG agreed to in 2000. Several key venues
to this goal are located in international trade where the record of poverty
reduction has been exceedingly poor, if not outright negative.
The fundamental question whether trade can replace or even augment
socio-economic development remains unasked, let alone
answered. Until such issues are earnestly addressed,
protectionism will re-emerge in the poor countries. Under such
conditions, if democracy expresses the will of the people, democracy will
demand protectionism more than government by elite. It is not surprising
why WTO meetings are target of popular protects.
Exchange Rate as Virtual Countervailing tariff
While tariffs in the past decade have been coming down like leaves in
autumn, flexible exchange rates have become a form of virtual
countervailing tariff. In the current globalized neo-liberal
trade regime operating in a deregulated global foreign exchange market, the
exchanged value of a currency is regularly used to balance trade through
government intervention in currency market fluctuations against the world’s
main reserve currency – the dollar, as the head of the international
monetary snake.
Purchasing power parity (PPP) measures the disconnection between
exchange rates and local prices. PPP contrasts with the interest rate
parity (IRP) theory which assumes that the actions of investors, whose
transactions are recorded on the capital account, induces changes in the
exchange rate. For a dollar investor to earn the same interest rate in a
foreign economy with a PPP of four times, such as the purchasing power
parity between the US dollar and the Chinese yuan, local wages would have
to be at least 4 time lower than US wages.
PPP theory is based on an extension and variation of the "law of
one price" as applied to the aggregate economy. The law of
one price says that identical goods should sell for the same price in two
separate markets when there are no transportation costs and no differential
taxes applied in the two markets. But the law of one price does
not apply to the price of labor. Price arbitrage is the opposite of wage
arbitrage in that producers seek to make their goods in the lowest wage
locations and to sell their goods in the highest price markets. This
is the incentive for outsourcing which never seeks to sell products locally
at prices that reflect PPP differentials.
What is not generally noticed is that price deflation in an economy
increases its PPP, in that the same local currency buys more. But the cross-border
one price phenomenon applies only to certain products, such as oil, thus
for a PPP of 4 times, a rise in oil prices will cost the Chinese economy 4
times the equivalent in other goods, or wages than in the
US. The larger the purchasing power parity between a local
currency and the dollar, the more severe is the tyranny of dollar hegemony
on forcing down wage differentials.
Ever since 1971, when US president Richard Nixon, under pressure from
persistent fiscal and trade deficits that drained US gold reserves, took
the dollar off the gold standard (at $35 per ounce), the dollar has been a
fiat currency of a country of little fiscal or monetary discipline. The
Bretton Woods Conference at the end of World War II established the dollar,
a solid currency backed by gold, as a benchmark currency for financing
international trade, with all other currencies pegged to it at fixed rates
that changed only infrequently. The fixed exchange rate regime
was designed to keep trading nations honest and prevent them from running
perpetual trade deficits. It was not expected to dictate the living
standards of trading economies, which were measured by many other factors
besides exchange rates.
Bretton Woods was conceived when conventional wisdom in international
economics did not consider cross-border flow of funds necessary or
desirable for financing world trade precise for this reason. Since 1971,
the dollar has changed from a gold-back currency to a global reserve
monetary instrument that the US,
and only the US,
can produce by fiat. At the same time, the US
continued to incur both current account and fiscal deficits. That was the
beginning of dollar hegemony.
With deregulation of foreign exchange and financial markets, many
currencies began to free float against the dollar not in response to market
forces but to maintain export competitiveness. Government
interventions in foreign exchange markets became a regular last resort
option for many trading economies for their preserving export
competitiveness and for resisting the effect of dollar hegemony on domestic
living standards.
World Trade and Dollar Hegemony
World trade under dollar hegemony is a game in which the US
produces paper dollars and the rest of the world produce real things that
paper dollars can buy. The world’s interlinked economies no longer trade to
capture comparative advantage; they compete in exports to capture needed
dollars to service dollar-denominated foreign debts and to accumulate
dollar reserves to sustain the exchange value of their domestic currencies
in foreign exchange markets. To prevent speculative and manipulative
attacks on their currencies in deregulated markets, the world’s central
banks must acquire and hold dollar reserves in corresponding amounts to
market pressure on their currencies in circulation. The higher the market
pressure to devalue a particular currency, the more dollar reserves its
central bank must hold. This creates a built-in support for a strong dollar
that in turn forces all central banks to acquire and hold more dollar
reserves, making it stronger. This anomalous phenomenon is known as dollar
hegemony, which is created by the geopolitically constructed peculiarity
that critical commodities, most notably oil, are denominated in dollars.
Everyone accepts dollars because dollars can buy oil. The denomination of
oil in dollars and the recycling of petro-dollars is the price the US
has extracted from oil-producing countries for US tolerance of the
oil-exporting cartel since 1973.
By definition, dollar reserves must be invested in dollar-denominated
assets, creating a capital-accounts surplus for the US
economy. A strong-dollar policy is in the US
national interest because it keeps US
inflation low through low-cost imports and it makes US assets denominated
in dollars expensive for foreign investors. This arrangement, which Federal
Reserve Board chairman Alan Greenspan proudly calls US
financial hegemony in congressional testimony, has kept the US
economy booming in the face of recurrent financial crises in the rest of
the world. It has distorted globalization into a “race to the bottom”
process of exploiting the lowest labor costs and the highest environmental
abuse worldwide to produce items and produce for export to US markets in a
quest for the almighty dollar, which has not been backed by gold since
1971, nor by economic fundamentals for more than a decade. The adverse
effects of this type of globalization on the developing economies are
obvious. It robs them of the meager fruits of their exports and keeps their
domestic economies starved for capital, as all surplus dollars must be
reinvested in US treasuries to prevent the collapse of their own domestic
currencies.
Dollar hegemony is detrimental even to the US domestic
economy, as it is only good for the global dollar economy of which
the US economy
is but one component, albeit a key major one. Through globalization and the
growth of euro-dollars (the name given to all offshore dollars and has no
direct relation to the euro or the EU), the global dollar economy is
increasingly detached from the US domestic
economy. What is good for the global dollar economy is not necessarily good
for the US domestic
economy. Economic nationalists in the US are
beginning to understand the threat of internationalist dollar hegemony to
the US economy
itself.
The adverse effect of this type of globalization on the US
economy is also becoming clear. In order to act as consumer of last resort
for the whole world, the US
economy has been pushed into a debt bubble that thrives on conspicuous
consumption and fraudulent accounting. The unsustainable and irrational
rise of US equity and real estate prices, unsupported by revenue or profit,
had merely been a de facto devaluation of the dollar. Ironically, the
recent fall in US equity prices from its 2004 peak and the anticipated fall
in real estate prices reflect a trend to an even stronger dollar, as it can
buy more deflated shares and properties for the same amount of dollars. The
rise in the purchasing power of the dollar inside the US
impacts its purchasing power disparity with other currencies unevenly,
causing sharp price instability in the economies with freely exchangeable
currencies and fixed exchange rates, such as Hong Kong
and until recently Argentina. For
the US,
falling exchange rate of the dollar actually causes asset prices to rise.
Thus with a debt bubble in the US
economy, a strong dollar is not in the US
national interest. Debt has turned US
policy on the dollar on its head.
The setting of exchange values of currencies is practiced not only by
sovereign governments on their own currencies as a sovereign
right. The US,
exploiting dollar hegemony, usurps the privilege of dictating the exchange
value of all foreign currencies to support its own economic nationalism in
the name of global free trade. And US
position on exchange rates has not been consistent. When the dollar was
rising, as it did in the 1980s, the US,
to protect its export trade, hailed the stabilizing wisdom of fixed
exchange rates. When the dollar falls as it has been in recent
years, the US, to deflect the blame of its trade deficit, attacks fixed
exchange rates as currency manipulation, as it targets China’s currency now
which has been pegged to the dollar for over a decade, since the dollar was
lower. How can a nation manipulate the exchange value of its currency when
it is pegged to the dollar at the same rate over long
periods? Any manipulation came from the dollar, not the yuan.
The rise of the euro against the dollar, the first appreciation wave
since its introduction on January
1, 2002, was the result of an EU version of the 1985 Plaza
Accord on the Japanese yen, albeit without a formal accord. The
strategic purpose was more than merely moderating the US
trade deficit. The record shows that even with the 30% drop of the
dollar against the euro, the US
trade deficit has continued to climb. The strategic purpose of driving up
the euro is to reduce the euro to the status of the yen, as a subordinated
currency to dollar hegemony. The real effect of the Plaza Accord was
to shift the cost of support for the dollar-denominated US
trade deficit, and the socio-economic pain associated with that support,
from the US
to Japan.
What is happening to the euro now is far from being the beginning of
the demise of the dollar. Rather, it is the beginning of the
reduction of the euro into a subservient currency to the dollar to support
the US debt
bubble. Six and a half years since the launch of European Monetary Union,
the eurozone is trapped in an environment in which monetary policy of sound
money has in effect become destructive and supply-side fiscal policy
unsustainable. National economies are beginning to refuse to bear the pain
needed for adjustment to globalization or the EU’s ambitious
enlargement. The European nations are beginning to resist the US
strategy to make the euro economy a captive supporter of a rising or
falling dollar as such movements fit the shifting needs of US
economic nationalism.
By allowing a trade surplus denominated in dollars to be accumulated
by non-dollar economies, such as yen, euro, or now the Chinese yuan, the
cost of supporting the appropriate value of the dollar to sustain perpetual
economic growth in the dollar economy is then shifted to these non-dollar
economies, which manifests themselves in perpetual relative low wages and
weak domestic consumption. For already high-wage EU and Japan,
the penalty is the reduction of social welfare benefits and job security
traditional to these economies. For China,
now the world’s second largest creditor nation, it is reduced to having to
ask the US,
the world’s largest debtor nation, for capital denominated in dollars the US
can print at will to finance its export trade to a US
running recurring trade deficits denominated in dollars.
The IMF, which has been ferocious in imposing draconian fiscal and
monetary “conditionalities” on all debtor nations everywhere in the decade
after the Cold War, is nowhere to be seen on the scene in the world’s most
fragrantly irresponsible debtor nation. This is because the US
can print dollars at will and with immunity. The dollar is a
fiat currency not backed by gold, not backed by US
productivity, not back by US
export prowess, but by US
military power. The US
military budget request for Fiscal Year 2005 was $420.7 billion. For Fiscal
Year 2004, it was $399.1 billion; for 2003, $396.1 billion; for 2002,
$343.2 billion and for 2001, $310 billion. In the first term of
the Bush presidency, the US
spent $1.5 trillion on its military. That is bigger than the
entire GDP of China in 2004. The US
trade deficit is around 6% of its GDP while it military budget is around
4%. In other words, the trading partners of the US
are paying for one and a half times of the cost of a military that can
someday be used against any one of them for any number of reasons,
including trade disputes. The anti-dollar crowd has nothing to
celebrate about the recurring US
trade deficit.
Normally, according to free trade theory, trade can only stay
unbalanced temporarily before equilibrium is re-established or free trade
would simply stop. When bilateral trade is temporarily unbalanced, it is
generally because one trade partner has become temporarily uncompetitive,
inefficient or unproductive. The partner with the trade deficit receives
more goods and services from the partner with the trade surplus than it can
offer in return and thus pays the difference with its currency that someday
can buy goods produced by the deficit trade partner to re-established
balance of payments. This temporary trade imbalance is due to a
number of socio-economic factors, such as terms of trade, wage levels,
return on investment, regulatory regimes, shortages in labor or material or
energy, trade-supporting infrastructure adequacy, purchasing power
disparity, etc. A trading partner that runs a recurring trade
deficit earns the reputation of being what banks call a habitual borrower,
i.e. a bad credit risk, one who habitually lives beyond his/her means. If
the trade deficit is paid with its currency, a downward pressure results in
the exchange rate. A flexible exchange rate seeks to remove or moderate a
temporary trade imbalance while the productivity disparities between
trading partners are being addressed fundamentally.
Dollar hegemony prevents US
trade imbalance from returning to equilibrium through market forces. It
allows a US
trade deficit to persist based on monetary prowess. This translates over
time into a falling exchange rate for the dollar even as dollar hegemony
keeps the fall at a slow pace. But a below-par exchange rate over a long
period can run the risk of turning the temporary imbalance in productivity
into a permanent one. A continuously weakening currency condemns
the issuing economy into a downward economic spiral. This has happened to
the US in
the last decade. To make matters worse, with globalization of deregulated
markets, the recurring US
trade deficit is accompanied by an escalating loss of jobs in sectors
sensitive to cross-border wage arbitrage, with the job-loss escalation
climbing up the skill ladder. Discriminatory US
immigration policies also prevent the retention of low-paying jobs within
the US and
exacerbate the illegal immigration problem.
Regional wage arbitrage within the US
in past decades kept the US
economy lean and productive internationally. Labor-intensive US
industries relocated to the low-wage South through regional wage arbitrage
and despite temporary adjustment pains from the loss of textile mills, the
Northern economies managed to upgrade their productivity, technology level,
financial sophistication and output quality. The Southern economies in the US
also managed to upgrade these factors of production and in time managed to
narrow the wage disparity within the national economy. This happened
because the jobs stay within the nation.
With globalization, it is another story. Jobs are leaving
the nation mercilessly. According to free trade theory, the US
trade deficit is supposed to cause the dollar to fall temporarily against
the currencies of its trading partners, causing export competitiveness to
rebalance to remove or reduce the US
trade deficit or face the collapse of its currency. Either case,
jobs that have been lost temporarily are then supposed to return to the US.
But the persistent US
trade deficit defies trade theory because of dollar hegemony. The current
international finance architecture is based on dollar hegemony which is the
peculiar arrangement in which the US dollar, a fiat currency, remains as
the dominant reserve currency for international trade. The broad trade-weighted
dollar index stays in an upward trend, despite selective appreciation of
some strong currencies, as highly-indebted emerging market economies
attempt to extricate themselves from dollar-denominated debt through the
devaluation of their currencies. While the aim is to subsidize exports, it
ironically makes dollar debts more expensive in local currency terms. The
moderating impact on US
price inflation also amplifies the upward trend of the trade-weighted
dollar index despite persistent US
expansion of monetary aggregates, also known as monetary easing or money
printing.
Adjusting for this debt-driven increase in the exchange value of
dollars, the import volume into the US
can be estimated in relationship to expanding monetary aggregates. The
annual growth of the volume of goods shipped to the US
has remained around 15% for most of the 1990s, more than 5 times the
average annual GDP growth. The US
enjoyed a booming economy when the dollar was gaining ground, and this
occurred at a time when interest rates in the US
were higher than those in its creditor nations. This led to the odd effect
that raising US interest rates actually prolonged the boom in the US rather
than threatened it, because it caused massive inflows of liquidity into the
US financial system, lowered import price inflation, increased apparent
productivity and prompted further spending by US consumers enriched by the
wealth effect despite a slowing of wage increases. Returns on
dollar assets stayed high in foreign currency terms.
This was precisely what Federal Reserve Board chairman Alan Greenspan
did in the 1990s in the name of pre-emptive measures against inflation.
Dollar hegemony enabled the US
to print money to fight inflation, causing a debt bubble of asset
appreciation. This data substantiated the view of the US
as Rome in a New Roman Empire
with an unending stream of imports as the free tribune from conquered
lands. This was what Greenspan meant by US “financial hegemony.”
The Fed Funds rate (ffr) target has been lifted eight times in steps
of 25 basis points from 1% in mid 2004 to 3% on May 3, 2005. If the same pattern of
“measured pace” continues, the ffr target would be at 4.25% by the end of
2005. Despite Fed rhetoric, the lifting of dollar interest rate has more to
do with preventing foreign central banks from selling dollar-denominated
assets, such as US Treasuries, than with fighting inflation. In
a debt-driven economy, high interest rates are themselves
inflationary. Rising interest rate to fight inflation could
become the monetary dog chasing its own interest rate tail, with rising
rate adding to rising inflation which then requires more interest rate
hikes. Still, interest rate policy is a double edged sword: it keeps funds
from leaving the debt bubble, but it can also puncture the debt bubble by
making the servicing of debt prohibitively expensive.
To prevent this last adverse effect, the Fed adds to the money
supply, creating an unnatural condition of abundant liquidity with rising
short-term interest rate, resulting in a narrowing of interest spread
between short-term and long-term debts, a leading indication for inevitable
recession down the road. The problem of adding to the money
supply is what Keynes called the liquidity trap, that is, an absolute
preference for liquidity even at near zero interest-rate levels. Keynes
argued that either a liquidity trap or interest-insensitive investment
draught could render monetary expansion ineffective in a recession. It is
what is popularly called pushing on a credit string, where ample money
cannot find credit-worthy willing borrowers. Much of the new low
cost money tends to go to refinancing of existing debt take out at
previously higher interest rates. Rising short-term interest rates,
particularly at a measured pace, would not remove the liquidity trap when
long term rates stay flat because of excess liquidity.
The debt bubble in the US
is clearly having problems, as evident in the bond market. With just 14
deals worth $2.9 billion, May 2005 was the slowest month for high-yield bond
issuance since October 2002. The late-April downgrades of the debt of
General Motors and Ford Motor to junk status roiled the bond markets. The
number of high-yield, or junk bond deals fell 55% in the March-to-May 2005
period, compared with the same three months in 2004. They were also down
45% from the December-through-February period. In dollar value, junk bond
deals totaled $17.6 billion in the March-to-May 2005 period, compared with
$39.5 billion during the same three months in 2004 and $36 billion from
December through February 2005. There were 407 deals of
investment-grade bond underwriting during the March-to-May 2005 period,
compared with 522 in
the same period 2004 - a decline of 22%. In dollar volume, some $153.9
billion of high-grade bonds were underwritten from March to May 2005,
compared with $165.5 billion in the same period in 2004 - a 7% decline. Oil
at $50, along with astronomical asset price appreciation, particularly in
real estate, is giving the debt bubble additional borrowed time. But this
game cannot go on forever and the end will likely be triggered by a new
trade war’s effect on reduced trade volume. The price of a
reduced US
trade deficit is the bursting of the US
debt bubble which can plunge the world economy into a new depression. Given
such options, the US has no choice except to ride the trade deficit train
for as long as the traffic will bear, which may not be too long,
particularly if protectionism begins to gather force.
The transition to offshore outsourced production has been the source
of the productivity boom of the “New Economy” in the US
in the last decade. The productivity increase not attributable to the
importing of other nations’ productivity is much less impressive. While
published government figures of the productivity index show a rise of
nearly 70% since 1974, the actual rise is between zero and 10% in many
sectors if the effect of imports is removed from the equation. The lower
productivity values are consistent with the real-life experience of members
of the blue-collar working class and the white collar middle class who have
been spending the equity cash-outs from the appreciated market value of
their homes. World trade has become a network of cross-border arbitrage on
differentials in labor availability, wages, interest rates, exchange rates,
prices, saving rates, productive capacities, liquidity conditions and debt
levels. In some of these areas, the US
is becoming an underdeveloped economy.
The Bush Administration repeatedly assured the public that the state
of the economy was sound while in reality the US
had been losing entire sectors of its economy, such as manufacturing and
information technology, to foreign producers, while at the same time
selling off the part of the nation to finance its rising and unending trade
deficit. Usually, when unjustified confidence crosses over to fantasized
hubris on the part of policymakers, disaster is not far ahead.
To be fair, the problems of the US
economy started before the second Bush Administration. The Clinton Administration’s
annual economic report for 2000 claimed that the longest economic expansion
in US
history could continue “indefinitely” as long as “we stick to sound
policy”, according to Chairman Martin Baily of the Council of Economic
Advisors (CEA) as reported in the Wall Street Journal. The New
York Times report differed somewhat by quoting Baily as saying:
“stick to fiscal policy.” Putting the two newspaper reports
together, one got the sense that the Clinton Administration thought that
its fiscal policy was the sound policy needed to put an end to the business
cycle. Economics high priests in government, unlike the rest of us mortals
who are unfortunate enough to have to float in the daily turbulence of the
market, can afford to aloofly focus on long-term trends and their
structural congruence to macro-economic theories. Yet, outside of
macro-economics, long-term is increasingly being re-defined in the real
world. In the technology and communication sectors, long-term
evokes periods lasting less than 5 years. For hedge funds and
quant shops, long-term can mean a matter of weeks.
Two factors were identified by the Clinton CEA Year 2000 economic
report as contributing to the “good” news: technology-driven
productivity and neo-liberal trade globalization. Even with somewhat slower
productivity and spending growth, the CEA believed the economy could
continue to expand perpetually. As for the huge and growing trade deficit,
the CEA expected global recovery to boost demand for US exports, not
withstanding the fact that most US
exports are increasingly composed of imported parts. Yet the US
has long officially pursued a strong dollar policy which weakens world
demand for US exports.
Schumpeter’s creative destruction theory, while revitalizing the
macro-economy with technological obsolescence in the long run, leaves real
corporate bodies in its path, not just obsolete theoretical
concepts. Financial intermediaries and stock exchanges face
challenges from Electronic Communication Networks (ECNs) which may well turn
the likes of NYSE into sunset industries. ECNs are electronic
marketplaces which bring buy/sell orders together and match them in virtual
space. Today, ECNs handle roughly 25% of the volume in NASDAQ
stocks. The NYSE and the Archipelago Exchange (ArcaEx) announced
on April 20, 2005 that
they have entered a definitive merger agreement that will lead to a
combined entity, NYSE Group, Inc., becoming a publicly-held company.
If approved by regulators, NYSE members and Archipelago shareholders, the
merger will represent the largest-ever among securities exchanges and
combine the world’s leading equities market with the most successful
totally open, fully electronic exchange. Through Archipelago, the NYSE will
compete for the first time in the trading of NASDAQ-listed stocks; it will
be able to indirectly capture listings business that otherwise would not
qualify to list on the NYSE. Archipelago lists stocks of companies that do
not meet the NYSE’s listing standards.
On fiscal policy, US
government spending, including social programs and defense, declined as a
share of the economy during the eight years of the Clinton
watch. This in no small way contributed to a polarization of
both income and wealth, with visible distortions in both the demand and
supply sides of the economy. This was the opposite of the FDR
record of increasing income and wealth equality by policy. The wealth
effect tied to bloated equity and real estate markets could reverse
suddenly and did in 2000, bailed out only by the Bush tax cut and the
deficit spending on the War on Terrorism after 2001. Private
debt kept making all time highs throughout the 1990s and was celebrated by
neo-liberal economists as a positive factor. Household spending
was heavily based on expected rising future earnings or paper profits, both
of which might and did vanished on short notice. By election
time in November 1999, the Clinton
economic miracle was fizzling. The business cycle had not ended
after all, and certainly not by self-aggrandizing government policies. It
merely got postponed for a more severe crash later. The idea of
ending the business cycle in a market economy was as much a fantasy as Vice
President Cheney’s assertion in a speech before the Veterans of Foreign
Wars in August 26, 2002
that “the Middle East expert Professor Fouad Ajami
predicts that after liberation, the streets in Basra
and Baghdad are sure to erupt
in joy ….”
Clinton-Gore Defaulted on Campaign Promises to Equalilize wealth
Distribution
In their 1991 populist campaign for the White House, Bill Clinton and
Al Gore repeatedly pointed out the obscenity of the top 1% of Americans
owning 40% of the country’s wealth. They also said that if you eliminated
home ownership and only counted businesses, factories and offices, then the
top 1% owned 90% of all commercial wealth. And the top 10%, they said,
owned 99%. It was a situation they pledged to change if elected. But once
in office, Clinton and Gore did
nothing to redistribute wealth more equally - despite the fact that their
two terms in office spanned the economic joyride of the 1990s that would
eventually hurt the poor much more severely than the rich. On the contrary,
economic inequality only continued to grow under the
Democrats. Reagan spread the national debt equally among the
people while Clinton gave all
the wealth to the rich.
Geopolitically, trade globalization was beginning to face complex
resistance worldwide by the second term of the Clinton
presidency. The momentum of resistance after Clinton
would either slow further globalization or force the terms of trade to be
revised. The Asian financial crises of 1997 revived economic nationalism
around the world against US-led neo-liberal globalization, while the North
Atlantic Treaty Organization (NATO) attack on Yugoslavia in 1999 revived
militarism in the EU. Market fundamentalism as espoused by the US,
far from being a valid science universally, was increasingly viewed by the
rest of the world as merely US national ideology, unsupported even by US
historical conditions. Just as anti-Napoleonic internationalism was
essentially anti-French, anti-globalization and anti-moral-imperialism are
essentially anti-US. US
unilateralism and exceptionism became the midwife for a new revival of
political and economic nationalism everywhere. The Bush Doctrine of
monopolistic nuclear posture, pre-emptive wars, “either with us or against
us” extremism, and no compromise with states that allegedly support
terrorism, pours gasoline on the smoldering fire of defensive nationalism
everywhere.
Greenspan celebrates global financial crisis as having salutary
effect” on the US
Alan Greenspan in his October
29, 1997 Congressional testimony on Turbulence in World
Financial Markets before the Joint Economic Committee said that
“it is quite conceivable that a few years hence we will look back at this
episode [Asian financial crisis of 1997]…. as a salutary event in terms of
its implications for the macro-economy.” When one is focused
only on the big picture, details do not make much of a difference: the
earth always appears more or less round from space, despite that some
people on it spend their whole lives starving and cities get destroyed by
war or natural disasters. That is the problem with
macroeconomics. As Greenspan spoke, many around the world were
waking up to the realization that the turbulence in their own financial
markets was viewed by the US
central banker as having a “salutary effect” on the US
macro-economy. Greenspan gave anti-US sentiments and monetary
trade protectionism held by participants in these financial markets a solid
basis and they were no longer accused of being mere paranoia.
Ironically, after the end of the Cold War, market capitalism has
emerged as the most fervent force for revolutionary
change. Finance capitalism became inherently democratic once the
bulk of capital began to come from the pension assets of workers, despite
widening income and wealth disparity. The monetary value of US
pension funds is over $15 trillion, the bulk of which belong to average
workers. A new form of social capitalism has emerged which would gladly
eliminate the worker’s job in order to give him/her a higher return on
his/her pension account. The capitalist in the individual is exploiting the
worker in same individual. A conflict of interest arises between a worker’s
savings and his/her earnings. As Pogo used to say: “The enemy: they are
us.” This social capitalism, by favoring return on capital over
compensation for labor, produces overinvestment, resulting in overcapacity.
But the problem of overcapacity can only be solved by high income
consumers. Unemployment and underemployment in an economy of overcapacity
decrease demand, leading to financial collapse. The world economy needs low
wages the way the cattle business need foot and mouth disease.
The nomenclature of neo-classical economics reflects, and in turn dictates,
the warped logic of the economic system it produces. Terms such as money,
capital, labor, debt, interest, profits, employment, market, etc, have been
conceptualized to describe synthetic components of an artificial material
system created by the power politics of greed. It is the capitalist greed
in the worker that causes the loss of his/her job to lower wage earners
overseas. The concept of the economic man who presumably always acts in his
self-interest is a gross abstraction based on the flawed assumption of
market participants acting with perfect and equal information and clear
understanding of the implication of his actions. The pervasive use of these
terms over time disguises the artificial system as the logical product of
natural laws, rather than the conceptual components of the power politics
of greed.
Just as monarchism first emerged as a progressive force against feudalism
by rationalizing itself as a natural law of politics and eventually brought
about its own demise by betraying its progressive mandate, social
capitalism today places return on capital above not only the worker but
also the welfare of the owner of capital. The class struggle has been
internalized within each worker. As people facing the hard choice of
survival in the present versus wellbeing in the future, they will always
choose survival, social capitalism will inevitably go the way of absolute
monarchism, and make way for humanist socialism.
SPV to Skirt Basel II Capital
Requirements
In a May 14, 2002 AToL article: The BIS vs National Banks,
I warned about Special Purpose Vehicles (SPV) five years before the credit
crisis broke out in July 2007:
“While Third World banks that do not meet BIS capital requirements
are frozen from the global interbank funds, BIS rules have been eroded by
so-called large, complex banking organizations (LCBOs) in advanced
economies through capital arbitrage, which refers to strategies that reduce
a bank’s regulatory capital requirements without a commensurate reduction
in the bank’s risk exposures. One example of such arbitrage is the sale, or
other shift-off, from the balance sheet, of assets with economic capital
allocations below regulatory capital requirements, and the retention of
those for which regulatory requirements are less than the economic capital
burden.
“Aggregate regulatory capital thus ends up being lower than the economic
risks require; and although regulatory capital ratios rise, they are in
effect merely meaningless statistical artifacts. Risks never disappear;
they are always passed on. LCBOs in effect pass their unaccounted-for risks
onto the global financial system. Thus the fierce opponents of socialism
have become the deft operators in the socialization of risk while retaining
profits from such risk socialization in private hands.
“Set for 2004, implementation of the new Basel II Capital Accord is meant
to respond to such regulatory erosion by LCBOs. “Synthetic securitization”
refers to structured transactions in which banks use credit derivatives to
transfer the credit risk of a specified pool of assets to third parties,
such as insurance companies, other banks, and unregulated entities, known
as Special Purpose Vehicles (SPV), used widely by the likes of Enron and
GE. The transfer may be either funded, for example, by issuing
credit-linked securities in tranches with various seniorities
(collateralized loan obligations or CLOs) or unfunded, for example, using
credit default swaps. Synthetic securitization can replicate the economic
risk transfer characteristics of securitization without removing assets
from the originating bank’s balance sheet or recorded banking book
exposures.
“Synthetic securitization may also be used more flexibly than traditional
securitization. For example, to transfer the junior (first and second loss)
element of credit risk and retain a senior tranche; to embed extra features
such as leverage or foreign currency payouts; and to package for sale the
credit risk of a portfolio (or reference portfolio) not originated by the
bank. Banks may also exchange the credit risk on parts of their portfolios
bilaterally without any issuance of rated notes to the market.”
Central Bank uses SPV
to Hide Expansion of Balance Sheet
The Treasury's Troubled
Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of
2008 would finance the first $20 billion of troubles assets purchases by
buying distressed debt in the NY Fed’s SPV. If more than $20 billion
in assets are bought by the SPV through TALF, the NY Fed will lend the
additional money to the SPV. Since a loan is treated in accounting as an
asset, the NY Fed, by providing the funds to buy distress debt, actually
expands it balance sheet positively while its SPV assumes more liability.
Troubled Assets Relief
Program (TARP)
TARP allows the US
Treasury to purchase or insure up to $700 billion of “troubled assets”,
defined as:
A) residential or commercial
mortgages and any securities, obligations, or other instruments that are
based on or related to such mortgages, that in each case was originated or
issued on or before March 14, 2008, the purchase of which the Secretary
determines promotes financial market stability; and
B) any other financial
instrument that the Secretary, after consultation with the Chairman of the
Board of Governors of the Federal Reserve System, determines the purchase
of which is necessary to promote financial market stability, but only upon
transmittal of such determination, in writing, to the appropriate
committees of Congress.”
TARP allows the Treasury
to purchase illiquid, difficult-to-value assets at full face value from
banks and other financial institutions. The targeted assets can be
collateralized debt obligations (CDO), which were sold in a booming market
until July 2007, when they were hit by widespread foreclosures on the
underlying loans.
TARP is intended to
restore liquidity of these assets in a failed market with no other buyers,
by purchasing them using secondary market mechanisms, thus allowing
participating institutions to stabilize their balance sheets and avoid
further losses.
TARP does not allow banks
to recoup losses already incurred on troubled assets, but Treasury
officials expect that once trading of these assets resumes, their prices
will stabilize and ultimately increase in value, resulting in gains to both
participating banks and the Treasury itself. The concept of future gains
from troubled assets comes from the hypothesis in the financial industry
that these assets are oversold, as only a small percentage of all mortgages
are in default, while the relative fall in prices represents losses from a
much higher default rate. Yet the low default rate was not produced
by economic conditions, but by the Fed’s financial manipulation. Thus the
banks are saved, but not the economy as a whole, which ultimately still has
to pay off the undistinguished debt.
The Emergency Economic
Stabilization Act of 2008 (EESA) requires financial institutions selling
assets to TARP to issue equity warrants (a type of security that entitles,
but without the obligation, its holder to purchase shares in the company
issuing the security for a specific price), or equity or senior debt
securities (for non-publicly listed companies) to the Treasury. In the case
of warrants, the Treasury will only receive warrants for non-voting shares,
or will agree not to vote the stock.
This measure is supposedly
designed to protect taxpayers by giving the Treasury the possibility of
profiting through its new ownership stakes in these institutions. Ideally,
if the financial institutions benefit from government assistance and
recover their former strength, the government will also be able to profit
from their recovery.
Another important goal of
TARP is to encourage banks to resume lending again at levels seen before
the crisis, both to each other and to consumers and businesses. If TARP can
stabilize bank capital ratios, it should theoretically allow them to
increase lending instead of hoarding cash to cushion against future
unforeseen losses from troubled assets.
The Fed argues that
increased lending equates to “loosening” of credit, which the government
hopes will restore order to the financial markets and improve investor
confidence in financial institutions and the markets. As banks gain
increased lending confidence, the interbank lending interest rates (the
rates at which the banks lend to each other on a short term basis) should
decrease, further facilitating lending. So far, this goal has not been
achieved as bank merely used TARP money to deleverage rather than increase
lending.
TARP will operate as a
“revolving purchase facility”. The Treasury will have a set spending limit,
$250 billion at the start of the program, with which it will purchase the
assets and then either sell them or hold the assets and collect the
“coupons”. The money received from sales and coupons will go back into the
pool, facilitating the purchase of more assets.
The initial $250 billion
can be increased to $350 billion upon the president's certification to
Congress that such an increase is necessary. The remaining $350 billion may
be released to the Treasury upon a written report to Congress from the
Treasury with details of its plan for the money. Congress then has 15 days
to vote to disapprove the increase before the money will be automatically
released. The first $350 billion was released on October 3, 2008, and
Congress voted to approve the release of the second $350 billion on January
15, 2009.
One way that TARP money is
being spent is to support the “Making Homes Affordable” plan, which was
implemented on March 4, 2009, using TARP money by the Treasury. Because “at
risk” mortgages are defined as “troubled assets” under TARP, the Treasury
has the power to implement the plan. Generally, it provides refinancing for
mortgages held by Fannie Mae or Freddie Mac. Privately held mortgages will
be eligible for other incentives, including a favorable loan modification
for five years.
The authority of the
Treasury to establish and manage TARP under a newly created Office of
Financial Stability (OFS) became law October 3, 2008, the result of an
initial proposal that ultimately was passed by Congress as H.R. 1424,
enacting the Emergency Economic Stabilization Act of 2008 and several other
related acts.
Collateral assets accepted
by TARP include dollar-denominated cash ABS with a long-term credit rating
in the highest investment-grade rating category from two or more major
“nationally recognized statistical rating organizations (NRSROs)” and do
not have a long-term credit rating below the highest investment-grade
rating category from a major NRSRO. Synthetic ABS (credit-default swaps on
ABS) do not qualify as eligible collateral. The program was launched on
March 3, 2009.
Zero Interest Rate and
Quantitative Easing
As interest rates cannot go
below zero, central banks are forced to resort to quantitative easing to
inject money into the financial system which allows insolvent financial
institutions to deny the disastrous reality of insolvency from the collapse
of the market value of collaterals to pretend that the global financial
market is merely facing a temporary liquidity problem and that massive
liquidity injection from the central bank would allow an orderly
restructuring of the massive overhanging distressed private debt by
shifting it to the public sector with no borrower defaults and therefore no
“haircuts” for exposed creditors.
The price for this
strategy of short-term crisis resolution of excessive private sector debt
by increasing public sector debt is the long-term stagnation of the global
economy. This is because private sector deleveraging with public sector
money drains economic vitality that will take a long time to work
through.
The Cure Worse than the
Disease
It is now becoming clear
that notwithstanding the Fed’s assertion that its bailouts prevented a
systemic melt down of global financial markets, the cure of saving the
banking sector at the expense of the economy is looking more like a cure
worse than the disease. A faster recovery might have been the net bonus if
the banks were left to go belly up on their own.
As it happened, the panic
rescue by central banks left the global economy a fate of a lost decade.
This is critical because economic recovery and the existing international
financial architecture depends on a high rate of growth. And three years
after the outbreak of the global financial crisis that began in mid July
2007, the global economy is still plagued by high unemployment and
stagnation despite massive amount of liquidity injection by center banks.
Sovereign Debt
Denominated in Foreign Currency
To make matters worse, all
trading economies, particularly the exporting emerging market economies,
that denominate their debts in one of the two prime reserve currencies for
international trade, such as the dollar and the euro, will find critically
needed counter cyclical monetary measures unavailable to their governments
because their central banks cannot issue dollars or euros, thus have to
earn more dollars or euros from the global trading system at a time when the
global economy has been condemned to suffer demand deficit with a decade of
economic decline engineered by central bank monetary measures to save the
banking sector in the advanced economies. These emerging economies also
cannot borrow more dollars or euros from global capital and debt markets
because their credit ratings are being cut by suddenly less-permissive
credit rating agencies. They invariably become financial wards of the
stronger economies and prisoners of the International Monetary Fund (IMF) conditionalities.
A Complex Rescue Plan for Europe
with a Special Purpose Vehicle
A European official told CNBC on the sideline of the IMF meeting in Washington
on Saturday, September 17, 2011
that the EU is working on a detailed plan aimed at shoring up the stability
of European banks.
The plan appears to involve a complex flow of funds. It would involve
money from the European Financial Stability Facility (EFSF), a bailout
vehicle created in 2010 to alleviate the sovereign debt crisis in Europe,
to capitalize a special purpose vehicle (SPV) that would be created by the European Investment Bank (EIB), the
European Union’s finance institution. EFSF shareholders are the 27 member
states of the EU, which have jointly subscribed its capital. The Board of
Governors of the EIB is composed of the finance ministers of these 27
member states.
The role of the EIB in
this plan is to provide long-term financing in support of investment
projects. The SPV serves the purpose of isolating the parent (EIB) from financial risk
of the plan, a device commonly used in complex financing to separate
different layers of equity infusion.
The EIB’s SPV would issue bonds to investors and use the proceeds to
purchase sovereign debt of distressed eurozone member states from their
state central banks. The hope is that this would alleviate the pressure on
the financially distressed member states and on the eurozone banks
(primarily French and German banks) that hold a lot of the distressed
sovereign debt. The bonds issued by EIB’s SPV could then be used by the EIB
as collateral for borrowing from the European Central Bank (ECB), allowing
the member state central banks to make loans to commercial banks faced with
liquidity shortages.
Banks loaded down with distressed eurozone sovereign debt would be
able to sell the debt to the EIB’s SPV financed by the ECB with the
distressed sovereign debts as collaterals at full face value so that
eurozone commercial banks can access the liquidity facilities of the ECB.
Although the structure is complex, the underlying objective is
relatively simple. Banks would essentially be allowed to exchange their
distressed sovereign debt at face value for debt issued by a special
purpose vehicle created by the EIB capitalized with funds from the EFSF.
In some ways, this resembles the original plan for the Troubled Asset
Relief Program (TARP) used by the Federal Reserve on 2008. As originally
conceived, the TARP would have purchased “toxic securities” from banks.
(This plan was abandoned when U.S.
regulators concluded that it was too difficult to price the securities and
that the plan would take too long to implement.) In the European case, the
“toxic securities” would be distressed sovereign debt rather than
securitized mortgage bonds.
Plan to Stabilize Banks Holding Eurozone Sovereign Debt
Over the weekend of September 17, finance leaders from around the
world met in the annual IFM/World Bank conference in Washington
to discuss the global economic state of affairs. At this meeting European
finance ministers said that they would take bolder steps to fight the
sovereign debt crisis, which is plaguing recovery of the global economy.
A focal point for the European officials is the stabilization
European commercial banks, which have been under a heavy market pressure.
European commercial banks, particularly French and German banks, hold
significant amounts of sovereign debt from the peripheral eurozone member
states, know as PIIGS (Portugal,
Italy, Ireland,
Greece and Spain).
Concern over Greek sovereign default is threatening a European banking
crisis.
European TARP
Suggestions have surface for Europe to deal with this possible
banking crisis by creating a plan similar to that of the US TARP program of
2008, following the collapse of the US housing market and the bankruptcy of
Lehman Brothers, “Troubled Asset Relief Program” (TARP) was created by the
US government to strengthen financial institutions. Under TARP $700 billion
of capital was injected into US banks.
For a Euro TARP, it is estimated that at least $202 billion of
capital will need to be injected into the European Financial Stability
Facility (EFSF) to purchase distressed sovereign debt from the European
commercial banks. The hope is that this would alleviate the pressure on the
peripheral European member states and on the European commercial banks.
Still Higher Leverage as Cure for High Leverage
One question is what the JP Morgan Cazenove approach would mean for
the balance sheet of the EFSF, which already carries committed emergency
loans to Ireland,
Portugal
and Greece.
It is expected to provide over €100 billion ($134.9 billion) in additional
funding for a Greek bailout. After committed loans, the Fed’s war chest
will be down to about €298 billion ($402 billion). German Finance Minister
Wolfing Schaeuble said on Monday, September 19, that there is no plan to
expand the EFSF.
This plan will catapult the EFSF into the category of a highly
leveraged fund, which borrows more than its equity capital provided by EU
member governments. No official plans have been released. Details of the
structure will change as European policymakers fight over the best course
of action from the perspective of their different national interest.
Many of the proposed options to expand further the €440 billion ($596
billion) European Financial Stability Facility (EFSF) have problems,
including opposition from countries like Germany, which fears a replay of
its disastrous inflationary monetary policies of the 1920s during the
Weimar Republic.
Meanwhile, euro zone officials played down rumor on Monday, September
19, of emerging plans to cut by half Greece’s sovereign debts and to
recapitalize European banks to cope with the fallout, stressing that no
such scheme is on the table yet.
Rough calculations suggest the EFSF, which borrows its funds from
credit markets backed by guarantees from eurozone member states, might cope
with a bailout of Spain
but that it would not have enough financial power if Italy
needed help.
The EFSF is already committed to providing €17.7 billion ($24 billion)
in emergency loans to Ireland
and €26 billion ($35.3 billion) to Portugal.
In addition, the EFSF takes over the remainder of Europe’s
contribution to an initial bailout of Greece,
which is likely to require around €25 billion ($34 billion), and is
expected to provide two-thirds of a €109 billion ($147.7 billion) second
bailout of Greece.
Taken together, the EFSF’s current commitments total at least €142
billion ($193 billion), leaving it €298 billion ($405 billion). A package
for Spain
might top €290 billion ($395 billion), while a rescue bill for Italy
could total almost €490 billion ($666 billion).
If Greece
defaults on its sovereign debt, contagion will spread to cause sovereign
defaults by all the other PIIGS governments and a massive failure in
financial markets world wide.
Some suggest doubling the funding of EFSF, while others talk of
boosting it to “several trillion”. But the way to restore confidence, which
will be determined by the reaction of already stressed markets, goes beyond
simple mathematics.
Greece
only a Detonator of European Sovereign Debt Bomb
The sovereign debt default haunting Europe has
its detonator in Greece,
one of the smallest yet most heavily indebted economies in Europe.
Greece,
while not a poor country, desperately needs a next aid payment of $11
billion to avoid running out of cash within weeks, but negotiations between
the Greek government and the “troika” of the European Union, European
Central Bank, and International Monetary Fund have stalled. The problem is
no one believes that the next payment of $11 billion will by itself solve
Greece’s sovereign debt problem. Considered unthinkable not too long ago, a
Greek default now seems imminent — a subsequent exit from the eurozone no
longer improbable.
Orderly Default Option
Talks of a potential “orderly default” of Greek sovereign debt have
emerged, even suggestions of a Greek exit from the eurozone as a possible
scenario. Time is running out for continuing indecision and denial. In the
end, the governments of the stronger economies, such as Germany and France,
will have to step up to the plate, as their economies had the most to lose
from a wave of falling dominos of sovereign debt default in the eurozone.
French and German Responsibility
In many ways, France
and Germany
were responsible for the sad state of affair facing eurozone governments
today. Financial stability in the eurozone had been guaranteed by the euro
convergence criteria as spelled out in the Stability and Growth Pact (SGP)
are:
1. Inflation rates:
No more than 1.5 percentage points higher than the average of the three
best performing (lowest inflation) member states of the EU.
2. Government finance:
Annual government fiscal deficit:
The ratio of the annual government fiscal deficit to GDP must not exceed 3%
at the end of the preceding fiscal year. If not, it is at least required to
reach a level close to 3%. Only exceptional and temporary excesses would be
granted for exceptional cases.
Government debt:
The ratio of gross government debt to GDP must not exceed 60% at the end of
the preceding fiscal year. Even if the target cannot be achieved due to the
specific conditions, the ratio must have sufficiently diminished and must
be approaching the reference value at a satisfactory pace.
3. Exchange rate:
Applicant countries should have joined the exchange rate mechanism (ERM II)
under the European Monetary System (EMS) for two consecutive years and
should not have devaluated its currency during the period.
4. Long-term interest rates:
The nominal long-term interest rate must not be more than 2 percentage
points higher than in the three lowest inflation member states.
Had these criteria set by the Stability and Growth Pact (SGP) been
observed, it is unlikely that eurozone governments would face any sovereign
debt crisis today. Ironically, the watering down of the SGP, which led to
the current sovereign debt crisis in the eurozone, had been at the request
of Germany
and France, two of the strongest of the then 16 eurozone member states.
Eurozone financial markets had been imitating the rush to phantom wealth
creation through synthetic structured finance and debt securitization
invented by fearless young traders in New York
and London working with money
provided by loose monetary measures of all central banks led the Federal
Reserve.
In March 2005, the EU’s Economic and Financial Affairs Council
(ECOFIN), under the pressure of France and Germany, relaxed SPG rules to
respond to criticisms of insufficient flexibility and to make the pact more
enforceable. Permissiveness infested the European theoretical regulatory
framework, following the US
example.
ECOFIN, one of the oldest configurations of the Council of the
European Union, is composed of the Economic and Finance Ministers of the 27
European Union member states, as well as Fiscal Budget Ministers when
budgetary issues are discussed.
The EU Council covers a number of EU policy areas, such as economic
policy coordination, economic surveillance, monitoring of member state
budgetary policies and public finances, the shape of the euro (legal,
practical and international aspects), financial markets and capital
movements and economic relations with third countries. It also prepares and
adopts every year, together with the European Parliament, the budget of the
European Union which is about €100 billion ($136 billion).
The Council meets once a month and makes decisions mainly by
qualified majority, in consultation or co-decision with the European
Parliament, with the exception of fiscal matters which are decided by
unanimity. When the ECOFIN examines dossiers related to the euro and EMU,
the representatives of the member states whose currency is not the euro do
not take part in the vote of the Council.
At the urging of Germany
and France,
the ECONFIN agreed on a reform of the SGP. The ceilings of 3% for budget
deficit and 60% for public debt were maintained, but the decision to
declare a country in excessive deficit can now rely on certain new
parameters: the behavior of the cyclically adjusted budget, the level of
debt, the duration of the slow growth period and the possibility that the
deficit is related to productivity-enhancing procedures. The pact is part
of a set of Council Regulations, decided upon the European Council Summit
22-23 March 2005.
Greece
a Victim of Structured Finance
Greece fell into the euro debt trap by yielding to the temptation of
structured finance, the instruments of which were first developed in the US
and adopted by US transnational financial institutions such as Goldman
Sachs, Citibank, JPMorgan Chase and Bank of America to generate phenomenal
profit for them in deregulated global markets fueled by floods of
dollar-denominated liquidity release by the Federal Reserve, the US central
bank, through the virtual transaction of synthetic derivatives known as
synthetic collateralized debt obligations (CDO).
This new game of phantom wealth creation was soon joined by copycats
in Europe such as Barclay, Société Générale,
Deutsche Bank and ING. Such synthetic instruments were designed to, among
other things, help banks hide their liabilities by pushing them off their
balance sheets and thus lowering their capital requirement to increase
profit from expanded loan-making to yield higher return on capital.
(Please see my May 9, 2007 AToL article: Liquidity
Boom and Looming Crisis, written and published two months before the
credit crisis first imploded in New York in July 2007.)
Later, expanding from the private sector, such schemes were sold to
EMU member governments to help them mask their true public debt levels to
skirt strict EMU rules, in order to engage in permanent monetary easing.
Across the eurozone, in obscure and opaque over-the-counter (OTC)
derivative deals that traded directly between counterparties off exchanges
between “special purpose vehicles” (SPV), and designed to help governments
legally skirt EMU criteria, transnational banks provided Eurozone
governments with cash upfront in return for future payments by government.
Such payments would reduce government fiscal revenue since the revenue from
collateral assets has been pledged to investors of CDOs.
The liabilities were taken off their national balance sheets to
present a healthy picture of national finance, until the government is
forced to make up the revenue shortfall in a recession. Thus it is
hypocrisy of the extreme for Germany to hold Greece hostage with demand of
severe fiscal austerity that will lead to socio-political instability, by
asserting disingenuously that Germans work harder than Greeks, and that the
German government is fiscally more responsible than the Greek government,
and that Greece cannot expect German taxpayers to bail out Greece from a
decade of poor public finance, made possible by German influence on
diluting the criteria of the SPG.
Goldman Doing God’s Work Again
Wall Street is directly responsible for Greece’s public finance
predicament. In 2005, Goldman Sachs, doing what its chairman told Congress
as “God’s work”, sold interest rate swaps it created to the National Bank
of Greece (NBG), the country’s largest bank. In 2008, Goldman Sachs helped
NGB put the swap denominated in euros into a legal special purpose vehicle
(SPV) called Titlos. National then retained the bonds that Titlos
issued as collateral to borrow even more euros from the European Central
Bank (ECB) and in turn from international banks. The swap will be costly
and unprofitable for the Greek government through its long contract term,
while Goodman profited handsome in fees up front.
Appropriately, in Greek manuscripts, the titlo was often used
to mark the place where a scribe accidentally skipped the letter, if there
was no space to draw the missed letter above. SPV Titlos performed
the special purpose of skipping the sovereign liability Greece
had assumed in order to get more loans from the ECB and international banks
than was permitted under SPG criteria. Such SPV deals were not made public
even though Titlos obligations are among the weak links in Greek
public finance in 2010. Information on them finally trickled out only
through government investigations and media investigative reporting.
Der Spiegel reported in early January 2010 that Goldman Sachs
two years earlier had helped the government of Greece
cover up part of its huge fiscal deficit via a currency swap deal name Titlos,
which used artificially high exchange rates. A report commissioned by the
Greek Finance Ministry released on February
1, 2010, revealed that Greece
had used swaps to defer interest repayments by several years.
On February 15, 2010,
Bloomberg reported a Greek government inquiry uncovered a series of swaps
agreements with securities firms that allowed it to mask its growing public
debts. The document did not identify the securities firms Greece
used. But the former head of Greece’s Public Debt Management Agency told
Bloomberg that the government turned to Goldman Sachs in 2002 to obtain $1
billion through a swap agreement.
(Please see my AToL series on GLOBAL POST-CRISIS ECONOMIC OUTLOOK:
Part XII: Financial
Globalization and Recurring Financial Crises
Part XI: Comparing Eurozone
Membership to Dollarization of Argentina
Part X: The Trillion Dollar
Failure
Part IX: Effect of the Greek
Crisis on German Domestic Politics
Part VIII: Greek Tragedy
Part VII: Global Sovereign
Debt Crisis
Part VI: Public Debt and
Other Issues
Part V: Public Debt, Fiscal
Deficit and Sovereign Insolvency
In these articles, I warned against the danger of SPVs that would eventual
put Greece into a disastrous sovereign debt crisis.)
Political Hurdles
The fundamental decisions over the future of the European monetary
union will be politically difficult, and they will be costly for the richer
economies. The costs of not acting decisively now, however, are going to be
even higher. The urgency in bailing out Greece
is the contagion on Spain
and Italy
should Greece
defaults, and through these economies to the US
and Asia.
This fact is validated by
the blunt warning from US Treasury Secretary Timothy Geithner on Friday,
September 16 to eurozone finance ministers at a closed meeting
of in Wroclaw, Poland. Geithner told the Europeans to stop political
bickering and take control of the financial aspects of the debt crisis that
has brought “catastrophic risk” to global financial markets.
Geithner Warns Europe
Mr. Geithner reportedly said on the sideline of the ministerial
meeting: “What’s very damaging is not just seeing the divisiveness in the
debate over strategy in Europe but the ongoing
conflict between countries and the [European] central bank”, adding that “governments
and central banks need to take out the catastrophic risk to markets.”
Geithner’s presence at the meeting of EU financial ministers
underlined the concerned of the US
government about the danger of financial contagion from the eurozone
sovereign debt and banking crisis and its negative effect on the
fragile economic recovery in the US
and other parts of the world, including Asia.
In a blunt warning that
reflected Washington’s growing concern, Secretary Geithner urged European
leaders to halt a months-long clash with the European Central Bank and
argued that the EU’s growing reliance on foreign lenders would imperil the
zone’s ability to control its own destiny.
“What is very damaging [in
Europe] from the outside is not the divisiveness about the broader debate,
about strategy, but about the ongoing conflict between governments and the
central bank, and you need both to work together to do what is essential to
the resolution of any crisis,” Mr Geithner said on the sidelines of a
meeting of eurozone finance ministers in Wroclaw, Poland on Friday,
September 16.
“Governments and central
banks have to take out the catastrophic risk from markets… [and avoid]
loose talk about dismantling the institutions of the euro,” he added.
Mr Geithner’s comments came
as the Europe’s finance ministers agreed to withhold an €8 billion loan
payment to Greece, a move that could leave Athens scrambling to satisfy its
lenders before it runs out of cash.
European Response
George Osborns, UK
chancellor, echoed Mr Geithner’s comments, telling Sky news on Saturday,
September 18, that “people know that time is running out, that the eurozone
needs to show it can get a grip on the situation.”
However, some eurozone
finance ministers hit back at Mr Geithner’s comments, questioning the
usefulness of his visit. “I found it peculiar that even though the
Americans have significantly worse fundamental data than the eurozone, that
they tell us what we should do and when we make a suggestion ... that they
say no straight away,” said Maria Fekter, Austria’s finance minister.
Sweden’s Anders Borg said: “we
need to make progress, but it’s quite clear the US has a big debt problem
and the situation would be better if the US could show a sustainable way
forward.”
The eurozone’s more fiscally
prudent governments – particularly Germany and the Netherlands - are keen
to prove to their voters that they were forcing Greece to comply with the
deep fiscal budget cuts and other reforms it promised when it accepted a
€109 billion rescue package last year.
Several eurozone ministers also
dismissed a US suggestion to give additional flexibility to the eurozone’s
€440 billion rescue fund, re-opening trans-Atlantic fissures over fiscal
and economic policy.
Markets Respond Negatively to
EU Postponement on Decision
Finance ministers of the EU
extended the time frame to approve a revamp of the €440 billion rescue fund
that was agreed by heads of member state in July. After predicting that all
17 governments of eurozone member states would ratify the changes by the
end of this September, they are now expecting the process to drag on until
mid-October.
Some eurozone ministers expressed unhappiness with Mr Geithner’s comments
about Europe ending divisions as such comments
actually opened up new divisions.
Austria's
Finance Minister Maria Fekter, one eurozone politician at the meeting who
voiced her objection to Mr Geithner's comments, said: “I found it peculiar
that even though the Americans have significantly worse fundamental
[economic] data than the eurozone, that they tell us what we should do.”
She was referring to US
high national debt and the recurring trade and fiscal deficits, not
mentioning the political standoff in Congress over the increase of the
national debt ceiling.
Too Little, Too Late
Only two months after a second bailout was agreed to by European leaders,
and amid new data indicating that the Greek economy is shrinking at a
faster rate than expected, the size of rescue packages currency being
discussed already seems to be inadequate. Furthermore, a number of
indicators suggest the markets have already begun to discount a default —
yields on Greek bonds have soared to record highs, while the price for
credit-default swaps to insure Greek debt has rocketed. Many hedge funds
are poised to make a killing on a Greek sovereign default.
Despite these punishing moves by investors who react with incomplete and
unsubstantiated information, markets may still be under-pricing the total
cost of a Greek default. A default on this scale is unprecedented, and its
potentially widespread ramifications are unknown. Markets can limit some of
their risk, but it is far from certain that an actual default would not
lead to further panic and turmoil.
There are a number of other regional organizations that, while
not supranational unions, have adopted or intend to adopt policies that may
lead to a similar sort of integration in some respects.
- African
Union (AU)
- Association
of Southeast Asian Nations (ASEAN)
- Caribbean
Community (CARICOM)
- Central
American Integration System (SICA)
- Cooperation
Council for the Arab States of the Gulf (CCASG)
- Eurasian
Economic Union (EEU)
- Inter-Parliamentary
Union (IPU)
- South
Asian Association for Regional Cooperation (SAARC)
- Union
of South American Nations (USAN)
- Union
State
- Turkic
Council (TurkKon)
- Economic
Cooperation Organization (ECO)
- Organization
of Ibero-American States (OEI)
Other organizations that have also discussed greater integration
include:
- Arab
League into an "Arab Union"
- North
American Free Trade Agreement (NAFTA) into the "North
American Union"
- Pacific
Islands Forum into
the "Pacific Union"
- Customs
Union of Belarus,
Kazakhstan
and Russia into
the "Eurasian Union"
ASEAN Pursues EU article provides one instance of a region in support
of regional integration. “The European Union organized a group of nations
with different currencies and languages - and profits followed” (Conde,
2007, para. 1).
Currencies from various nations along with the economic system would
build a strong relationship to assist this regional integration. Just as
the EU had done, The Association of Southeast Nations (ASEAN) had their
desires to try and duplicate the same techniques and integrate currencies
in the areas. only to have this idea rejected by the past former prime
minister of Singapore Lee Kuan Yew (Jazi, 2008).
The reason for this was, the prime minister believed that the country
could achieve this objective but perhaps after 50-80 years. To start the
process they would require writing a charter however the organization
has opposed during the past because of the different financial systems in
the region. This is currently in the starting phases, however, it has been
stated that it will be a legally binding charter just like the one in the European
Union, taking into consideration that any members who do not abide by
this charts principles as well as procedures would need to incur on
sanctions.
To put it differently, ASEAN desires to turn into the European
Union of the other part of the world. For instance Thailand
and Vietnam
have strong expanding economies whereas Myanmar
is somewhat poor as well as separated from the rest. This integration
comes in a time in which communism is not a big issue for these nations.
A few of the possibilities this regional integration would provide the
organization and the 10 member states are the power as well as
capability make business with bigger potencies such as China as well
as the United States of America. A few of the advantages and benefits
that will come from this venture will be the national reconciliation and
democracy, increase trade, and reinforce security to prevent conflicts and
terrorism providing this region the chance to perform and get more
business from other nations in addition to franchises, corporations,
and trade exemption policies in the region.
Against Regional Integration
Prof. Zivojin Jazic explains the elements, similarities and
differences between the EU and ASEAN and APEC and describes their
point of view regarding world globalization. This short article also
integrates as well as describes the key reasons a few organizations aren't
in support of regional integration even now and their suggestions to
the region they serve.
The EU is the most essential player in politics with regard to Asia
as well as Africa because is the second market of
foreign trade in the region. In regard to ASEAN and APEC they
both have political problems however mostly because they encourage trade
andinvested not regional integration in their 21 member countries in said
region.
APEC is a strong economy in Asia as well
as the Pacific and is continuing to grow as fast rates. That is
why the influence of regional integration must not influence their
stability as well as status in region these days. APEC has a strong
impact in Asia's economic growth also
on the globalization process in general. Right now, APEC has 10
Member Countries, but has partners of the dialogue with India,
Japan, the United
States, China, EU,
particularly in regard to security and economic cooperation of these
sovereign nations. A few of the hurdles or factors that influence
ASEAN regional integration development are: political barrel and of safety,
economic barrel, functional barrel, and the barrel of the progress.
All of these before described are quite critical to meet the goals of
progress. From 2002 ASEAN is thinking about the creation of free trade
zone to accomplish their execution of roadmap by 2020.
In comparison to the process of globalization it is clear and is
established that this process has not produced any benefits with the
large sections of the human population of the world, most likely
because the main impulsive force is the trend for the benefit. The
article refers that the solution may be to incorporate local organizations
as well as projects for the economic cooperation and integration to
contribute with two goals: to guarantee the social justice as well as the
security of the underprivileged people and to encourage equal benefits
with globalization and the economic progress and business
opportunities with movements of products, money as well as labor. This
continues to be to be EU's mission.
In conclusion, after studying both articles above, one in support
of regional integration and one in opposition to it, it has been explained
the various disadvantages and advantages of it in regions and how it can
relate with their economic system. To conclude, the writer firmly
thinks regional integration is useful for both the organization
that is attempting to conduct business and to the nation in general
for said region. Not just regional integration assists that region
grow their economy and develop but also provides them the opportunity
to overcome governmental hurdles linked with trade of products to other
nations. Regional integration also provides the chance to the organization
to progress in other nations and simultaneously make that country
develop their economic system and impulse their working labor as
well as capital.
The People’s Agenda for Alternative Regionalisms is an effort to
promote cross-fertilization of experiences on regional alternatives among
social movements and civil society organizations from Asia,
Africa, Latin America and Europe.
It aims to contribute to the understanding of alternative regional
integration as a key strategy to struggle against neoliberal globalization
and to broaden the base among key social actors for political debate and
action around regional integration.
Specifically, it aims to build trans-regional processes to develop
the concept of “people’s integration”, articulate the development of new
analyses and insights on key regional issues, expose the problems of
neoliberal regional integration and the limits of the export-led
integration model, share and develop joint tactics and strategies for
critical engagement with regional integration processes as well as the
development of people’s alternatives.
The initiative People’s Agenda for Alternative Regionalisms, draws
from the work and relates to regional alliances such as Hemispheric
Social Alliance (Latin America), Southern African People’s
Solidarity Network- SAPSN (Southern Africa),Solidarity for Asian
People’s Advocacy – SAPA (South East Asia), People’s SAARC (South
Asia) as well as organizations and networks in Europe,
includingTransnational Institute (TNI), that struggle for “Another Europe”.
Ultimately, PAAR aims to support these and other networks in their
efforts to reclaim the regions, recreate the processes of regional
integration and advance people-centered regional alternatives.
The Transnational Institute (TNI) is an international research and
advocacy institute committed to building a just, democratic and sustainable
planet. For more than 40 years, TNI has served as a unique nexus between
social movements, engaged scholars and policy makers.
Stakeholders mull European Union 'Aid for Trade' Strategy
In one of the side events organized in the framework of the 5th Global
Review of Aid for Trade, Mr. Stephen Karingi, Director of Regional
Integration and Trade Division of the Economic Commission for Africa (ECA),
was invited to speak as a panelist at a stakeholder consultation on “The
Future of the European Union Aid for Trade strategy”.
Mr Karingi started his intervention by recalling some of the key
findings of a joint ECA-WTO report titled “Reducing Trade Costs to support
Africa’s Transformation – the Role of Aid for Trade”, which contained a
detailed monitoring of Aid for Trade flows to Africa.
He recalled that it is encouraging to see the increase in Aid for Trade
funds to Africa, as well as the focus on countries
with special needs (namely Least Developed Countries, Landlocked countries
and Small Island
Developing States).
However, he pointed out that one source of concern from Africa’s point of
view is that recent growth has not translated meaningfully into structural
change and industrialization. Aid for Trade strategies should ideally
contribute to redressing this situation; yet, over the 2011-2013 period,
industry only accounted for 6 percent of Aid for Trade disbursements to Africa.
A related point emphasized by Mr. Karingi was that African countries
show relatively high participation in global value chains, but this is
driven mainly by exports of raw materials and intermediate goods embodying
limited domestic transformation. Accordingly – he argued – one way in
which Aid for Trade could have greater impact is to support the emergence
of regional value chains, harnessing the regional market to foster economic
diversification and domestic value addition. In this context, the
establishment of the Continental Free Trade Area and the implementation of
the African Union Action Plan for Boosting intra-African Trade warrant the
adequate support as key avenues to achieve authentic regional integration
in the continent.
Mr Karingi also pointed out the critical role played by the services
sector in terms of employment creation and contribution to value addition
along the value chain. In line with this consideration, he contended that
Aid for Trade should target in a more pronounced way those high-end
services which promise to exert positive spillovers on the rest of the
economy; that is the case of business and financial services, logistics and
distribution, as well as infrastructure-related services such as transport
and energy provision.
Touching upon the specific theme of this Fifth Global review – trade
facilitation – Mr. Karingi warned against the risk of limiting the trade
facilitation agenda to those specific measures that respond to the
interests of large traders and transnational corporations. He instead
argued that Aid for Trade support to Africa should
also focus specifically on the needs of small and medium enterprises, as
well as informal traders. Moreover, it should support efforts to streamline
procedure while enhancing the effectiveness of custom controls, with a view
to strengthen domestic resource mobilization and curb illicit financial
flows through trade mis-pricing.
Echoing some of the concerns raised also in the African region, other
panelists noted that there is scope for reducing the volatility and
unpredictability of Aid for Trade support, and improving the degree of
alignment with recipient countries’ development strategies. They also
mentioned the need to facilitate access to Aid for Trade funds by
harmonizing procedures and strengthening the coordination across donors, as
well as enhancing the dissemination of information about funding
opportunities.
Limitation of Market Forces
No economy, whether modern or ancient, monarchist or democratic,
capitalist or socialist, can rely solely on market forces to meet all
the needs of society or to direct the development of the nation toward a
desired destiny.
A properly regulated market performs many important economic
functions that are necessary for any economy, feudal, capitalist or
socialist. However, market forces, when unregulated or undirected by
government, as neoliberals advocate for capitalist market economies,
naturally allocate resources most efficiently toward efforts and
investments with the highest potential return on capital rather than where
it is needed most by the nation and its people.
These propositions add up to a wholesale reduction of the central role
of government in the economy and its primary obligation to protect the weak
from the strong, both foreign and domestic. (See the World
Order, Failed States and Terrorism series of reports Asia Times
Online, February 3, 2005.)
Generally, highly efficient markets, particularly modern financial
markets, aside from their fault of misallocating financial resources based
on maximum return on capital, do not produce sustainable or balanced
financial or economic outcomes if left unregulated by government.
Minsky’s Financial Instability Hypothesis
Hyman P Minsky (1919-1996), American economist and professor of
economics at Washington University in St Louis, developed the Financial
Instability Hypothesis (FIH) in the 1960s, linking financial market
fragility in business cycles with speculative investment bubbles endogenous
to financial markets, in a direct challenge to the Efficient Market
Hypothesis (EMH), which had been developed by Eugene Fama at the University
of Chicago Booth School of Business.
A basic rule in EMH in the field of behavioral finance says that
trading profit has always
and will always come from reducing financial market inefficiencies.
EMH states that prices of stocks reflect the market’s aggregate response to
information. Any one market participant can be wrong about price levels;
even every market participant can be wrong. But the market as a whole is
always right. After the dot-com bubble burst in 2000, apologists for the
EMH defended it by arguing that the dot-com bubble operated within the EMH;
only the information behind the rational expectation was false. It was an
argument that the operation was a success but the patient died. … continue
@ Asia
Times Online :: PAY, PROFIT AND GROWTH : Low wages and revolutions
The Westphalian World Order
The world order of sovereign states began with the Peace of Westphalia
of 1648 which ended the Thirty Years' War (1618-48) during which the German
Protestant princes struggled, with the self-serving help of foreign powers,
against the unifying central authority of the Holy Roman Empire, which was
under the Hapsburgs in alliance with the German Catholic princes. The Peace
of Westphalia established a new world order based on the principle of
sovereign states through the recognition of the independent sovereignty of
the more than 300 German principalities in the 17th century. These princely
states, recognized internationally as sovereign states by the peace, were
not nation-states, as they were all of German nationality.
The Peace of Westphalia represented a foreign-policy triumph for France
and its Swedish and Dutch allies, since it immobilized political
unification of the German nation and delayed it for two centuries. There
are clear indications that the "war on terrorism" today aims for
a foreign-policy triumph for US imperium that will immobilize the political
unification of Arab states as envisaged by Pan-Arabism.
The Peace of Westphalia advanced the modern Staatensystem or the
system of sovereign states in international relations and law. From the
17th century to the unification of Germany
by Otto von Bismarck in the aftermath of the failed democratic revolutions
of 1848, French foreign policy was to keep Europe
divided by the sovereign state principles of the Peace of Westphalia,
preventing a unified Germany
from emerging to threaten France
and the other established big powers. To achieve this aim, France,
although a Catholic nation, opposed the centralization aims of the Holy
Roman Emperor.
German unification was not achieved until after the defeat of France
in the Franco-Prussian War of 1870-71 when Bismarck
(1815-98) united Germany
by having a group of German princes gathering in the French
Palace of Versailles
proclaim the victorious William I of Prussia
emperor of the German Empire. But Bismarck
also divided Germany
by leaving one-sixth of the Germans outside of the new German Empire, a
condition that led a century later to another world war. Bismarck
opposed liberalism and advocated the unification of Germany
under the aegis of Prussia.
Bismarck suppressed socialism
with repressive laws that prohibited the circulation of socialist ideas,
legalized police power to put down socialist movements and put the trial of
socialists under the jurisdiction of police courts. Yet the persecution of
social democrats only increased their strength in parliament. To weaken socialist
influence and to implement his policy of economic nationalism, Bismarck
introduced sweeping social reform. Between 1883 and 1887, despite strong
opposition, laws were passed for health, accident and retirement social
insurance, prohibiting female and child labor exploitation, and limiting
working hours. These laws allowed Germany
to circumvent the evils of the Industrial Revolution that beset Britain.
Universalist Ideologies, Wars of Religion
The ideology behind the "war on terrorism" is universal
democracy, and in that respect it is analogous to the Holy Roman
Empire ideology of universal Catholicism. Yet with the
invasion and occupation of Iraq,
US foreign
policy has challenged the four-century-old Westphalia
principle of state sovereignty. This principle has kept the Middle
East divided to prevent a unified Arab state from emerging to
threaten the superpower status of the United
States and the national interests of its
neo-imperialist allies. The US
invasion of Iraq,
while satisfying the myopic mania of the neo-cons who temporarily captured US
policy, unwittingly gives legitimacy to pan-Arabism to unleash a frenzy of
regime changes unrestrained by the Westphalia
principle of sovereign states. The rise of pan-Arabism brought about by the
demise of the Westphalia principle of sovereign
states in the Middle East will be resisted by the
neo-imperialist powers and will inevitably lead to a new global war that
will make the Thirty Years' Year look like child's play.
The Thirty Years' War was fought on German soil, carried out by soldiers of
fortune who aspired to create principalities of their own with their own
political agendas. The "war on terror" today is fought on Islamic
soil, carried out by mercenary units and opportunistic local factions hoping
to carve out religious or ethnic fiefdoms. The Thirty Years' War dragged on
because the warring parties feared each other's success and regularly
changed alliances and war aims to keep the conflict going. Peace was not an
objective because the purpose of war was to prevent any one party from
winning, and as soon as peace was at hand, the potential winner would be
neutralized by a new balance of power. Peace is also not an objective in
today's "war on terrorism" because the purpose of the war was to
prevent indigenous political cultures from overwhelming the injudicious
push for universal democracy and collateral US
hegemony, which is enhanced by continuing local conflicts with the US
as a half-hearted peacemaker and arbitrageur with a not-so-hidden self-serving
agenda.
The "war on terrorism" today shares many parallel attributes with
the Thirty Years' War of four centuries ago. Both are global religious
conflicts conducted with geopolitical maneuverings. Both serve as unwitting
cradles for new world orders. While the Thirty Years' War was fought to
enforce universal Catholicism, today's "war on terror" is being
fought to spread universal democracy based on Judeo-Christian values. Like
the Thirty Years' War, the "war on terror" today is also complex
and multidimensional. US
President George W Bush has repeatedly served notice that it will be a
protracted and difficult war. Like the Thirty Years' War, the "war on
terrorism" today also has no clear single objective, not even the
elimination of terrorism. So far, the war has used the threat of terrorism
as a pretext to invade sovereign states not to the superpower's liking. The
administration of president George H W Bush launched the first Gulf War to
protect the tangible principle of sovereign states by driving Iraq
from its reincorporation of Kuwait,
thus putting the principle of state sovereignty above the intangible
principle pan-Arab nationalism. Yet in the second Gulf War to invade and
occupy Iraq,
the abstract principle of universal democracy was used to overrule the
tangible principle of state sovereignty.
Terrorism is as old as civilization itself and many political movements
have been forced to resort to it in varying degrees, especially in their
early stages of struggle. Powerful, established political powers regularly
resort to state terrorism, known euphemistically as war conducted by
overwhelming force applied with shock and awe - in other words, terror.
Thus the "war on terror" is in fact fought with state terror.
Even the most heinous war is always rationalized with high moral
justification.
In its most current manifestation, the "war on terrorism" today
is a religious war between a faith-based Christian nation and Islamic
extremists, both groups controlled by fundamentalists, not unlike the struggle
between the Roman Catholic Church and emerging Protestant movements during
the Thirty Years' War. It is an unevenly matched conflict between a
powerful state military machine and clandestine cells engaged in
asymmetrical warfare reminiscent of the early phases of the Thirty Years'
War. It is an unbalanced game between an organized system with visible and
open targets everywhere and a vast network of disjointed cells that are
impossible to find until after they surface with an attack. The same was
true with the Holy Roman Empire in its effort to
rein in the Protestant German princes and their religious zealot advisers
during the Thirty Years' War.
The "war on terrorism" today is a violent neo-imperialist
strategy that unwittingly enhances the unifying aim of pan-Arabism, by
threatening the sovereignty of the numerous small Arabic failed states
created by the imperialist powers of the last century to frustrate pan-Arab
nationalism. Just as the prevention of the unification of Germany
played a key role in the strategy of foreign powers during the Thirty
Years' War, the eventual emergence and prevention of pan-Arabism will play
a key role in the "war on terrorism" today. It is too early to
discern how the geopolitical implication of the development will shape up.
The "war on terrorism" is a unilateral war waged primarily by the
sole superpower that is putting strains on residual Cold War alliances,
forcing Europe to seek independence from post-Cold War US unilateralism. It
pushes Cold War US nemeses such as Russia,
China and India
to converge if not unite in support of a multipolar world order. The Holy
Roman Emperor was in a similar situation in its relations with the major
powers of Europe at the time of the Thirty Years'
War.
Bourbons, Bonaparte and Bush
The Peace of Westphalia that began in 1648 after 30 years of destruction
and slaughter marked the triumph of the doctrine of the balance of power.
The doctrine was directed against Hapsburg supremacy, which was
successfully blocked by a France
on its path toward superpower status. Later, when King Louis XIV of France
advanced the doctrine of "universal monarchy", or still later
when Napoleon Bonaparte expanded the same idea to a multinational,
multi-ethnic Empire of the French (not a French empire) based on universal
citizenship in the imperial Roman sense, the balance-of-power doctrine was
directed specifically against France.
Today, there is clear evidence of the balance-of-power doctrine being
directed against a hegemonic United States
that attempts to construct, by violent regime changes in distant sovereign
states, a world order of compulsive neo-liberalism. Unlike the Roman
Empire or the Empire of the French, US
neo-imperialism has yet to adopt an inclusive citizenship policy. US-led
neo-liberal globalization promotes only the cross-border free movement of
goods and capital, but not of people.
One and half centuries after the Peace of Westphalia, Napoleon co-opted the
democratic ideals of the French Revolution and applied them to the concept
of a universal empire ruled by a Bonaparte dynasty consisting of members of
his family. The people of Spain
proved to be less docile than their aristocratic leaders to the Pax
Napoleon. Even before Joseph, Napoleon's brother, was proclaimed king
of Spain
with alacrity by a Spanish Council of Regency, spontaneous anti-French
insurrection had broken out in every province
of Spain, without central
leadership, systemic organization or preparation. Spain
was by that time a mere shadow of its former greatness and, in every sense
of the term, a failed state. The popular insurrection was not explainable
by any aversion to a foreigner on the Spanish throne. The Spanish Bourbons
were a foreign dynasty. Joseph Bonaparte came to Spain
with an impressive record of liberal reforms as king of Naples
and he had the support of a substantial segment of the Spanish elite,
nobles, prelates, financiers, officials and intellectuals who looked to
France, even Napoleonic France, as a bearer of the liberal principles of
the French Revolution. Had Joseph been allowed to rule in peace, such
aspirations might not have been wrong.
The Shanghai Cooperation Organization
Unilateralism in US foreign policy, highlighted by US rejection of the
Kyoto Treaty and the Anti-Ballistic Missile Treaty, the hardline approach
toward North Korea and China, and until September 11, 2001, support for
anti-socialist terrorism in the name of human rights and democracy, has
solicited efforts by targeted countries to form their own sets of
cooperative multilateral mechanisms that exclude the US. The SCO process,
the most significant of such mechanisms, has quietly but steadily built up
its economic, military and diplomatic relations, seeking to present itself
as more viable counterweight to emerging US hegemony in Central Asia.
The SCO consists of China,
Kazakhstan,
Kyrgyzstan,
Russia, Tajikistan
and, most recently, Uzbekistan.
Until that sixth member joined, the group was known as the Shanghai Five.
The group emerged from a series of talks on border demarcation and demilitarization
which the four former Soviet republics held with China.
Since 1996, when the group held its first presidential summit meeting in Shanghai,
the five-country group has held annual summits. The statement from the July
2000 Dushanbe summit notes the
establishment of a "Council of National Coordinators" that would
further foster regularized cooperation among the member states. In
addition, the joint statement expressed the group's view of the
international security situation both within and beyond their borders. The
Dushanbe statement pledge the member states to crack down jointly on
secession movements, terrorism, and religious extremism within their
borders and to oppose intervention in another country's internal affairs on
the pretexts of humanitarianism and protecting human rights; and support
the efforts of one another in safeguarding the member states' national
independence, sovereignty, territorial integrity, and social stability. China
has called for strengthening mutual support in safeguarding the national
unity and sovereignty of the SCO member nations and jointly resisting all
kinds of threat to the security of the region, particularly from outside
the region.
With these aims in mind, the SCO defense ministers meet annually along with
their foreign ministers, and their militaries conduct joint exercises and
training, exchange information about peacekeeping operations, and hold
conferences and other exchanges on security issues. The Dushanbe
statement also noted the group's opposition to the use of force or threat
of force in international relations without United Nations Security Council
approval, a direct reference to recent US
undertakings in Iraq.
The group also opposes any attempt by countries or groups of countries to
monopolize global and regional affairs out of selfish interests. In similar
terms, the Dushanbe statement also expressed its opposition to US
missile-defense strategy by stating its strong support for the
Anti-Ballistic Missile (ABM) Treaty of 1972 and its opposition to "bloc-based"
(ie, US alliance-based) deployment of theater missile defense systems in
the Asia-Pacific region, particularly in Taiwan and Japan.
The SCO maintains that it is not an alliance, and is not aimed at any third
parties. Indeed, the group has a number of internal differences that will
likely prevent it from becoming like a North Atlantic Treaty Organization
(NATO). The two biggest countries in the group, China
and Russia,
have enjoyed much-improved relations over the past decade, but still harbor
mutual long-term strategic distrusts. In addition, individual members of
the group differ over other important issues, such as relations with
various neighbors such as India,
Pakistan
and Afghanistan,
and over how best to exploit the rich reserves of energy and other natural
resources in Central Asia for common use. Russian
President Vladimir Putin appears to welcome additional members to the group
(such as Uzbekistan;
Pakistan, Iran
and India
have expressed an interest), which, if admitted, would certainly complicate
the achievement of consensus within the group. China
and India
are engaged with serious efforts to improve relations.
The SCO process has resulted in impressive achievements, such as settling
border disputes, introducing confidence-building measures, and moving in
cooperative ways to combat illicit activities in their region such as
terrorism and drug smuggling. It has also issued increasingly pointed
statements in op
position to US hegemony. The SCO is indicative of efforts around the
world seeking security-related mechanisms independent of US
participation.
The Fatal Washington
Consensus
It has been said that when economics turns serious, it becomes
political. The Washington Consensus, a term coined in 1990 by John
Williamson of the Institute for International Economics to summarize the
synchronized ideology of Washington-based establishment economists,
reverberated around the world for a quarter of a century as the true gospel
of reform indispensable for achieving growth in a globalized market
economy.
Initially applied to Latin America and eventually to
all developing economies, the term has come to be synonymous with
globalized neo-liberalism or market fundamentalism to describe universal
policy prescriptions based on free-market principles and monetary
discipline within narrow ideological limits. It promotes for all economies
macroeconomic control, trade openness, pro-market microeconomic measures,
privatization and deregulation in support of a dogmatic ideological faith
in the market's ability to solve all socio-economic problems more
efficiently, and to assert a blanket denial of an obvious contradiction
between market efficiency and poverty eradication.
Financial-capital growth is to be served at the expense of human-capital
growth. Sound money, undiluted by inflation, is to be achieved by keeping
wages low through structural unemployment. Pockets of poverty in the
periphery are the necessary price for prosperous centers. Such dogmas grant
unemployment and poverty, conditions of economic disaster, undeserved
conceptual respectability. State intervention has come to focus mainly on
reducing the market power of labor in favor of capital in a blatantly
predatory market mechanism.
Unemployment and poverty then are viewed as temporary, transitional
fallouts from wholesome natural market selection, as unavoidable effects of
economic evolution that in the long run will make the economy stronger.
Neo-liberal economists argue that unemployment and poverty, deadly economic
plagues in the short term, can lead to macroeconomic benefits in the long
term, just as some historians perversely argue that even the Black Death
(1348) had long-range beneficial effects on European society.
The resultant labor shortage from abrupt thigh fatality during the Black
death in the short term pushed up wages in the mid-14th century, and the
sudden rise in mortality led to an oversupply of goods, causing prices to
drop. These two trends caused the standard of living to rise for those
still living. Yet the short-term shortage of labor caused by the Black
Death forced landlords to stop freeing their serfs, and to extract more
forced labor from them. In reaction, peasants in many areas used their
increased market power to demand fairer treatment or lighter burdens.
Frustrated, guilds revolted in the cities and peasants rebelled in the
countryside. The Jacquerie in 1358, the Peasants' Revolt in England
in 1381, the Catalonian Rebellion in 1395, and many revolts in Germany,
all served to show how seriously the mortality had disrupted traditional
economic and social relations.
Neo-liberalism in the past quarter-century created conditions that
manifested themselves in violent political protests all over the globe, the
extremist form being terrorism. But at least the bubonic plaque was
released by nature and not by human ideological fixation. And
neo-liberalism keeps workers unemployed but alive with subsistence
unemployment aid, maintaining an ever-ready pool of surplus labor to
prevent wages from rising from any labor shortage, eliminating even the
cruelly derived long-term benefits of the Black Death.
The Washington Consensus has since been characterized as a "bashing of
the state" (Annual Report of the United Nations, 1998) and a "new
imperialism" (M Shahid Alam, "Does Sovereignty Matter for
Economic Growth?", 1999). But the real harm of the Washington
Consensus has yet to be properly recognized: that it is a prescription for
generating failed states around the world among developing economies. Even
in the developed economies, neo-liberalism generates a dangerous but
generally unacknowledged failed-state syndrome.
The economics of neo-imperialism
The United States
is the leading advocate of the efficacy of free markets and the economic
benefits of privatization of the public sector. It prescribes policy
measures that aggressively weaken the state apparatus and that inevitably
lead to failed statehood. At the same time, the US
is also the leading proponent of superpower military intervention in failed
states around the world. The number of victims caused by neo-liberalism far
exceeds those from ethnic strife in failed states. Yet while neo-liberals,
together with their strange bedfellows the neo-conservatives, advocate
humanitarian military intervention in failed states, they adamantly oppose
government intervention in failed markets that accept unemployment as
necessary antidote for inflation (seeTackle
failed markets, not failed states
, March
26, 2002)
Neo-imperialists identify failed statehood as the natural outcome of
anti-imperialism. Historically, when power vacuums left by failed states
threatened great powers, the ready solution was imperialist conquest. Such
conquests were justified as necessary for imposing order and civilization
over chaos and backwardness. But imperialism lost its legitimacy as a
result of the disingenuous promotion of anti-imperialist sentiments by the
warring imperialist powers of World War II. These warring powers were
compelled to use anti-imperialism as incentives for mobilizing their
colonial subjects to support their total war efforts. Imperialism became an
unwitting victim of collateral conceptual damage in the second global war
to end all wars.
The world order during the Cold War was a condominium of two superpowers
who were opponents in dialectic ideological dispute as well as in
conflicting geopolitical state interests. Toward the end of the Cold War,
conflicting geopolitical state interests were overwhelming ideology
disputes, driving communist China toward strategic convergence with the
capitalist US against Soviet imperialism, in response to the Soviet
alliance with anti-communist India against China.
Localized ongoing superpower ideological wars by
proxy states were wound down and local political struggles were frozen to
avoid superpower conflict escalating into nuclear exchanges. The end of the
Cold War diminished both the legitimacy and ability of former client states
and satellites of the two opposing superpowers to control domestic rival
factions, leading to failures of state power in several regions. At the
same time, some states that had been divided by Cold War superpower
geopolitics were reunited, some only after decades of violence, as in the
case of Vietnam, others peacefully with the disintegration of the USSR, as
in the case of Germany. Other divided states are still not reunited, such
as the two Koreas.
The USSR itself broke up into separate states, held loosely together by a
Commonwealth of Independent States (CIS) that comprise 12 sovereign states
that were formerly Soviet republics. The CIS was formed on the basis of
sovereign equality of all its members and that the member states are
independent and equal subjects of international law. The CIS is not a state
- it does not have supranational powers. In September 1993, the heads of
the charter states signed a treaty on establishment of the Economic Union,
in which they developed the concept of transformation of economic
interaction within the commonwealth, taking into consideration residual
realities. The treaty was based on the necessity of formation of a common
economic space on the principles of free movement of goods, services,
workers and capital; elaboration of concerted money and credit, tax, price,
customs and foreign economic policies; rapprochement of the methods of
management of economic activities; and creation of favorable conditions for
development of direct production links.
Ukraine has since emerged as a danger point for regional peace in its
effort to free itself from the Russian sphere of influence and reorient
itself toward the West. In former Yugoslavia, a former Soviet bloc state,
ethnic strife has embroiled NATO (North Atlantic Treaty Organization)
members, primarily the US, in humanitarian intervention. The Middle East
continues to be a smoldering powder keg that threatens global peace. In
East Asia, US adventurism in trying to set up Taiwan as a separate
pretender state from China poses a threat to peace in the region and perhaps
even the whole world by turning a long-dormant unfinished civil war into a
new international war.
After the Cold War, with a new form of economic imperialism under the
euphemism of neo-liberal globalization ravishing economies around the
planet, the post-World War II restraint and the Cold War freeze against
political imperialism are now being dismantled as disorder in ravished
countries grows more threatening to the sole remaining superpower. The US
now mistakes military and economic prowess for moral superiority and views
itself as having earned the privileges of a benevolent and indispensable
hegemon. Thus the neo-imperialist formula for the new Pax Americana is a
two-punch operation. The first punch uses neo-liberalism to cause a weak
state's economy to collapse to produce a failed state. The second punch
invades by force the failed state to delivery liberty as defined by the new
imperialism to set it up as a US protectorate and economic colony.
Terrorism is only one of the threats that failed states allegedly pose to
the sole remaining superpower, albeit it has taken center stage after the
tragically spectacular events of September 11, 2001. Much of the world's
illegal drug supply comes from alleged failed states, whether it is opium
from Afghanistan or cocaine from Colombia.
Yet in the mid-19th century, when Great Britain
illegally shipped opium to China from British India and Yankee Clippers
shipped opium from , in open violation of Chinese law, neither Britain nor
the US was condemned as a failed state. Other kinds of criminal businesses,
such as new forms of slave traffic through the hazardous venue of illegal
immigration, flourish today under the aegis of what are now identified as
failed states while the recipient strong states remain immune. Furthermore,
the economy of the southern US had been built by slavery with blatant
immunity. For a whole century and through half of its history, the US was
in egregious violation of the most obvious and fundamental human rights
with its institution of slavery without fear of being liberated by a
self-righteous foreign power.
How the strong define 'failure'
In 1919, Woodrow Wilson presented his self-righteous
Fourteen Points of utopian liberty to cynical European diplomats at the
Versailles Peace Conference, while at home, a series of immigration quota
acts based of racial discrimination were passed; government persecution and
deportation of leftists became the unconstitutional and illegal response
when 4 million workers went on strike in 1919 and Nicola Sacco and
Bartolomeo Vanzetti, both Italian immigrant anarchists, were arrested,
convicted on insufficient evidence and executed in 1927; the Ku Klux Klan,
dedicated to the persecution of "Negroes", Catholics and Jews,
achieved a membership of 5 million by 1924 without being outlawed; and
civil rights legislation would not be passed for another half century. A
series of Chinese exclusion acts that banned all immigration of Chinese
ethnicity and denied the right of Chinese to become naturalized US citizens
were not repealed until 1943 when the US needed China as an ally against
Japan. Yet through all this, the US was never invaded in the name of foreign
humanitarian intervention.
Today, the strong recipient states of illicit drugs from weak failed states
are themselves excused from failed-state status even though state functions
to eliminate such illicit traffic consistently fail. Failed states are generally
said to be increasingly trapped in a downward cycle of poverty and
violence. Notwithstanding that many of the ills of failed states have been
caused by globalized neo-liberal market fundamentalism, neo-imperialists
argue that the solution is for the sole remaining superpower and its
subservient allies to resort to new, improved imperialism again for the
good of the world.
The spread of AIDS in many regions has been associated with failed-state
syndrome. Yet the responsibility for failing to contain the spread of the
virus at its early stages lies squarely on the shoulders of US president
Ronald Reagan, who saw it as God's righteous punishment for sinful sexual
deviants. On the issue of AIDS eradication, the US has been in every sense
of the term a failed state.
Failed and collapsed states are a structural trait of the contemporary
international system, and not a temporary dysfunction of the Westphalian
world order of sovereign states. Failed states are not always weak states.
They are sometimes strong states that have voluntarily forfeited basic
state functions as a matter of ideology, or allowed them to be usurped by
special-interest groups. Strong failed states are states that possess
powerful military/police power for advancing the narrow economic interests
of a small class of citizens while sacrificing a significant segment of the
population as failed market victims. In the US, socio-economic Darwinism is
again celebrated as indispensable for the survival of the economy in the
market place, while scientific theories of evolution are challenged by
Creationism in public schools. Those who believe God created man apparently
do not believe he created all men as equals. These structural anomalies and
conceptual inconsistencies produce tensions in the international system,
with serious consequences for advanced and developing economies
alike.
In the Third World, the notion of "failed states" is problematic
since many Third World states collapsed after decolonization simply because
they were artificial Western imperialistic constructs in the first place,
and not true sovereign states. All failed states in the Third World are
located in former Western empires. Some Third World states are deemed
failed statehood by the hegemonic superpower if the state apparatus is
unable to uphold an effective monopoly of coercion over its entire
territory to prevent meta-state activities deemed dangerous to the
superpower. Such failed states usually lack an effective judiciary system
similar to that in advanced economies to safeguard the rights of foreign
and domestic private property, or are unable to fulfill international
obligations such as repayment of sovereign or private debts to foreign
financial institutions, or cannot prevent and police transactional economic
crimes or the use of asymmetrical warfare by meta-state groups against
strong states.
On the other hand, market states with advanced economies increasingly do
not consider most human aspects of societies as proper state concerns, such
as the provision of a rising standard of welfare to their citizens, which
has been conveniently assigned to the indifferent workings of the market,
but confining themselves to guarding and strengthening no-holds-barred
free-market conditions through which private wealth is generated for the
benefit of the strong elite, leaving the weak multitude to perish in a
natural selection. Wealth-distribution functions are assigned to the market
even though the structural maldistribution of market power is maintained by
the state. This amounts to a selective exercise of state power of coercion
to favor one preferred segment of the population or one type of
institutions at the expense of all others.
The popular will is repeatedly frustrated through inflated minority rights
backed by distorted constitutional interpretation on the part of
politically appointed and biased courts. In that respect, states such as
the US can also be deemed as having failed through its rule by law, not of
law. Other attributes of failed states, such as privatization of basic
legitimate state functions, fit the ideological trends in super-strong
market states such as the US today. Thus the ideological fixation prevalent
in the US today can be seen as moving the US toward a failed-state
syndrome. These market states try to coerce other states also to become
market economy states to prevent them from exercising sovereign control
over their national territories, protecting their economies from
structurally predatory global markets that amount to economic tyranny, regulating
the behavior and lives of their population for the common good and in
general aspiring to be strong states in defiance of globalized market
fundamentals that lock them in permanent victimization by strong market
states.
The collapsed state
A collapsed state is a failed state in its
advanced stage. It is identifiable by three features, according to
neo-imperialists. The first is its colonial legacy and ineffective
post-colonial state-building. States formed from residual colonial rule may
be confronted with insufficient love or loyalty to and from their
artificially constituted population, with their domestic and international
authority based not on legitimacy but on dominance, either economic or
police/military. The historical process in accumulating centralized power
in these states consists of subordination and assimilation that tend to
maximize popular resentment, resulting in polarization derived from
disillusionment and dissatisfaction by disfranchised minority or even
majority groups and their elites. Thus neo-imperialists consider collapsed
states to be the illegitimate children of anti-imperialism. In a way, collapsed
states are juvenile delinquents of the international system left from the
wreckage of the imperialist world order. The proper response to collapsed
states is to re-colonize them, so argue neo-imperialists.
The second feature of a collapsed state is the withdrawal of superpower
sponsorship/protection. The world order during the Cold War was a
condominium of two superpowers. Local struggles and conflicts were frozen
to avoid bringing the two superpowers into nuclear conflict. The end of the
Cold War reduced both the legitimacy and the power of the client states of
the sole remaining superpower to control domestic rival factions. The
solution to this unhappy state of affairs is for the sole remaining
superpower to assert its irresistible power by imposing a new world order
according to its alleged superior values, camouflaged as freedom and
democracy.
This is the neo-conservative agenda. President George W Bush says that free
and democratic states are peaceful states, notwithstanding the historical
fact that World War II was launched by an expansionist German Third Reich
born of a democratic process and the stubborn resistance by a British
emergency coalition government born through the suspension of elections.
What Bush really means is that when the whole world subscribes to US values
and accepts US power, not only out of fear but also out of respect for its
power-backed legitimacy, the world will be peaceful. Adolf Hitler sang the
same tune and failed. The US under her governing establishment is attempting
an ambitious undertaking of universal ideological control that even
Christianity under the Holy Roman Empire failed to accomplish with the
Thirty Years' War, having to yield finally to the Peace of Westphalia of
independent sovereign states.
The third feature of a collapsed state is the impact on it from neo-liberal
globalization. Unlike globalization in the past, which was implemented
through an empire structure, neo-liberal globalization is imposed through a
network of failed states by weakening state sovereignty in international
relations and limiting the legitimate role of the state in
socio-economic arenas. Imperialist globalization of the past did not
recognize the sovereignty of protectorates or colonies. In contrast,
neo-imperialist globalization today employs weak client states with
restricted sovereign rights as proxies of the strong market state to
enforce its exploitative agenda worldwide.
Neo-liberal ideology is implemented through a venue of integrated global
markets, free flow of capital and credit, wholesale deregulation and
mandatory structural pro-market conditionalities imposed on weak and poor
economies. It strips states of their sovereign authority to intervene in
markets on behalf of their national interests, causing state authority to
collapse in all area except the protection of foreign and domestic private
property rights. Failed states depend on globalized market fundamentals to
finance their state functions and inevitably fall into collapsed-state
status for insufficient revenue. In a sense, whereas the age of imperialism
used Christian values as a pretext for empire, the age of neo-imperialism
uses neo-liberalism as its missionary calling. The relationship of the
neo-conservatives to the neo-liberals today is similar to the relationship
of the Emperor and the Church in history. Missionaries are the velvet
gloves of the ruthless hands of imperialists.
How the strong define 'success'
Success in statism is measured by a state's
ability to deliver political goods. Security, both external and internal,
is a primary political good the provision of which is the state's primary
function. It provides a framework through which all other political goods
are delivered. The events of September 11, 2001, revealed that even the
most powerful state cannot guarantee its citizen protection from terrorism,
a fact since openly acknowledged by the Bush administration. The modus
operandi of the "war on terrorism" and the Department of Homeland
Security is based on the acceptance of spectacular terrorist attacks
continuing in the future and their likelihood of repeated success. The aim
is not to eradicate terrorism by removing its root cause, but only to make
it more difficult to implement. It is a war lost before it begins.
Neo-imperialism detaches economic security from legitimate state functions.
Freedom from want is not considered a state responsibility recognized by
neo-liberalism. Financial security is merely a market risk that should be
faced by each individual market participant. Another political good
provided by the state is the enforcement of law as expressed in a system of
codes and procedures that equitably regulate the affairs and financial
interactions of the population. The state is responsible for setting and
maintaining standards for equity and acceptable conducts both domestically
and in its foreign relations. Neo-liberalism relieves the state from such
responsibility and assigns it to the market.
Friedrich A Hayek (1899-1992) wrote The Road to Serfdom (1944)
to warn of the invasion of the welfare state in people's private lives, the
fundamental conflict between liberty and bureaucracy. Hayek and his fellow
Austrian economists who viewed the market economy working as the calculus
of independent individual decisions differed with Milton Friedman and the
Chicago School economists who thought macroeconomically in analyzing total
quantity of money, total price level, total employment, etc, in aggregates
and averages terms. Hayek's rejection of socialist thinking was based on
his view that prices are an instrument of communication and guidance that
embodies more information than each market participant individually
processes. To him, it was impossible to bring about the same price-based
order based on the division of labor by any other means. Similarly, the
distribution of incomes based on a vague concept of merit or need is
impossible. Prices, including the prices of labor, are needed to direct
people to where they can do the most good. The only effective distribution
is one derived from market principles. On that basis, Hayek intellectually
rejected socialism.
In Hayek's social philosophy, value and merit are and ought to be two
distinctly separate issues. Individuals should be remunerated purely on the
basis of value contributed and not in accordance with any concept of
justice, whether it be Puritan ethic or egalitarianism. Hayek went as far
as to deny that the concept of social justice has any meaning whatever, on
the basis that justice refers to rules of individual conduct. Since no
rules of the conduct of individuals can determine how the good things of
life should be distributed, the question of justice is moot. Since a free
market is the natural outcome of a multitude of individual decisions, how
the market decides is amoral.
Accordingly, a spontaneously working market, where prices act as guides to
action, cannot take account of what people need or deserve, because it
operates according to a neutral distribution system that nobody has
designed. Such a distribution system cannot be just or unjust. And the idea
that things ought to be designed in a "just" manner means, in
effect, that one must abandon the market and turn to a planned economy in
which somebody decides how much each ought to have. And the price for that
justice is the complete abolition of personal liberty.
Hayek's free-market ideas have been applied to much of unregulated
globalization of the past quarter-century, and the socio-economic damage is
now very visible. Notwithstanding Hayek's repugnant social philosophy, even
his "scientific" claims on the effectiveness of free markets has
not been substantiated by events. Hayek's fallacy rest on his blind faith
in "spontaneous" prices that neglect the potential of long-term
value through excessive instant sub-optimization.
Another political good is the provision of universal health care and
education, the maintenance of a vibrant economy of full employment at
living wages that will allow workers to afford decent housing and secure
retirement, and a clean environment, without which all rhetoric about
liberty becomes irrelevant. Freedom from want is a first freedom that
neo-liberalism denies by imposing the tyranny of the market. The logic of a
segmented health-insurance market based on tiers of risk profiles is
fundamentally flawed. It assigns high premiums to high-risk customers,
instead of universal protection for all. For those who are healthy, the
fact that they do not need medical care is already worth a fortune; do they
need also to deny financial support to others in the insured pool who are
unfortunate enough to be ill? For the healthy, not needing medical care is
itself the benefit. Who would wish to be ill merely to get their money's
worth from insurance? If the healthy in a community do not help the sick,
who will? There is no logical or ethical argument against universal health
care.
To deliver such political goods, the state is granted police power and the
power to issue sovereign credit to steer the economy toward rewarding
activities that produce such political goods. The unregulated market
rewards activities that externalize such political goods from their cost
structure and siphons off the resultant surplus value as private profit. In
fact, failed states are often generated by failed markets. The state has an
obligation to preserve and protect its sovereign credit authority from
being usurped by private interest groups. Capitalists use globalized
finance markets to tilt a level playing field in trade to create private
profit out of public poverty. This is done through the private control of
money as a legal tender, through a monetary system under a central banking
regime that ideologically accepts structural unemployment as the
unavoidable means to combat inflation. Central banking is the policy of a
failed state. A globalized foreign-exchange market dominated by dollar
hegemony is the venue for US superpower financial imperialism (see US dollar hegemony has got to go, April 11, 2002).
A Bank of International Settlement (BIS) regime of global network of
central banks whose main function is to protect the value of privately
controlled money through unemployment and slave wages is a world order of
failed states, not sovereign states. Dollar hegemony, the status of the
dollar as a dominant reserve currency in international trade despite its
fiat nature, operates in a globalized foreign-exchange market to rob sovereign
states of their right and ability to issue sovereign credit for domestic
development, by exposing their domestic currencies to market attacks. Since
sovereign control over the monetary system and the economy is the sine
qua nonprerequisite of sovereignty, the BIS financial world order of
failed states has in fact replaced the Westphalian world order of sovereign
states through financial globalization
Both strong and weak states can be failed states. Successful states are
those in full control of their territories and economies to provide
rising-quality political goods to all their citizens. Failed states contain
ethnic, religious, linguistic, or other tensions such as ideology that
limit or decrease their ability to deliver political goods. The
privatization of education, health care and social security is a formula
for state failure. These smoldering tensions, if unattended, eventually
explode into violent open conflicts. Some strong states became strong by
failing. They abdicated normal legitimate state obligations in order to
focus state resources on building up a strong military/police capability to
disarm domestic and foreign opposition to their failed-state
policies.
Failed states provide only substandard political goods, if any at all. Weak
failed states involuntarily forfeit, and strong failed states do so
voluntarily, the responsibility for delivering political goods, and leave
it to non-state actors, ie the private sector through the market mechanism.
Privatization of the public sector is more than the outsourcing of state
functions. It is the selling off of state prerogatives.
In the military sphere, this is manifested in two ways: 1) the use of
mercenaries within the regular army and 2) deferral of state-security
functions to contractors. The killing and mutilation last April 2 in
Fallujah, a Sunni stronghold 50 kilometers west of Baghdad, of four US
contract security personnel - mercenaries in all but name - testified to
the hate and rage of an occupied people. More than 30,000 mercenaries serve
as armed security guards for foreign private contractors engaged in the
rebuilding of Iraq for profit, taking over from the military the
responsibility of providing security and maintaining order in a war zone.
Even US civilian administrator L Paul Bremer sought protection by contract
security personnel, not US soldiers.
These armed mercenaries are officially not engaged in offensive operations
and are authorized to use their weapons only defensively if fired on. The
distinction is only technical, since invaders can hardly claim self-defense
against hostile fire from the invaded. The very presence of invaders is
itself an offensive act that naturally draws hostile response from the
invaded. The use of mercenaries is nothing more than the privatization of
war, the ultimate epidemic of neo-liberal market fundamentalism.
Mercenaries do not enjoy protection under the Geneva Convention on war
crimes and the mutilation was not perpetrated by an enemy army but by an
angry mob in a country under occupation. The television images of the
burned remains of US mercenaries, brutal on one level, were symbolic of
failed US policy on another. They represent violence against the crime of
regime change for profit. Iraq after US invasion fell deeper into failed
statehood.
The failure to provide security for all citizens is the first sign of a
failed state, as is the use of state violence on its own citizens. So is a
larger prison population or one that is racially or ethnically
disproportioned. An economic infrastructure that failed to deliver income
or wealth equitably is another sign of a failed state, measurable with the
Ginni coefficient on income inequality. The absence of a universal
health-care system is another sign, as is a dysfunctional public educational
system primarily reserved only for poor children. An excess of per capita
national debt is also a sign of failed statehood, as is pervasiveness of
corruption and fraud in government and business. Hunger and food shortage
for the poor while food surplus persists in the economy is another sign of
failed statehood. Failed states often have a very rich minority that takes
advantage of the failed system with the blessing of the state.
Collapsed states are failed states with a significant vacuum of central
authority. They are political black holes with regards to all indicators of
institutional health. It is much less costly to stop a state from failing
than to reconstruct it after it has failed or collapsed. Neo-liberal
efforts aimed at saving weak states have been mostly ceded to financial
institutions (banks and funds) that focus their efforts either on profit
incentives, returns from loans and investments or export expansion for
Western producers, particularly of agriculture, arms and intellectual property.
This is a form of blood-letting cure. There is not only no financial reward
for populism, but in fact also heavy penalties of operational losses.
Wealth and income maldistribution inevitably lead to impending economic
collapse and subsequently state collapse. A system of rewards and
punishment that leads a state to more populist policies can help to prevent
state failure. Financial shocks frequently cause a state to fail, or at
least its regime to fall.
World order in flux
Contemporary world order is a complex, contested
and interconnected order. This world order, its rules and institutions that
circumscribe the structures of power, is in a process of change, putting
stress on the order. The traditional world order based on the primacy of
interstate or geopolitical relations is being injected with other ordering
principles such as the world order of global politics and global governance
is one of such injections. Financial, economic and trade globalization is
another. The voluminous literature on humanitarian interventions focuses
mostly on security and force. Economic humanitarianism is neglected in
favor of a "natural law" of market competition. The increased
propensity of states to intervene is, then, on the one hand illustrative of
a new world order where states put human-rights principles and norms above
the classical principles of sovereignty and non-interference in another
state's internal affairs. On the other hand, domestic human suffering from
globalized economic exploitation is off limits to state intervention within
its sovereign territory.
Russian President Vladimir Putin, who declared in 2004 that the collapse of
the USSR had been a "national tragedy on an enormous scale", in
trying to save Russia from the fate of failed statehood by reversing
wholesale privatization of state-owned enterprises and media, is being
accused by neo-liberals of trying to restore central state power as if that
were a terrible thing. His policy on Chechnya is a crucial element in the
US-led "global war on terrorism", while Russia's disastrous
human-rights record in the breakaway republic conflicts with US
standards.
While sovereignty is the organizing principle of the Westphalian world
order, the legitimacy of international actions today is governed by
Westphalian principles only if the state relinquishes it responsibility in
economic affairs. A clear case of this is the way the sole remaining
superpower treats oil-producing states. Nationalization of the oil industry
by any member state of the Organization of Petroleum Exporting Countries
(OPEC), if coupled with a state policy detrimental to the fundamental
oil-import needs of the sole superpower, or measures that upset the pricing
structure of oil, will run the risk of being invaded by the
superpower.
Seen from a development-theory perspective, the failed-states phenomenon is
based on a universal acceptance of the theory of teleological development
of societies toward specific developmental goals. This implies progression
from a simple toward a more complex form of society. To Western theorists,
this points in the direction of emulating the Western model. To non-Western
theorists, it points to development models with indigenous characteristics.
The role of the state is crucial in these processes. Failed states have
only attracted interest as part of a revisionist revaluation of
colonialism, imperialism and dependency as benign blessings, but not as
part of a critique of market capitalism, of the folly of universal
application of Western democratic processes and social values, and of the
destructive impact on community cohesion by a fixation on individual
freedom. Superpower intervention seldom acts to prevent failed statehood in
a weak state. Rather, it intervenes to stamp out resistance to
superpower-instigated failed statehood.
In a fundamental way, terrorism is the weapon of last resort for resisters
of foreign-instigated failed statehood. Historically, terrorism tends to
end when terrorists are granted due recognition of their legitimate
grievances and promises of equitable redress. The policy of refusal to
negotiate with terrorists is a propaganda slogan of little logic or usefulness.
Since 1990, concerns for failed and failing states have occupied center
stage in international politics because the Westphalian order of sovereign
states has been challenged at the geopolitical convenience of the sole
remaining superpower. States are put in a position of either not being
strong enough to deal with their own internal problems and thus risking
non-acceptance by other states as sovereign, or being labeled as failed
states for violation of human rights in their attempt to maintain internal
security.
The structure of the Westphalian international system
is based on states upholding one another as sovereign actors. Cross-border
intervention on human-rights or economic issues is in conflict with that
principle, particularly when the option of intervention belongs exclusively
to strong states that on the basis of military strength also claim the
privilege to define the standards of human rights and economic equity. The
sole reason the US has not been a victim of humanitarian intervention is
its military strength, not because it is free of human-rights violations.
Humanitarian or human-rights or economic intervention are frequently acts
of moral imperialism by strong states.
World-order principles have historically been crucial in setting the
parameters for how failed-state intervention has been rationalized and
conducted. With the end of the Cold War, different world-order principles
have gained prominence as competing political cultures for how state power
and national interests are to be translated into policy. World-order
principles are products of political cultures. They form the structure of
the international system, provide the content for state and national
interests and add ideological meaning to state power.
The structure of the international system both in its political and
socio-economic forms has historically set very different rules of the game
for how failed states are identified and dealt with. The Roman Empire was
seen as a model for later attempts to provide international governance. The
idea is that a hegemonic system with dominant power can serve best as
guarantor of world or regional order. The concept of the United Nations was
a community of sovereign states governed by a Security Council of major
powers.
In contrast to the strict notion of territoriality behind the Roman Empire,
the Middle Ages saw several competing non-territorial organizing
institutions: the Holy Roman Empire, the Church, and feudalism. In the
early Middle Ages, world order was contested even though the
non-territorial systems co-existed. There was no clear conception of
sovereignty, and lines of authority were mixed at best. Failed and failing
states made no real sense in such a system except in a religious sense as
defenders of the faith.
It is with the growth of territoriality that an international order of sovereign
states was constructed whereby states were empowered by recognition by
other states, rather than by the Church. The coming of age of the
nation-state in the 18th and 19th centuries gave enduring strength to the
Westphalian system, with state sovereignty at its core. This sovereignty
may be seen to have a constitutional and a functional dimension. On the one
hand, the state is the actor in international relations. It alone has the
political authority to deal with other states. On the other hand, the state
has sovereignty over all functions in society and defines the rules of the
domestic game. Thus states may vary in how they define their domestic
setups and how they claim their functional sovereignty. Tyranny, even as
repulsive as it has become in modern society, has not been a basis for
disqualification of state sovereignty.
On this foundation of state sovereignty was built the system of balance of
power as an ordering principle in international relations. Since states are
sovereign with reference to one another, they must build alliances in order
to guard themselves against the dominance of the powerful over the less
powerful. The balance-of-power logic reflects both a systemic logic and a
historical reality in the 19th century.
In this system, failed and failing states constituted a serious problem.
The system had a dual logic with regard to failed and failing states.
Outside of the European balance-of-power system, non-European states were
subjugated and made into colonies in order to maintain stability. To
prevent fighting over the colonies, the balance-of-power logic could be
applied as it was with the founding in 1871 of the German Empire.
The European system was a rational system that matured during the age of
reason when statesmen worked out the mechanics of power and balancing in
order to create a stable international order. Beyond Europe, the state
system was introduced in the colonies after the age of imperialism, and the
international system was in fact created and based on the rules and
functionalities of the European state system.
In East Asia, the world order until the advent of
European imperialism was one of tributary states to China as the central
kingdom whose international relations were based on generous gifts from the
central kingdom in return for meager tributes from lesser states. The Asian
world order of a prosperous and benevolent center showering gifts on the
less prosperous periphery was different from the European system of empire
of the center exploiting the periphery. This was due to both the relatively
advanced stage of Chinese civilization and the sheer size of the Chinese
economy, which did not need much from outside. The West had to use force to
open trade with China.
World order, then, is the network of economic and strategic pressures that
both holds a system together and constrains its members to act in
acceptable ways through commonly accepted rules and institutions. When
those rules and institutions are set by a hegemon or an empire,
failed-state status will be defined by those rules and institutions. When
the rules of balance of power are dominant, state failure is a different
phenomenon. Modern state failures are not associated with losses on the
battlefield, but with fractional fighting and a crisis of legitimacy that
feeds the fighting, or with the loss of sovereignty due to globalization.
State failure is inseparably connected with the problems of authority and
political legitimacy, as well of recognition of sovereignty. World-order
principles define the sovereign foundations for legitimacy and authority.
The type of world order is thus connected directly to why and how states
fail, and how actions to remedy state failure are perceived.
As a new century begins, the US advances the
notion of "failed states" in international affairs, which claims
a mandate for the sole remaining superpower to stage regime changes in any
nation deemed a failed state in the world order of nation states that has
existed since the Peace of Westphalia of 1648.
Edmund Burke (1729-1797), PC (His Majesty's Most Honourable Privy
Council), Anglo-Irish statesman, author, orator, political
theorist, and philosopher, philosophical founder of conservatism,
prophetically recognized the first partition of Poland in 1773 as the
beginning of the crumbling of the old international order. The principle of
the balance of power had historically been invoked to preserve the
independence of European states, to secure weak or small states against
universal monarchy. Poland was the first nation in the European system to
be partitioned out of existence without a war, a source of great
satisfaction to the participating powers: Russia, Austria and Prussia.
The event showed that in a world where great powers had risen, controlling
modern apparatus of state, it was dangerous for a sovereign state not to be
strong. A century later, Africa, lacking strong governments, was also partitioned
without war among the states of Europe. Furthermore, the partition of
Poland profoundly altered the balance of power in Europe. Emerging Western
European powers, such as France and England, began championing the cause of
Polish resistance and nationalism for anti-Germanic geopolitical purpose.
Resistance to the coercive internationalism of the Napoleonic empire gave
rise to modern European nationalism in protest against the Napoleonic idea
of a European continent united by uniform law and administration, with a
single economic system and foreign policy and a unified command of its
armed forces, the forerunner of the European Union. Since the international
system was essentially French, nationalist movements were generally
anti-French, except in territories outside French influence.
The nationalism of the Napoleonic epoch was a mélange of conservative and
liberal forces, with conservatives emphasizing the preservation of
traditional national culture, while liberals emphasized self-determination
and decentralization. Nationalism thus was highly complex and dependent on
a larger political context that was different in each country. Patriotism
in England during the Napoleonic Wars helped her through the social crisis
of the evolving Industrial Revolution, caused by dislocation, unemployment
and associated revolutionary agitation. With minor exceptions, Spanish
nationalism was counterreformation and counterrevolution, aiming to restore
the corrupt clergy and the dethroned Bourbons.
German nationalism rebelled not only against progressive Napoleonic rule,
but also against century-long ascendancy of French civilization. The age of
the French Revolution and Napoleonic triumph coincided with German cultural
efflorescence, with Beethoven, Goethe, Schiller, Herter, Kant, Fichte,
Hegel, etc, who embodied German romanticism against the rational dryness of
the French-dominated Age of Reason.
During the Peace of Westphalia, German nationalism was largely dormant
until the late 18th century. The German upper class was contemptuous of
anything German: their taste and mannerism and literature were French;
their music, art and architecture were Italian. Frederich the Great
(1740-86) hired French tax collectors and wrote in French.
Not until 1784, five years before the French
Revolution, did J G Herder write his Ideas on the Philosophy of the
History of Mankind in which he asserted that all true culture must
rise from native roots, the life of the common people "the volk",
not from the cosmopolitan mannerism of the upper classes. A sound
civilization must express the volksgeist, or national character.
Mozart’s first composition with a German libretto
was written in 1767, Die Schuldigkeit
des ersten Gebots, Part I (Eng:
The Obligation of the first and foremost Commandment) K35, a sacred
Singspiel by Librettist Ignaz von Weiser. Die Zauberflöte (Eng: The Magic Flute) K.620, was written in 1791,
a Singspiel in two acts with libretto in German by Emanuel Schikaneder.
The French, in comparison, had a less developed
tolerance for cultural relativity. The idea of volksgeist became a highly
significant idea through Europe and later around the world. It was the
fundamental appeal in romantic thought against rationalism. It celebrates
difference along with similarity in mankind, in contrary paths against the
Age of Enlightenment and its coercive universality. Hegel asserts that for
a people to enjoy freedom, order, and dignity, it must be in control of a
potent and independent state, the institutional embodiment of collective
reason and liberty.
In economics, Friedrich List, in his National System of Political
Economy (1841), asserts that political economy as espoused in England,
far from being a valid science universally, was merely British national
opinion, suited only to English historical conditions. List's institutional
school of economics asserts that the doctrine of free trade at the time was
devised to keep England rich and powerful at the expense of its trading
partners and it must be fought with protective tariffs and other
compensatory measures of economic nationalism by the weaker countries.
Henry Clay's "American system" was a national system of political
economy.
The failure of the Frankfort Assembly in the 1850s was more nationalist
than social. Its desire to retain non-Germans in the new Germany at a time
when nationalism was on the rise, forced it to depend fatally on the
military. After its failure, German liberal and revolutionaries emigrated
in large numbers to the US, known as "Forty-Eighters",
contributing to American socialist tradition.
From 1870 on, a nation-state system prevailed in modern world politics,
with the consolidation of large nation states. War between capitalist states
dominated the 20th century. Nationalist sentiments overran socialist
internationalism at the start of World War I. The anti-war Zimmerwald
program at the International Socialist Conference held in Zimmerwald
in September 1915 consisted of delegates from the Central Committee of the R.S.D.L.P.,
the Left Social-Democrats of Sweden, Norway, Switzerland and Germany, the
Polish Social-Democratic opposition and the Social-Democrats of the Latvian
area.
Led
by Lenin, the Zimmerwald Left group waged a struggle against the Centrist majority of the Conference and
moved resolutions condemning the First World War, exposing the betrayal by
the social-chauvinists,
and urging the necessity of active struggle against the war. These draft
resolutions were rejected by the Centrist majority.
The
Zimmerwald Left succeeded, however, in getting a number of important points
from its own draft resolution included in the manifesto adopted by the
Conference. Regarding this manifesto as a first step in the fight against
the war, the Zimmerwald Left voted for it.
The
Zimmerwald left issued a special statement detailing the inadequacy and
inconsistency of the manifesto and their reasons for voting for it. They
declared that while remaining within the Zimmerwald organisation they would
disseminate their views and work independently on an international scale.
The group elected an executive body
– Lenin, Zinoviev and Radek. The Zimmerwald Left
published a journal Vorbote (Herald) in German, which carried a number of articles
by Lenin.
The Bolsheviks were
the guiding force in the Zimmerwald Left. The Zimmerwald Left soon became
the rallying point for internationalist elements of world Social-Democracy.
The Social-Democrats of various countries who belonged to the Ziminerwald Left
group carried on active revolutionary work and played an important role in
the establishment of Communist parties in their countries.
Its aim was revolution in the belligerent
countries caused by the continuation of war, while the rest aimed for
peace. It was the first step towards forming what later became
the Comintern. The Stalinist split with Trotskyism centered on the
conflict between socialism in one country and international revolution.
The Asian financial crises of 1997 revived latent economic nationalism around
the world against US-led neo-liberal globalization, while the North
Atlantic Treaty Organization attack on Yugoslavia revived military
nationalism. Market fundamentalism as espoused in the US, far from being a
valid science universally, is increasingly viewed as merely US national
opinion, suited only to US historical conditions. Just as anti-Napoleonic
internationalism was essentially anti-French, anti-globalization and
anti-humanitarian intervention are essentially anti-US. US unilateralism
and exceptionism have become the midwife for a new revival of political and
economic nationalism. The Bush Doctrine of nuclear posture pours gasoline
on the smoldering fire of nationalism everywhere.
The notion of failed states advanced by US neo-liberals is not accompanied
by any notion of failed markets, despite signs of market failure
everywhere. Yet a real failed state is one that tolerates, nay, promotes
failed markets.
When the market does not provide efficient outcomes for society, economists
say that the market has "failed". Economists have identified
different types of market failures.
Monopolies are the market failure of competition. Microsoft has been
convicted of monopolistic practices, although the final legal decision is
still pending. AT&T was a monopoly that the US Supreme Court broke up
in 1983 after a 10-year legal battle. The US Congress passed the Sherman
Antitrust Act in 1890. It declared illegal every contract, combination (be
it a trust, monopoly or otherwise), or conspiracy that restrained
interstate and foreign trade. The Supreme Court refused to uphold its
constitutionality.
US president Theodore Roosevelt's "trust-busting" campaigns and a
change in the opinion of the court achieved some results. In 1914, Congress
passed the Clayton Act and established the Federal Trade Commission,
expanding and tightening antitrust laws by explicitly forbidding actions
taken to force competitors out of business by slashing prices, buying up
and hoarding supplies, bribery or intimidation.
When a firm such as Microsoft has market power, it tends to restrict
production in order to drive up prices and increase profit margins. This
results in too few goods and innovation being produced in non-competitive
markets. The recent rejection of the GE/Honeywell merger by the EU was
primarily based on GE's financial market power in vendor financing. The
world is awash with overcapacity in manufacturing and telecommunication
because finance capitalism promotes monopolies in finance that thrive on
ruinous over-investment in manufacturing and telecommunication. It also
means that income is concentrated in the hands of those who have market
power at the expense of those who do not. Under financial capitalism,
dollar hegemony is a fundamental monopoly that permeates all sectors of the
global economy.
Another market failure economists have identified is the underprovision of
public goods. Examples of public goods range from national defense to
street lights. Public goods will either be underprovided or not provided at
all by the market. Because the benefits from a public good enjoyed by any
individual are almost always less than the cost of producing the public
good, the market does not provide them. The market has tended to under
supply insurance for particular kinds of activities or risk (especially
health insurance).
The post-September 11 insurance crisis surrounding the US airlines and the
property casualty sector is another example. AIG, Citigroup and GE are
selling their property casualty units. The US market, on its own, also
fails to supply adequate loans for education and small-business ventures,
as well as urban development for black neighborhoods. In each of these
cases, government programs to complete or supplement the naturally
incomplete markets are the only solution. Medicaid and Medicare are
government financed "insurance" programs for the poor and the
elderly.
The Department of Education and state and local student loan agencies find
it necessary to underwrite or guarantee loans to students attending
accredited colleges and universities. And the Small Business Administration
helps individuals secure the funding they need to start their own
businesses. Globalization based on the rules of market fundamentalism in
the past decade has grossly underprovided public goods. The mostly obvious
examples are environmental protection and poverty elimination.
When someone other than the recipient of a benefit bears the costs for its
production, the costs of the benefit are external to its enjoyment.
Economists call these external costs negative "externalities".
These amount to a market failure to distribute costs and benefits
efficiently. Globalization is basically a game of negative externalities,
as evidenced by the infamous Summer World Bank memo on the immaculate logic
of locating pollution in the poorest countries. Inhuman wages and working
conditions, together with unfunded environmental protection and cleanup,
are other negative externalities that benefit the US inflation rate.
Another market failure stems from the market's inadequate provision of
information. The effect of asymmetrical information on the proper
functioning of the market has been well recognized, having been cited as
the basis for selecting last year's Nobel Prize on Economics. But the real
information market failure is Western domination of the world media. Thirty
years after developing countries first called for a new world information
order, Western media are still being faulted for distorting and ignoring
much of the world around them. Even as Western media bolster their
domination of global news, Western news content seems less and less
informative, particularly about issues not central to Western concerns.
Another form of information monopoly is structurally built into TRIPS
(Agreement on Trade-Related Aspects of Intellectual Property Rights), which
is Annex 1C of the Marrakesh Agreement Establishing the World Trade
Organization, signed in Marrakesh, Morocco, on April 15, 1994. Under TRIPS,
the less developed nations will be condemned to intellectual feudal serfdom
perpetually.
Incomplete markets are another form of failure. There are some goods and
services that may not be "pure" public goods, which are
nonetheless undersupplied by the market. There are numerous goods and
services that have the potential to improve the economic fortunes of
individuals and of society that are not widely available. In such
circumstances, the need or demand for a particular good or service is
higher than the available supply of that good or service, hence there is an
incomplete market.
In many circumstances the amount of coordination required to complete a
market is so extensive that government intervention is required. In the
case of the Internet, governmental support is largely responsible for the
creation of a massive multibillion-dollar complementary market. While the
world is faced with food overproduction, famines continue to be regular
occurrences.
All governments coordinate, if not regulate, businesses and the markets in
which they operate. For years, Japan's Ministry International Trade and
Industry (MITI) has been held up as a shining example of successful
governmental coordination of a nation's economy through an industrial
policy. Economic setbacks in Japan during the last decade have been blamed
by Western analysts on the inability of MITI to outguess and outperform the
natural forces of the market. A case can be built that MITI's error was not
industrial policy per se, but its failure to understand the destructive
power of dollar hegemony under finance capitalism. It is not enough to
plan. Planning needs to be intelligent. Japan's failure was that it played
the game of industrial capitalism while the US moved to finance capitalism.
The "Business Cycle" is a structural and recurring market failure
of market capitalism. Unemployment as a devise to combat inflation is a
policy market failure.
In a market system, there is a structural tendency for income to be
distributed unevenly. Even in the US, the consummate beneficiary of
globalized markets, 26.3 percent of all children in the US live in families
that are below the official poverty level, according to the United Nations
Children's Fund (UNICEF). On the global level, 30 percent of the population
lives on less than US$1 a day, mostly women and children. No amount of
sophist argument can deny such obvious market failure.
Failed markets threaten the future of the world much more than failed
states. To preserve world peace, the real regime change needs to be on
failed markets.
Merely two years before the end of the first
decade of the 21st century, the post-Cold-War world economic order found
itself facing its most serious crisis under the weight of unsustainable
deregulated debt capitalism created by dollar hegemony. There are clear
signs that out of this current crisis a new world economic order will
emerge. China is in a promising position to influence this development
toward a sustainable, balanced and cooperative world order of global
fairness and universal justice.
The root cause of the current crisis can be traced
to the dismantlement of the Bretton Woods international finance
architecture by the US in 1971 when president Richard Nixon suspended the
dollar's link to gold, and the subsequent deregulation of globalized
financial markets that has allowed free cross-border movement of funds.
Toward the end of the World War II, the United
States, through its dominance in the Bretton Woods Conference of 1944,
constructed a post-war international finance architecture based on a
gold-back dollar as a reserve currency to revive world trade. The Bretton
Woods monetary regime allowed the US, which at that time was in possession
of most of the world's gold, to take over the role of financial and
economic hegemon in a new age of neo-imperialism under finance capitalism
previously played by Britain in the age of imperialism under industrial
capitalism.
Economics thinking prevalent immediately after
World War II, drawing lessons from the 1930s' Great Depression, had deemed
international capital flow undesirable and unnecessary for national
economic development. Trade, a relatively small aspect of most national
economies at the time, was to be mediated through fixed exchange rates
pegged to a gold-backed dollar. These fixed exchange rates were to be
adjusted only gradually and periodically to reflect the relative strength
of the economies participating in international trade, which was expected
to augment, but not overwhelm, the national economies.
The impact of exchange rates was limited to the
settlement of international trade. Exchange rate considerations were not
expected to dictate domestic monetary and fiscal policies, the chief
function of which was to support domestic development and regarded as the inviolable
province of national sovereignty.
During the Cold War, there was no global trade.
The economies of the two contending ideology blocks were completely
disconnected and did not trade outside of their own blocks. Within each
block, allied economies interacted through foreign aid from and memorandum
trade with their respective superpowers. The competition was not for profit
but for the hearts and minds of the people in the two opposing blocks, as
well as those in the non-aligned nations in the Third World. The
competition between the two superpowers was to give rather than to take
from their separate fraternal economies.
Convergence to equality the aim
The population of the superpowers worked hard to
help the poor within their separate blocks. Convergence toward equality was
the policy aim even if not always the practice. The Cold War era of foreign
aid and memorandum trade had a better record of poverty reduction within
either of the two camps than post-Cold War, globalized, neo-liberal trade
dominated by one single superpower. The aim was not only to raise income and
increase wealth, but also to reduce income and wealth disparity between and
within economies.
In the world economic order that emerged after the
Cold War, income and wealth disparity has been rationalized as a necessity
for capital formation even in the rich economies. From 1980 to 2007, the
total after-tax income earned by the top 0.1% of earners in the US more
than quadrupled, while the share earned by everyone else in the top 10%
rose far less and the share of the bottom 90% actually declined in
purchasing power.
In China, privatization of state-owned-enterprises
since 1978 has pushed a large segment of the working population outside of
the socialist sphere of free social benefits in healthcare, education and
retirement entitlements. Unemployment is now a serious structural problem
everywhere, including in the Chinese socialist market economy.
Excessive reliance on export financed by foreign
capital has also left developmental imbalances between China's exporting
coastal regions and the isolated interior. Despite recurring big trade
surpluses denominated in dollars, China has been prevented by dollar
hegemony from using sovereign credit to finance domestic development. China
is now the world's biggest creditor nation, yet the Chinese economy
continues to require foreign capital that demands rates of return higher
than such capital could get in their home economies.
Ironically, much of this "foreign"
capital comes from the US which is deeply indebted to China. The US is
investing in China with money it borrows from China. The US is able to do
this because the debt and capital are both denominated in dollars that the
US can print at will.
Today's post-industrial financial market economies
are all plagued by overcapacity created by insufficient consumer purchasing
power. The Chinese market economy is a glaring example of this structural
contradiction which arises from the need of companies to keep down wages to
maximize corporate profit. Workers everywhere are not able to afford all
the products they produce, thus causing overcapacity that has to be
absorbed by export.
American entrepreneur Henry Ford (1867-1943)
understood this structural contradiction in industrial market economies and
identified rising wages as a solution to overcapacity caused by rising
labor productivity. But foreign capital denominated in foreign currency
(dollars) rejects the need for high local wages because it earns its dollar
profits from export to foreign markets. This is the main reason why
emerging economies must avoid excess dependence on export for dollars
financed by foreign capital in dollars.
China needs to accelerate its domestic development
with sovereign credit denominated in Chinese currency to proportionally
reduce its excessive dependence on export for dollars financed by foreign
capital in dollars. China needs to denominate its export trade in Chinese
currency to break free from dollar hegemony. This is the key strategy for
positively influencing a new world economic order of universal justice to
replace current predatory terms of international trade under dollar
hegemony.
Since the Cold War, which officially ended with
the dissolution of the USSR in 1991, world economic growth has been
distorted by a shift from aggregate domestic development with sovereign
credit within sovereign nations to excessive reliance on globalized
neo-liberal trade engineered and led by the US as the sole remaining
superpower. International trade has since been denominated in the US
dollar, a fiat currency after 1971, as the main reserve currency.
International trade has been driven by the huge US consumer market made
possible by the high wages of US workers backed, not by rising
productivity, but by US dollars that the US, and only the US, can print at
will through its central bank.
In China, rising worker productivity has not
resulted in higher wages, but only in lower export prices. This is the main
reason why the Chinese domestic market lags behind in consumer demand
despite enormous rise in Chinese worker productivity. Many Western critics
erroneously pressure China to revalue its currency to address the
persistently large trade imbalance. The only effective measure to deal with
this trade imbalance is for China to raise wages rather than to revalue the
exchange rate of its currency.
For the two decades before the global financial
crisis that first broke out in mid 2007, economic growth in the
dysfunctional world economic order has been, and still is, based primarily
on free cross-border flow of capital and speculative funds driven by
cross-border wage and regulatory arbitrage. This growth has been sustained
by knocking down national tariffs worldwide through the authority of
supranational institutions such as the World Trade Organization, and
financed by a deregulated foreign exchange market working in concert with a
global central banking regime independent of national political pressure,
lorded over by the supranational Bank of International Settlement and the
International Monetary Fund.
Domestic development overwhelmed by World Trade
Ever since the end of the Cold War in 1991, which
actually began winding down in the early 1970s with US policy of detente,
trade has increasingly overwhelmed domestic development in the global
economy, as superpower competition to win the hearts and minds of the world
in the form of aid subsided. Persistent fiscal and trade deficits forced
the US to suspend in 1971 the peg of the dollar to gold at $35 per ounce,
in effect abandoning the Bretton Woods regime of fixed exchange rates
linked to a gold-back dollar. The flawed international finance architecture
that resulted has since limited the global growth engine to operating with
only the one cylinder of international trade, leaving all other cylinders
of domestic development in a state of permanent stagnation.
The venue of sovereign credit for national
development has been foreclosed permanently. China needs to free itself
from dollar hegemony to use sovereign credit to develop her domestic
economy.
Since 1978, China has exposed itself to the
disadvantages of export trade denominated in dollars. Much of the wealth
created in China during the last 30 years has ended up in the US, leaving
China in an extended state of capital shortage despite being the largest
holder of foreign reserves in the world. When it comes to consumer power
and environmental pollution, China is only the kitchen; the dining room is
in the US. In a new world economic order, China should move the dining room
back inside China.
The global economy is a comprehensive and complex
system of which trade is only one sector. Yet economists and policy-makers
promoting neo-liberal globalization tend to view trade as the entire global
economy itself, downplaying the importance of non-trade-related domestic
development. Neo-liberals promote market fundamentalism as the sole,
indispensable path for national economic growth, despite ample evidence in
the past three decades that trade globalization tends to distort balanced
domestic development in ways that hurt not only the less developed, but
also the developed economies.
This is why a new world economic order must
restore domestic development, with sovereign credit as the driving force,
and reduce world trade as an auxiliary force in which export should be
denominated in the exporting country's currency.
The distributional consequences of predatory terms
of global trade liberalization under dollar hegemony work against the
developing economies in the world. Such predatory terms of trade also work
against the poor and the financially weak in all economies, including the
advance economies, putting the less-educated and the less-skilled in a
downward spiral of chronic unemployment and persistent hopelessness.
Reductions in tariffs reduce tax revenues for
public spending that can help poor people and weaken needed protection for
endangered domestic industries. While distributional consequences of trade
liberalization are complex and country-specific, the general trend has been
to exacerbate income disparity everywhere, which in turn leads to economic
underperformance and political instability in all countries.
In the United States, the Mecca of free-market
entrepreneurship, spending by the statist sectors - government operations,
public finance, defense, health care, social security and public education
- have kept the economy afloat in recurring protracted recessions, while
entrepreneurial ventures in corporate finance, insurance, high-tech
manufacturing, airlines and communication languish in extended doldrums
needing government bailouts.
Unregulated markets lead naturally to monopolistic
consolidation and abuses in corporate governance and finance through the
concentration of market power. It has become clear and undeniable that
"free" markets are inherently self-destructive of their own freedom.
Free markets depend on enlightened government regulations to remain free
and to prevent them from turning into failed markets.
Government, from monarchy to democracy, within
capitalist market economies or socialist economies, exists to protect the
weak from the strong and to maintain socio-political stability with a just
socio-economic order. A new world economic order will have to be based on
this principle of universal justice between and within sovereign nations.
For China to exert influence on the formation of this new world economic
order, it must construct its domestic economic order on the same principle
of equality and fairness.
World trade is now a game in which the US produces
fiat dollars of uncertain exchange value and zero intrinsic value, and the
rest of the world produces goods and services that fiat dollars can buy.
The world's interlinked economies no longer trade to capture Ricardian
comparative advantage; they compete in exports to capture needed dollars to
service dollar-denominated foreign capital and debts and to accumulate
dollar reserves to stabilize the value of their currencies in world
currency markets.
To prevent speculative and manipulative attacks on
their currencies, central banks of all trading governments must acquire and
hold dollar reserves in amounts that can withstand market pressure on their
currencies in circulation. The higher the market pressure to devalue a
particular currency, the more dollar reserves its central bank must hold.
Only the Federal Reserve is exempt from this pressure, because the US
Treasury can print dollars at will with relative immunity. This creates a
built-in support for a strong dollar that in turn forces the world's
central banks to acquire and hold more dollar reserves, making the dollar
even stronger.
Dollar hegemony
This phenomenon is known as dollar hegemony, which
is created by a geopolitically constructed peculiarity through which critical
commodities, among the most notable being oil, are denominated in dollars.
Everyone accepts dollars because dollars can buy oil. The recycling of
petro-dollars into other dollar assets is the price the US has extracted
from oil-producing countries for US tolerance for the oil-exporting cartel
since 1973. The trade value of a currency is no longer tied to the
productivity of its issuing economy, but to the size of dollar reserves
held by its central bank.
By definition, dollar reserves must be invested in
dollar assets, creating an automatic capital-accounts surplus for the
dollar economy. Even though the US has been a net debtor since 1986, its
net income on the international investment position has remained positive,
as the rate of return on US investments abroad continues to exceed that on
foreign investments in the US.
This reflects the overall strength of the US
economy, and that strength is derived from the US being the only nation
that can enjoy the benefits of sovereign credit utilization while amassing
external debt denominated in dollars, largely due to dollar hegemony.
Unlike other economies, the US economy incurs no foreign debt, only
domestic debt denominated in dollars held by foreigners. These debts can
always be repaid by the Federal Reserve, the US central bank, printing more
dollars.
Since such a move will devalue the exchange rate
of the dollar, foreign holders of the US dollar sovereign or private debt
are prevented from demanding payment. Further, when basic commodities are
denominated in dollars, the US essentially owns all such commodities.
Foreign owners of dollar assets are merely unwitting temporary agents of
the US dollar hegemony.
Under the Westphalian world order of sovereign
nation states, which has framed international relations since 1648, only
coordinated economic nationalism that focuses on domestic development can
pull the world economy out of its current downward spiral.
Economic nationalism should not be confused with
trade protectionism. Decades of predatory cross-border neo-liberal finance
and trade have generated strong anti-globalization sentiments in every
country around the world. It has become a class struggle between the
financial elite and the working poor in rich and poor countries alike.
Before the end of the first decade of the 21st century,
in a world where market fundamentalism has become the operative norm,
misguided trade protectionism appears to be fast re-emerging and developing
into a new global trade war with complex dimensions. The irony is that this
new trade war is being launched not by the abused poor economies that have
been receiving the short end of the trade stick, but by the US, as leader
of rich nations which have been winning more than they have been losing in
the current economic order and trade system.
Much of this protectionism is designed to protect
industries that the rich nations have voluntarily moved offshore for
financial and environmental advantage. Such protectionism aims to protect
non-existent economic activities by imposing tariffs on goods that the
importing nations chose not to produce.
The biggest battles of this new trade war are
being fought on the currency exchange rate front under dollar hegemony, a
global monetary regime in which export nation ship real wealth produced
with low wages and high environmental abuse in exchange for fiat paper
money of uncertain exchange value and zero intrinsic worth.
Rich nations need to recognize that their efforts
to squeeze every last drop of advantage at all levels from already unfair
finance and trade will only plunge the world into deeper depression.
History has shown that while the poor suffer more in economic collapse, the
rich, even as they are financially cushioned by their ill-gained wealth and
structural advantage, are hurt by the sociopolitical repercussions of such
a collapse, in the form of war, revolution or both.
The structural problem of the Chinese economy can
be described in one sentence: China produces from plants on its soil
financed by foreign investment that operate with low domestic wages for
foreign markets that pay with dollars that cannot be used in the Chinese
domestic economy.
Domestic Market is the Key
The solution to this structural problem can also
be summed up in one sentence: China must finance Chinese plants with
sovereign credit to produce for the domestic market where consumer
purchasing power will come from high wages, with sovereign credit repaid by
increased tax revenue from a vibrant domestic economy.
The adverse impact from the current global
financial crisis on the Chinese economy originates from the bloated export
sector financed in large part by foreign capital denominated in dollars.
Foreign markets have abruptly contracted since mid-2007 to cause massive
closure of tens of thousands of foreign joint-ventures or wholly owned
enterprises, big, medium and small, in the Chinese export sector located
along the coastal regions that has caused serious unemployment.
Economic recovery through the shifting from export
dependency to domestic development requires coordinated actions by both the
state and the private sectors. The government's role is to guide
state-owned enterprises and private-sector incentives toward a national
full employment program through tax incentives and regulatory regimes.
Government fiscal spending should be limited to
funding infrastructure, both physical and social, that cannot be
efficiently financed by private or even collective capital. Consumer demand
should be enhanced as a priority in a national income policy to quickly
raise wage levels in parallel with a well-funded social security program to
eliminate the need for compulsory over-saving out of concern for emergency
health expenses and provision for old-age security.
In conclusion, China can exert a positive
influence on a new world economic order by setting an example with its own
national development policy. To achieve this goal, China needs to adopt the
following policy initiatives:
1. China must recognize that a deregulated market
economy is counterproductive to national development. The clear evidence of
this is what deregulated markets have done to the US economy, destroying US
superpower status within three decades. China must revitalize central
planning to guide national development and to use the market mechanism only
to augment central planning targets. National destiny and national interest
cannot be subjected to the dictation of market profit incentives.
2. China must place full employment with rising
wages as a national economic priority and shift from the current market
fundamentalist, macro-management on growth in gross domestic product, with
unemployment as a natural outcome of a monetary policy of price stability.
Economic equality and justice must be the guiding developmental principle
within the context of merit-based compensation.
3. China must break free from dollar hegemony to
use sovereign credit to finance balanced domestic development and to reduce
excessive dependence on export for dollars and reliance on foreign capital
denominated in dollars. A first step in this direction is to require all
Chinese exports be settled in yuan, not in dollars.
4. China should conduct its foreign trade on the
principle of mutual development for both trading partners rather than as a
financial profit center for Chinese capital. China must reject the
predatory terms of international trade developed during the age of
imperialism. Unlike 19th century England and Japan, the huge size of the
Chinese economy and its domestic market does not require imperialist terms
of trade to survive. The US model failed because it aped the British model
of empire after World War II. China must avoid making the same error.
5. China must guard against the fallacy of hoping
to use green-tech investment as a stimulus to recover from the current
global financial crisis. The global environment needs protection. But the
time-scale concerning the needs of the environment is not congruent with
that of the current global financial crisis. The environmental protection
problem cannot be solved without first solving the global financial crisis.
Attempting to use green-tech investment to jump-start the current economic
crisis is putting the cart before the horse. Such an approach will only end
up falling short on both environmental and economic aims.
Dollar Hegemony Against Sovereign Credit
This article appeared in AToL on June
24, 2005
Global trade has forced all countries to adopt market
economy. Yet the market is not the economy. It is only one
aspect of the economy. A market economy can be viewed as an aberration of
human civilization, as economist Karl Polanyi (1886-1964) pointed out. The
principal theme of Polanyi’s Origins of Our Time: The Great
Transformation(1945) was that market economy was of very recent origin
and had emerged fully formed only as recently as the 19th century, in
conjunction with capitalistic industrialization. The current globalization
of markets following the fall of the Soviet bloc is also of recent
post-Cold War origin, in conjunction with the advent of the electronic
information age and deregulated finance capitalism. A severe and prolonged
depression can trigger the end of the market economy, when intelligent
human beings are finally faced with the realization that the business cycle
inherent in the market economy cannot be regulated sufficiently to prevent
its innate destructiveness to human welfare and are forced to seek new
economic arrangements for human development. The principle of
diminishing returns will lead people to reject the market economy, however
sophisticatedly regulated.
Prior to the coming of capitalistic industrialization, the market played
only a minor part in the economic life of societies. Even where market
places could be seen to be operating, they were peripheral to the main
economic organization and activities of society. In many pre-industrial economies,
markets met only twice a month. Polanyi argued that in modern market
economies, the needs of the market determined social behavior, whereas in
pre-industrial and primitive economies the needs of society determined
market behavior. Polanyi reintroduced to economics the concepts of
reciprocity and redistribution in human interaction, which were the
original aims of trade.
Reciprocity implies that people produce the goods and services they are
best at and enjoy most in producing, and share them with others with joy.
This is reciprocated by others who are good at and enjoy producing other
goods and services. There is an unspoken agreement that all would produce
that which they could do best and mutually share and share alike, not just
sold to the highest bidder, or worse to produce what they despise to meet
the demands of the market. The idea of sweatshops is totally unnatural to
human dignity and uneconomic to human welfare. With reciprocity, there is
no need for layers of management, because workers happily practice their
livelihoods and need no coercive supervision. Labor is not forced and
workers do not merely sell their time in jobs they hate, unrelated to their
inner callings. Prices are not fixed but vary according to what different
buyers with different circumstances can afford or what the seller needs in
return from different buyers. The law of one price is inhumane, unnatural,
inflexible and unfair. All workers find their separate personal fulfillment
in different productive livelihoods of their choosing, without distortion
by the need for money. The motivation to produce and share is not personal
profit, but personal fulfillment, and avoidance of public contempt,
communal ostracism, and loss of social prestige and moral standing.
This motivation, albeit distorted today by the dominance of money, is still
fundamental in societies operating under finance capitalism. But
in a money society, the emphasis is on accumulating the most financial
wealth, which is accorded the highest social prestige.
The annual report on the world's richest 100 as
celebrities by Forbes is a clear evidence of this anomaly. The opinion of
figures such as Bill Gates and Warren Buffet are regularly sought by the
media on matters beyond finance, as if the possession of money itself
represents a diploma of wisdom. In the 1960s, wealth was an
embarrassment among the flower children in the US. It was only in the 1980s
that the age of greed emerged to embrace commercialism.
In a speech on June 3 at the Take Back America
conference in Washington, D.C, Bill Moyers drew attention to the conclusion
by the editors of The Economist, all friends of business and
advocates of capitalism and free markets, that “the United States risks
calcifying into a European-style class-based society.” A
front-page leader in the May 13, 2005 Wall Street Journal concluded that
“as the gap between rich and poor has widened since 1970, the odds that a
child born in poverty will climb to wealth - or that a rich child will fall
into middle class - remain stuck....Despite the widespread belief that the
U.S. remains a more mobile society than Europe, economists and sociologists
say that in recent decades the typical child starting out in poverty in
continental Europe (or in Canada) has had a better chance at
prosperity.”
The New York Times ran a 12-day series in June 2005 under the heading
of “Class Matters” which observed that class
is closely tied to money in the US and that “the movement of families up
and down the economic ladder is the promise that lies at the heart of the
American dream. But it does not seem to be happening quite as often as it used
to.” The myth that free markets spread equality seems to be
facing challenge in the heart of market fundamentalism.
People trade to compensate for deficiencies in their current state of
development. Free trade is not a license for exploitation. Exploitation is
slavery, not trade. Imperialism is exploitation by systemic coercion on an
international level. Neo-imperialism after the end of the Cold War takes
the form of neo-liberal globalization of systemic coercion. Free
trade is hampered by systemic coercion. Resistance to systemic coercion is
not to be confused with protectionism.
To participate in free trade, a trader must have
something with which to trade voluntarily in a market free of systemic
coercion. All free trade participants need to have basic pricing power
which requires that no one else commands monopolistic pricing power. That
tradable something comes from development, which is a process of
self-betterment. Just as equality before the law is a prerequisite for
justice, equality in pricing power in the market is a prerequisite for free
trade. Traders need basic pricing power for trade to be
free. Workers need pricing power for the value of their labor to
participate in free trade.
Yet trade in a market economy by definition is a game to acquire overwhelming
pricing power over one’s trading partners. Wal-Mart for example has
enormous pricing power both as a bulk buyer and a mass
retailer. But it uses its overwhelming pricing power not to pay
the highest wages to workers in factories and in its store, but to deliver
the lowest price to its customers. The business model of Wal-Mart, whose
sales volume is greater than the GDP and trade volume of many small
countries, is anti-development. The trade off between low income
and low retail price follows a downward spiral. This downward spiral has
been the main defect of trade de-regulation when low prices are achieved
through the lowering of wages. The economic purpose of development is to
raise income, not merely to lower wages to reduce expenses by lowering
quality. International trade cannot be a substitute for domestic
development, or even international development, although it can contribute
to both domestic and international development if it is conducted on an
equal basis for the mutual benefit of both trading partners. And the chief
benefit is higher income.
The terms of international trade needs to take into consideration local
conditions not as a reluctant tolerance but with respect for diversity.
Former Japanese Vice Finance Minister for International
Affairs, Eisuke Sakakibara, in a speech“The End of Market
Fundamentalism” before the Foreign Correspondent's Club, Tokyo,
Jan. 22, 1999, presented a coherent and wide ranging critique of
global macro orthodoxy. His view, that each national economic system must
conform to agreed international trade rules and regulations but needs not
assimilate the domestic rules and regulations of another country, is heresy
to US-led one-size-fits-all globalization. In a computerized world
where output standardization has become unnecessary, where the mass
production of customized one-of-a-kind products is routine, one-size-fit
all hegemony is nothing more than cultural imperialism. In a world of
sovereign states, domestic development must take precedence over international
trade, which is a system of external transactions made supposedly to
augment domestic development. And domestic development means every nation
is free to choose its own development path most appropriate to its
historical conditions and is not required to adopt the US development
model. But neo-liberal international trade since the end of the Cold War
has increasingly preempted domestic development in both the center and the
periphery of the world system. Quality of life is regularly
compromised in the name of efficiency.
This is the reason the French and the Dutch voted against the EU
constitution, as a resistance to the US model of globalization. Britain has
suspended its own vote on the constitution to avoid a likely voter
rejection. In Italy, cabinet ministers suggested abandoning the
euro to return to an independent currency in order to regain monetary
sovereignty. Bitter battles have erupted between member nations in the EU
over national government budgets and subsidies. In that sense, neo-liberal
trade is being increasingly identified as an obstacle, even a threat, to
diversified domestic development and national culture. Global
trade has become a vehicle for exploitation of the weak to strengthen the
strong both domestically and internationally. Culturally, US-style
globalization is turning the world into a dull market for unhealthy
MacDonald fast food, dreary Walt-Mart stores, and automated Coca Cola and
ATM machines. Every airport around the world is a replica of a giant US
department store with familiar brand names, making it hard to know which
city one is in. Aside from being unjust and culturally destructive,
neo-liberal global trade as it currently exists is unsustainable, because
the perpetual transfer of wealth from the poor to the rich is unsustainable
anymore than drawing from a dry well is sustainable in a drought, nor can a
stagnant consumer income sustain a consumer economy. Neo-liberal claims of
fair benefits of free trade to the poor of the world, both in the center
and the periphery, are simply not supported by facts. Everywhere, people
who produce the goods cannot afford to buy the same goods for themselves
and the profit is siphoned off to invisible investors continents away.
Trade and Money
Trade is facilitated by money. Mainstream monetary economists view
government-issued money as a sovereign debt instrument with zero maturity,
historically derived from the bill of exchange in free banking. This view
is valid only for specie money, which is a debt certificate that entitles
the holder to claim on demand a prescribed amount of gold or other specie
of value. Government-issued fiat money, on the other hand, is not a
sovereign debt but a sovereign credit instrument, backed by government
acceptance of it for payment of taxes. This view of money is known as the
State Theory of Money, or Chartalism. The dollar, a fiat currency, entitles
the holder to exchange for another dollar at any Federal Reserve Bank, no
more, no less. Sovereign government bonds are sovereign debts denominated
in money. Sovereign bonds denominated in fiat money need never default
since sovereign government can print fiat money at will. Local government
bonds are not sovereign debt and are subject to default because local
governments do not have the authority to print money. When fiat money buys
bonds, the transaction represents credit canceling debt. The relationship
is rather straightforward, but of fundamental importance.
Credit drives the economy, not debt. Debt is the mirror
reflection of credit. Even the most accurate mirror does violence to the
symmetry of its reflection. Why does a mirror turn an image right to left
and not upside down as the lens of a camera does? The scientific answer is
that a mirror image transforms front to back rather than left to right as
commonly assumed. Yet we often accept this aberrant mirror distortion as
uncolored truth and we unthinkingly consider the distorted reflection in
the mirror as a perfect representation. Mirror, mirror on the wall, who is
the fairest of them all? The answer is: your backside.
In the language of monetary economics, credit and debt are opposites but
not identical. In fact, credit and debt operate in reverse
relations. Credit requires a positive net worth and debt does not. One can
have good credit and no debt. High debt lowers credit rating. When one
understands credit, one understands the main force behind the modern
finance economy, which is driven by credit and stalled by
debt. Behaviorally, debt distorts marginal utility calculations
and rearranges disposable income. Debt turns corporate shares into Giffen
goods, demand for which increases when their prices go up, and creates what
Federal Reserve Board Chairman Alan Greenspan calls "irrational
exuberance", the economic man gone mad.
If fiat money is not sovereign debt, then the
entire financial architecture of fiat money capitalism is subject to
reordering, just as physics was subject to reordering when man’s world view
changed with the realization that the earth is not stationary nor is it the
center of the universe. For one thing, the need for capital formation to
finance socially useful development will be exposed as a cruel hoax. With
sovereign credit, there is no need for capital formation for socially
useful development in a sovereign nation. For another, savings are not
necessary to finance domestic development, since savings are not required
for the supply of sovereign credit. And since capital formation through
savings is the key systemic rationale for income inequality, the proper use
of sovereign credit will lead to economic democracy.
Sovereign Credit and Unemployment
In an economy financed by sovereign credit, labor
should be in perpetual shortage, and the price of labor should constantly
rise. A vibrant economy is one in which there is a persistent labor shortage
and labor enjoys basic, though not monopolistic, pricing power. An economy
should expand until a labor shortage emerges and keep expanding through
productivity rise to maintain a slight labor shortage. Unemployment is an
indisputable sign that the economy is underperforming and should be avoid
as an economic plague.
The Phillips curve, formulated in 1958, describes
the systemic relationship between unemployment and wage-pushed inflation in
the business cycle. It represented a milestone in the development of
macroeconomics. British economist A. W. H. Phillips observed that
there was a consistent inverse relationship between the rate of wage
inflation and the rate of unemployment in the United Kingdom from 1861 to
1957. Whenever unemployment was low, inflation tended to be
high. Whenever unemployment was high, inflation tended to be low. What
Phillips did was to accept a defective labor market in a typical business
cycle as natural law and to use the tautological data of the flawed regime
to prove its validity, and made unemployment respectable in macroeconomic
policymaking, in order to obscure the irrationality of the business cycle.
That is like observing that the sick are found in
hospitals and concluding that hospitals cause sickness and that a reduction
in the number of hospitals will reduce the number of the sick. This theory
will be validated by data if only hospital patients are counted as being
sick and the sick outside of hospitals are viewed as “externalities” to the
system. This is precisely what has happened in the US where an
oversupply of hospital beds has resulted from changes in the economics of
medical insurance, rather than a reduction of people needing hospital
care. Part of the economic argument against illegal immigration
is based on the overload of non-paying patients in a health care system
plagued with overcapacity.
Nevertheless, Nobel laureates Paul Samuelson and Robert Solow led an army
of government economists in the 1960s in using the Phillips curve as a
guide for macro-policy trade-offs between inflation and unemployment in
market economies. Later, Edmund Phelps and Milton Friedman
independently challenged the theoretical underpinnings by pointing out
separate effects between the “short-run” and “long-run” Phillips curves,
arguing that the inflation-adjusted purchasing power of money wages, or
real wages, would adjust to make the supply of labor equal to the demand
for labor, and the unemployment rate would rest at the real wage level to
moderate the business cycle. This level of unemployment they called the
"natural rate" of unemployment. The definitions of the natural
rate of unemployment and its associated rate of inflation are circularly
self-validating. The natural rate of unemployment is that at which
inflation is equal to its associated inflation. The associated rate of
inflation rate is that which prevails when unemployment is equal to its
natural rate.
A monetary purist, Friedman correctly concluded that money is all
important, but as a social conservative, he left the path to truth half
traveled, by not having much to say about the importance of the fair
distribution of money in the market economy, the flow of which is largely
determined by the terms of trade. Contrary to the theoretical relationship
described by Phillips curve, higher inflation was associated with higher,
not lower, unemployment in the US in the 1970s and contrary to Friedman’s
claim, deflation was associated also with high unemployment in Japan in the
1990s. The fact that both inflation and deflation accompanied
high unemployment ought to discredit the Phillips curve and Friedman’s
notion of a natural unemployment rate. Yet most mainstream economists
continue to accept a central tenet of the Friedman-Phelps analysis that
there is some rate of unemployment that, if maintained, would be compatible
with a constant rate of inflation. This they call the “non-accelerating
inflation rate of unemployment” (NAIRU), which over the years has crept up
from 4% to 6%.
NAIRU means that the price of sound money for the US is 6% unemployment.
The US Labor Department reported the “good news” that in May 2005, 7.6
million persons, or 5.1% of the workforce, were unemployed in the US, well
within NAIRU range. Since the low income tend to have more
children than the national norm, that translates to households with more
than 20 million children with unemployed parents. On the shoulders of these
unfortunate, innocent souls rests the systemic cost of sound money, defined
as having a non-accelerating inflation rate, paying for highly
irresponsible government fiscal policies of deficits and a flawed monetary
policy that leads to sky-rocketing trade deficits and debts. That is
equivalent to saying that if 6% of the world population dies from
starvation, the price of food can be stabilized. And unfortunately, such is
the terms of global agricultural trade. No government economist has
bothered to find out what would be the natural inflation rate for real full
employment.
It is hard to see how sound money can ever lead to full employment when
unemployment is necessary to keep money sound. Within limits and within
reason, unemployment hurts people and inflation hurts money. And if money
exists to serve people, then the choice between inflation and unemployment
becomes obvious. The theory of comparative advantage in world trade is
merely Say’s Law internationalized. It requires full employment to be
operative.
Wages and Profit
And neoclassical economics does not allow the
prospect of employers having an objective of raising wages, as Henry Ford
did, instead of minimizing wages as current corporate management, such as
General Motors, routinely practices. Henry Ford raised wages to
increase profits by selling more cars to workers, while Ford Motors today
cuts wages to maximize profit while adding to overcapacity. Therein resides
the cancer of market capitalism: falling wages will lead to the collapse of
an overcapacity economy.
This is why global wage arbitrage is economically
destructive unless and until it is structured to raise wages everywhere
rather than to keep prices low in the developed economies. That
is done by not chasing after the lowest price made possible by the lowest
wages, but by chasing after a bigger market made possible by rising
wages. The terms of global trade need to be restructured to
reward companies that aim at raising wages and benefits globally through
internationally coordinated transitional government subsidies, rather than
the regressive approach of protective tariffs to cut off trade that
exploits wage arbitrage. This will enable the low-wage economies to begin
to be able to afford the products they produce and to import more products
from the high wage economies to move towards balanced trade. Eventually,
certainly within a decade, wage arbitrage would cease to be the driving
force in global trade as wage levels around the world equalize. When
the population of the developing economies achieves per capita income that
matches that in developed economies, the world economy will be rid of the
modern curse of overcapacity caused by the flawed neoclassical economics of
scarcity.
When top executives are paid tens of million of
dollars in bonuses to cut wages and worker benefits, it is not fair reward
for good management; it is legalized theft. Executives should
only receive bonuses if both profit and wages in their companies rise as a
result of their management strategies.
Sovereign Credit and Dollar Hegemony
In an economy that can operate on sovereign
credit, free from dollar hegemony, private savings are needed only for
private investment that has no clear socially redeeming purpose or value.
Savings are deflationary without full employment, as savings reduces
current consumption to provide investment to increase future supply.
Savings for capital formation serve only the purpose of bridging the gap
between new investment and new revenue from rising productivity and
increased capacity from the new investment. With sovereign
credit, private savings are not needed for this bridge financing. Private
savings are also not needed for rainy days or future retirement in an
economy that has freed itself from the tyranny of the business cycle
through planning. Say’s Law of supply creating its own demand is a very
special situation that is operative only under full employment.
Say’s Law ignores a critical time lag between
supply and demand that can be fatal to a fast-moving modern economy without
demand management. Savings require interest payments, the compounding of
which will regressively make any financial system unsustainable by tilting
it toward overcapacity caused by overinvestment. The religions forbade
usury also for very practical reasons. Yet interest on money is
the very foundation of finance capitalism, held up by the neoclassical
economic notion that money is more valuable when it is scarce. Aggregate
poverty then is necessary for sound money. This was what
President Reagan meant when he said that there is always going to be poor
people.
The Bank of International Finance (BIS) estimated
that as of the end of 2004, the notional value of global OTC interest rate
derivatives is around $185 trillion, with a market risk exposure of over $5
trillion, which is almost half of US 2004 GDP. Interest rate
derivatives are by far the largest category of structured finance
contracts, taking up $185 trillion of the total $250 trillion of notional
values. The $185 trillion notional value of interest rate derivatives is 41
times the outstanding value of US Treasury bonds. This means that interest
rate volatility will have a disproportioned impact of the global financial
system in ways that historical data cannot project.
Fiat money issued by government is now legal
tender in all modern national economies since the 1971 collapse of the
Bretton Woods regime of fixed exchange rates linked to a gold-backed
dollar. The State Theory of Money (Chartalism) holds that the general
acceptance of government-issued fiat currency rests fundamentally on
government’s authority to tax. Government’s willingness to accept the
currency it issues for payment of taxes gives the issuance currency within
a national economy. That currency is sovereign credit for tax liabilities,
which are dischargeable by credit instruments issued by government, known
as fiat money. When issuing fiat money, the government owes no one anything
except to make good a promise to accept its money for tax payment.
A central banking regime operates on the notion of government-issued fiat
money as sovereign credit. That is the essential difference between central
banking with government-issued fiat money, which is a sovereign credit
instrument, and free banking with privately issued specie money, which is a
bank IOU that allows the holder to claim the gold behind it.
With the fall of the USSR, US attitude toward the
rest of the world changed. It no longer needs to compete for the
hearts and minds of the masses of the Third /Fourth Worlds. So trade has
replaced aid. The US has embarked on a strategy to use Third/Fourth-World
cheap labor and non-existent environmental regulation to compete with its
former Cold War Allies, now industrialized rivals in trade, taking
advantage of traditional US anti-labor ideology to outsource low-pay jobs,
playing against the strong pro-labor tradition of social welfare in Europe
and Japan. In the meantime, the US pushed for global financial
deregulation based on dollar hegemony and emerged as a 500-lb gorilla in
the globalized financial market that left the Japanese and Europeans in the
dust, playing catch up in an un-winnable game. In the game of finance
capitalism, those with capital in the form of fiat money they can print
freely will win hands down.
The tool of this US strategy is the privileged role
of the dollar as the key reserve currency for world trade, otherwise known
as dollar hegemony. Out of this emerges an international financial
architecture that does real damage to the actual producer economies for the
benefit of the financier economies. The dollar, instead of being
a neutral agent of exchange, has become a weapon of massive economic
destruction (WMED) more lethal than nuclear bombs and with more blackmail
power, which is exercised ruthlessly by the IMF on behalf of the Washington
Consensus. Trade wars are fought through volatile currency valuations.
Dollar hegemony enables the US to use its trade deficits as the bait for
its capital account surplus.
Foreign direct investment (FDI) under dollar
hegemony has changed the face of the international economy. Since the early
1970s, FDI has grown along with global merchandise trade and is the single
most important source of capital for developing countries, not net savings
or sovereign credit. FDI is mostly denominated in dollars, a fiat currency
that the US can produce at will since 1971, or in dollar derivatives such
as the yen or the euro, which are not really independent
currencies. Thus FDI is by necessity concentrated in exports
related development, mainly destined for US markets or markets that also
sell to US markets for dollars with which to provide the return on
dollar-denominated FDI. US economic policy is shifting from trade promotion
to FDI promotion.
The US trade deficit is financed by the US capital
account surplus which in turn provides the dollars for FDI in the exporting
economies. A trade spat with the EU over beef and bananas, for example,
risks large US investment stakes in Europe. And the suggestion
to devalue the dollar to promote US exports is misleading for it would only
make it more expensive for US affiliates to do business abroad while making
it cheaper for foreign companies to buy dollar assets. An attempt to
improve the trade balance, then, would actually end up hurting the FDI
balance. This is the rationale behind the slogan: a strong
dollar is in the US national interest.
Between 1996 and 2003, the monetary value of US
equities rose around 80% compared with 60% for European and a decline of
30% for Japanese. The 1997 Asian financial crisis cut Asia
equities values by more than half, some as much as 80% in dollar terms even
after drastic devaluation of local currencies. Even though the
US has been a net debtor since 1986, its net income on the international
investment position has remained positive, as the rate of return on US
investments abroad continues to exceed that on foreign investments in the
US. This reflects the overall strength of the US economy, and
that strength is derived from the US being the only nation that can enjoy
the benefits of sovereign credit utilization while amassing external debt,
largely due to dollar hegemony.
In the US, and now also increasingly so in Europe and
Asia, capital markets are rapidly displacing banks as both savings venues
and sources of funds for corporate finance. This shift, along with the
growing global integration of financial markets, is supposed to create
promising new opportunities for investors around the globe. Neo-liberals
even claim that these changes could help head off the looming pension
crises facing many nations. But so far it has only created sudden and
recurring financial crises like those that started in Mexico in 1982, then
in the UK in 1992, again in Mexico in 1994, in Asia in 1997, and Russia,
Brazil, Argentina and Turkey subsequently.
The introduction of the euro has accelerated the
growth of the EU financial markets. For the current 25 members of the
European Union, the common currency nullified national requirements for
pension and insurance assets to be invested in the same currencies as their
local liabilities, a restriction that had long locked the bulk of Europe’s
long-term savings into domestic assets. Freed from foreign-exchange
transaction costs and risks of currency fluctuations, these savings fueled
the rise of larger, more liquid European stock and bond markets, including
the recent emergence of a substantial euro junk bond market.
These more dynamic capital markets, in turn, have
placed increased competitive pressure on banks by giving corporations new
financing options and thus lowering the cost of capital within euroland.
How this will interact with the euro-dollar market is still
indeterminate. Euro-dollars are dollars outside of US borders
everywhere and not necessarily Europe, generally pre-taxed and subject to
US taxes if they return to US soil or accounts. The term also applies to
euro-yens and euro-euros. But the idea of French retirement accounts
investing in non-French assets is both distasteful and irrational for the average
French worker, particularly if such investment leads to decreased job
security in France and jeopardizes the jealously guarded 35-hour work-week
with 30 days of paid annual vacation which has been part of French life.
Take the Japanese economy as an example, the
world’s largest creditor economy. It holds over $800 billion in dollar
reserves in 2005. The Bank of Japan (BoJ), the central bank, has bought
over 300 billion dollars with yen from currency markets in the last two
years in an effort to stabilize the exchange value of the yen, which
continued to appreciate against the dollar. Now, BoJ is faced with a
dilemma: continue buying dollars in a futile effort to keep the yen from
rising, or sell dollars to try to recoup yen losses on its dollar reserves.
Japan has officially pledged not to diversify its dollar reserves into
other currencies, so as not to roil currency markets, but many hedge funds
expect Japan to soon run out of options.
Now if the BoJ sells dollars at the rate of $4
billion a day, it will take some 200 trading days to get out of its dollar
reserves. After the initial 2 days of sale, the remaining unsold $792
billion reserves would have a market value of 20% less than before the
sales program began. So the BoJ will suffer a substantial net yen paper
loss of $160 billion. If the BoJ continues its sell-dollar program,
everyday Y400 billion will leave the yen money supply to return to the BoJ
if it sells dollars for yen, or the equivalent in euro if it sells dollars
for euro. This will push the dollar further down against the yen or euro,
in which case the value of its remaining dollar reserves will fall even
further, not to mention a sharp contraction in the yen money supply which
will push the Japanese economy into a deeper recession.
If the BoJ sells dollars for gold, two things may
happen. There would be not enough sellers because no one has enough gold to
sell to absorb the dollars at current gold prices. Instead, while price of
gold will rise, the gold market may simply freezes with no transactions.
Gold holders will not have to sell their gold; they can profit from gold
derivatives on notional values. Also, the reverse market effect that faces
the dollar would hit gold. After two days of Japanese gold
buying, everyone would hold on to their gold in anticipation for still
higher gold prices. There would be no market makers. Part of the
reason central banks have been leasing out their gold in recent years is to
provide liquidity to the gold market.
The second thing that may happen is that price of
gold will sky rocket in currency terms, causing a great deflation in gold
terms. The US national debt as of June 1, 2005 was $7.787 trillion. US
government gold holding is about 261,000,000 ounces. Price of gold required
to pay back the national debt with US-held gold is $29,835 per ounce. At
that price, an ounce of gold will buy a car. Meanwhile, market price of
gold as of June 4, 2005 was $423.50 per ounce. Gold peaked at $850 per
ounce in 1980 and bottom at $252 in 1999 when oil was below $10 a barrel.
At $30,000 per ounce, governments then will have to made gold trading
illegal, as FDR did in 1930 and we are back to square one. It is much
easier for a government to outlaw the trading of gold within its borders
than it is for it to outlaw the trading of its currency in world
markets. It does not take much to conclude that anyone who
advices any strategy of long-term holding of gold will not get to the top
of the class.
Heavily indebted poor countries need debt relief
to get out of virtual financial slavery. Some African governments spend
three times as much on debt service as they do on health care. Britain has
proposed a half measure that would have the IMF sell about $12 billion
worth of its gold reserves, which have a total current market value of
about $43 billion to finance debt relief. The US has veto power over gold
decisions in the IMF. Thus Congress holds the key. However,
the mining industry lobby has blocked a vote. In January, a letter opposing
the sale of IMF gold was signed by 12 US senators from Western mining
states, arguing that the sale could drive down the price of gold. A similar
letter was signed in March by 30 members of the House of Representatives.
Lobbyists from the National Mining Association and
gold mining companies, such as Newmont Mining and Barrick Gold Corp,
persuaded the Congressional leadership that the gold proposal would not
pass in Congress, even before it came up for debate. The BIS reports that
gold derivatives took up 26% of the world’s commodity derivatives market
yet gold only composes 1% of the world's annual commodity production value,
with 26 times more derivatives structured against gold than against other
commodities, including oil. The Bush administration, at first apparently
unwilling to take on a congressional fight, began in April to oppose gold
sales outright. But President Bush and UK Prime Minister Tony
Blair announced on June 7 that the US and UK are “well on their way” to a
deal which would provide 100% debt cancellation for some poor
nations to the World Bank and African Development Fund as a sign of
progress in the G-8 debate over debt cancellation.
Jude Wanniski, a former editor of the Wall Street
Journal, commenting in his Memo on the Margin on the Internet on June 15,
2005, on the headline of Pat Buchanan’s syndicated column of the same date:
Reviving the Foreign-Aid Racket, wrote: “This not a bailout of Africa’s
poor or Latin American peasants. This is a bailout of the IMF, the World
Bank and the African Development Bank…. The second part of the
racket is that in exchange for getting debt relief, the poor countries will
have to spend the money they save on debt service on "infrastructure
projects," to directly help their poor people with water and sewer
line, etc., which will be constructed by contractors from the wealthiest nations… What
comes next? One of the worst economists in the world, Jeffrey Sachs, is in
charge of the United Nations scheme to raise mega-billions from western
taxpayers for the second leg of this scheme. He wants $25 billion A YEAR
for the indefinite future, as I recall, and he has the fervent backing
of The New York Times, which always weeps crocodile tears for
the racketeers. It was Jeffrey Sachs, in case you forgot, who, with the
backing of the NYTimes persuaded Moscow under Mikhail
Gorbachev to engage in "shock therapy" to convert from communism
to capitalism. It produced the worst inflation in the history of Russia,
caused the collapse of the Soviet federation, and sank the Russian people
into a poverty they had never experienced under communism.”
The dollar cannot go up or down more than 20%
against any other major currencies within a short time without causing a
major global financial crisis. Yet, against the US equity markets the
dollar appreciated about 40% in purchasing power in the 2000-02 market
crash, so had gold. And against real estate prices between 2002
and 2005, the dollar has depreciated 60% or more. According to Greenspan’s
figures, the Fed can print $8 trillion more fiat dollars without causing
inflation. The problem is not the money printing. The problem is where that
$8 trillion is injected. If it is injected into the banking system, then
the Fed will have to print $3 trillion every subsequent year just to keep
running in place. If the $8 trillion is injected into the real economy in
the form of full employment and higher wages, the US will have a very good
economy, and much less need for paranoia against Asia or the EU. But US
wages cannot rise as long as global wage arbitrage is
operative. This is one of the arguments behind
protectionism. It led Federal Reserve Chairman Alan Greenspan to say
on May 5 he feared what appeared to be a growing move toward trade
protectionism, saying it could lessen the US and the world's economy
ability to withstand shock. Yet if democracy works in the US,
protectionism will be unstoppable as long as free trade benefits the elite
at the expense of the voting masses.
Fiat Money is Sovereign Credit
Money is like power: use it or lose it. Money
unused (not circulated) is defunct wealth. Fiat money not circulated
is not wealth but merely pieces of printed paper sitting in a safe. Gold
unused as money is merely a shiny metal good only as ornamental gifts for
weddings and birthdays. The usefulness of money to the economy is
dependent on its circulation, like the circulation of blood to bring oxygen
and nutrient to the living organism. The rate of money circulation is
called velocity by monetary economists. A vibrant economy requires a high
velocity of money. Money, like most representational
instruments, is subject to declaratory definition. In semantics, a
declaratory statement is self validating. For example: “I am King” is a
statement that makes the declarer king, albeit in a kingdom of one citizen.
What gives weight to the declaration is the number of others accepting that
declaration. When sufficient people within a jurisdiction accept the kingship
declaration, the declarer becomes king of that jurisdiction instead of just
his own house. When an issuer of money declares it to be credit it will be
credit, or when he declares it to be debt it will be debt. But the social
validity of the declaration depends on the acceptance of others.
Anyone can issue money, but only sovereign government
can issue legal tender for all debts, public and private, universally
accepted with the force of law within the sovereign domain. The issuer of
private money must back that money with some substance of value, such as
gold, or the commitment for future service, etc. Others who accept that
money have provided something of value for that money, and have received
that money instead of something of similar value in return. So the issuer
of that money has given an instrument of credit to the holder in the form
of that money, redeemable with something of value on a later date.
When the state issues fiat money under the principle of Chartalism, the
something of value behind it is the fulfillment of tax obligations. Thus
the state issues a credit instrument, called (fiat) money, good for the
cancellation of tax liabilities. By issuing fiat money, the state is not
borrowing from anyone. It is issuing tax credit to the economy.
Even if money is declared as debt assumed by an issuer who is not a
sovereign who has the power to tax, anyone accepting that money expects to
collect what is owed him as a creditor. When that money is used in a
subsequent transaction, the spender is parting with his creditor right to
buy something of similar value from a third party, thus passing the “debt”
of the issuer to the third party. Thus no matter what money is declared to
be, its functions is a credit instrument in transactions. When one gives
money to another, the giver is giving credit and the receiver is incurring
a debt unless value is received immediately for that money. When debt is
repaid with money, money acts as a credit instrument. When government buys
back government bonds, which is sovereign debt, it cannot do so with fiat
money it issues unless fiat money is sovereign credit.
When money changes hands, there is always a creditor and a debtor.
Otherwise there is no need for money, which stands for value rather than
being value intrinsically. When a cow is exchanged for another cow, that is
bartering, but when a cow is bought with money, the buyer parts with money
(an instrument of value) while the seller parts with the cow (the substance
of value). The seller puts himself in the position of being a new creditor
for receiving the money in exchange for his cow. The buyer exchanges his
creditor position for possession of the cow. In this transaction, money is
an instrument of credit, not a debt.
When private money is issued, the only way it will be accepted generally is
that the money is redeemable for the substance of value behind it based on
the strong credit of the issuer. The issuer of private money is a custodian
of the substance of value, not a debtor. All that is logic, and it does not
matter how many mainstream monetary economists say money is debt.
Economist Hyman P Minsky (1919-1996) observed correctly that money is
created whenever credit is issued. He did not say money is created when
debt is incurred. Only entities with good credit can issue credit or create
money. Debtors cannot create money, or they would not have to borrow.
However, a creditor can only be created by the existence of a debtor. So
both a creditor and a debtor are needed to create money. But only the
creditor can issue money, the debtor accepts the money so created which
puts him in debt.
The difference with the state is that its power to levy taxes exempts it
from having to back its creation of fiat money with any other assets of
value. The state when issuing fiat money is acting as a sovereign creditor.
Those who took the fiat money without exchanging it with things of value is
indebted to the state; and because taxes are not always based only on
income, a tax payer is a recurring debtor to the state by virtue of his
citizenship, even those with no income. When the state provides transfer payments
in the form of fiat money, it relieves the recipient of his tax liabilities
or transfers the exemption from others to the recipient to put the
recipient in a position of a creditor to the economy through the possession
of fiat money. The holder of fiat money is then entitled to claim goods and
services from the economy. For things that are not for sale,
such as political office, money is useless, at least in theory. The
exercise of the fiat money’s claim on goods and services is known as buying
something that is for sa<>le.
There is a difference between buying a cow with fiat money and buying a cow
with private IOUs (notes). The transaction with fiat money is complete.
There is no further obligation on either side after the transaction. With
notes, the buyer must either eventually pay with money, which cancels the
notes (debt) or return the cow. The correct way to look at sovereign
government-issued fiat money is that it is not a sovereign debt, but a
sovereign credit good for canceling tax obligations. When the government
redeems sovereign bonds (debt) with fiat money (sovereign credit), it is
not paying off old debt with new debt, which would be a Ponzi scheme.
Government does not become a debtor by issuing fiat money, which in the US
is a Federal Reserve note, not an ordinary bank note. The word “bank” does
not appear on US dollars. Zero maturity money (ZMM), which grew from
$550 billion in 1971 when Nixon took the dollar off gold, to $6.63 trillion
as of May 30, 2005 is not a Federal debt. It is a Federal credit to the
economy acceptable for payment of taxes and as legal tender for all debts,
public and private. Anyone refusing to accept dollars within US
jurisdiction is in violation of US law. One is free to set market prices
that determine the value, or purchasing power of the dollar, but it is
illegal on US soil to refuse to accept dollars for the settlement of
debts. Instruments used for settling debts are credit
instruments. When fiat money is used to buy sovereign bonds (debt), money
cannot be anything but an instrument of sovereign credit. If fiat money is
sovereign debt, there is no need to sell government bonds for fiat
money. When a sovereign government sells a sovereign bond for
fiat money issues, it is withdrawing sovereign credit from the economy. And
if the government then spends the money, the money supply remains
unchanged. But if the government allows a fiscal surplus by
spending less than its tax revenue, the money supply shrinks and the
economy slows. That was the effect of the Clinton surplus which produce the
recession of 2000. While run-away fiscal deficits are
inflationary, fiscal surpluses lead to recessions. Conservatives who are
fixated on fiscal surpluses are simply uninformed on monetary economics.
For euro-dollars, meaning fiat dollars outside of the US, the reason those
who are not required to pay US taxes accept them is because of dollar
hegemony, not because dollars are IOUs of the US government. Everyone
accept dollars because dollars can buy oil and all other key commodities.
When the Fed injects money into the US banking system, it is not issuing
government debt; it is expanding sovereign credit which would require
higher government tax revenue to redeem. But if expanding sovereign credit
expands the economy, tax revenue will increase without changing the tax
rate. Dollar hegemony exempts the dollar, and only the dollar, from foreign
exchange implication on the State Theory of Money. To issue sovereign debt,
the Treasury issues treasury bonds. Thus under dollar hegemony, the US is
the only nation that can practice and benefit from sovereign credit under
the principle of Chartalism. <>
Money and bonds are opposite instruments that cancel each other. That is
how the Fed Open Market Committee (FOMC) controls the money supply, by
buying or selling government securities with fiat dollars to set a fed
funds rate target. The fed funds rate is the interest rate at which banks
lend to each other overnight. As such, it is a market interest rate that
influences market interest rates throughout the world in all currencies
through exchange rates. Holders of a government bond can claim its
face value in fiat money at maturity, but holder of a fiat dollar can only
claim a fiat dollar replacement at the Fed. Holders of fiat dollars can buy
new sovereign bonds at the Treasury, or outstanding sovereign bond in the
bond market, but not at the Fed. The Fed does not issue debts, only credit
in the form of fiat money. When the Fed FOMC buys or sells government
securities, it does on behalf of the Treasury. When the Fed increases the
money supply, it is not adding to the national debt. It is increasing
sovereign credit in the economy. That is why monetary easing is not deficit
financing.
Money and Inflation
It is sometimes said that war’s legitimate child is revolution and war’s
bastard child is inflation. World War I was no exception. The US national
debt multiplied 27 times to finance the nation’s participation in that war,
from US$1 billion to $27 billion. Far from ruining the United States, the
war catapulted the country into the front ranks of the world’s leading
economic and financial powers. The national debt turned out to be a
blessing, for government securities are indispensable as anchors for a
vibrant credit market.<>
Inflation was a different story. By the end of World War I, in 1919, US
prices were rising at the rate of 15% annually, but the economy roared
ahead. In response, the Federal Reserve Board raised the discount rate in
quick succession, from 4 to 7%, and kept it there for 18 months to try to
rein in inflation. The discount rate is the interest rate charged to
commercial banks and other depository institutions on loans they receive
from their regional Federal Reserve Bank’s lending facility--the discount
window. The result was that in 1921, 506 banks failed. Deflation descended
on the economy like a perfect storm, with commodity prices falling 50% from
their 1920 peak, throwing farmers into mass bankruptcies. Business activity
fell by one-third; manufacturing output fell by 42%; unemployment rose
fivefold to 11.9%, adding 4 million to the jobless count. The economy came
to a screeching halt. From the Fed’s perspective, declining prices were the
goal, not the problem; unemployment was necessary to restore US industry to
a sound footing, freeing it from wage-pushed inflation. Potent medicine
always came with a bitter taste, the central bankers explained.
At this point, a technical process inadvertently gave the New York Federal
Reserve Bank, which was closely allied with internationalist banking
interest, preeminent influence over the Federal Reserve Board in
Washington, the composition of which represented a more balanced national
interest. The initial operation of the Fed did not use the open-market
operation of purchasing or selling government securities to set interest
rate policy as a method of managing the money supply. The Fed could not
simply print money to buy government securities to inject money into the
money supply because the dollar was based on gold and the amount of gold
held by the government was relatively fixed. Money in the banking system
was created entirely through the discount window at the regional Federal
Reserve Banks. Instead of buying or selling government bonds, the regional
Feds accepted "real bills" of trade, which when paid off would
extinguish money in the banking system, making the money supply
self-regulating in accordance with the "real bills" doctrine to
maintain the gold standard. The regional Feds bought government securities
not to adjust money supply, but to enhance their separate operating profit
by parking idle funds in interest-bearing yet super-safe government
securities, the way institutional money managers do today.
Bank economists at that time did not understand that when the regional Feds
independently bought government securities, the aggregate effect would
result in macro-economic implications of injecting "high power"
money into the banking system, with which commercial banks could create
more money in multiple by lending recycles based on the partial reserve
principle. When the government sold bonds, the reverse would happen. When
the Fed made open market transactions, interest rates would rise or fall
accordingly in financial markets. And when the regional Feds did not act in
unison, the credit market could become confused or become disaggregated, as
one regional Fed might buy while another might sell government securities
in its open market operations.
Benjamin Strong, first president of the New York Federal Reserve Bank, saw
the problem and persuaded the other 11 regional Feds to let the New York
Fed handle all their transactions in a coordinated manner. The regional
Feds formed an Open Market Investment Committee, to be run by the New York
Fed for the purpose of maximizing overall profit for the whole system. This
committee became dominated by the New York Fed, which was closely linked to
big-money center bank interests which in turn were closely tied to
international financial markets. The Federal Reserve Board approved the
arrangement without full understanding of its full implication: that the
Fed was falling under the undue influence of the New York internationalist
bankers. For the US, this was the beginning of financial globalization.
This fatal flaw would reveal itself in the Fed's role in causing and its
impotence in dealing with the 1929 crash.
The deep 1920-21 depression eventually recovered by the lowering of the Fed
discount rate into the Roaring Twenties, which, like the New Economy bubble
of the 1990s, left some segments of economy and the population in them
lingering in a depressed state. Farmers remained victimized by depressed
commodity prices and factory workers shared in the prosperity only by
working longer hours and assuming debt with the easy money that the banks
provided. Unions lost 30% of their membership because of high unemployment
in boom time. The prosperity was entirely fueled by the wealth effect of a
speculative boom in the stock market that by the end of the decade would
face the 1929 crash and land the nation and the world in the Great
Depression. Historical data showed that when New York Fed president Strong
leaned on the regional Feds to ease the discount rate on an already
overheated economy in 1927, the Fed lost its last window of opportunity to
prevent the 1929 crash. Some historians claimed that Strong did so to
fulfill his internationalist vision at the risk of endangering the national
interest. It is an issue of debate that continues in Congress
today. Like Greenspan, Strong argued that it was preferable to deal with
post-crash crisis management by adding liquidity than to pop a bubble
prematurely with preventive measures of tight money. It is a strategy that
requires letting a bubble to pop only inside a bigger bubble.
The speculative boom of easy credit in the 1920s attracted many to buy
stocks with borrowed money and used the rising price of stocks as new
collateral for borrowing more to buy more stocks. Broker’s loans went from
under $5 million in mid 1928 to $850 million in September of 1929. The
market capitalization of the 846 listed companies of the New York Stock
Exchange was $89.7 billion, at 1.24 times 1929 GDP. By current standards, a
case could be built that stocks in 1929 were in fact technically
undervalued. The 2,750 companies listed in the New York Stock Exchange had
total global market capitalization exceeding $18 trillion in 2004, 1.53
times 2004 GDP of $11.75 trillion.<>
On January 14, 2001, the DJIA reached its all time high to date at 11,723,
not withstanding Greenspan’s warning of “irrational exuberance” on December
6, 1996 when the DJIA was at 6,381. From its August 12, 1982 low
of 777, the DJIA began its most spectacular bull market in history.
It was interrupted briefly only by the abrupt and frightening crash on
October 19, 1987 when the DJIA lost 22.6% on Black Monday, falling to
1,739. It represented a 1,020-point drop from its previous peak
of 2,760 reached less than two months earlier on August 21. But
Greenspan’s easy money policy lifted the DJIA to 11,723 in 13 years, a 674%
increase. In 1929 the top came on September 4, with the DJIA at 386. A
headline in The New York Times on October 22, 1929,
reported highly-respected economist Irving Fisher as saying: “Prices of
Stocks Are Low.” Two days later, the stock market crashed, and by the end
of November, the New York Stock Exchange shares index was down
30%. The index did not return to the 9/3/29 level until November,
1954. At its worst level, the index dropped to 40.56 in July 1932, a drop
of 89%. Fisher had based his statement on strong earnings reports, few
industrial disputes, and evidence of high investment in research and
development (R&D) and in other intangible capital. Theory and
supportive data not withstanding, the reality was that the stock market boom
was based on borrowed money and false optimism. In hindsight,
many economists have since concluded that stock prices were overvalued by
30% in 1929. But when the crash came, the overshoot dropped the
index by 89% in less than three years.
Money and Gold
When money is not backed by gold, its exchange value must be managed by
government, more specifically by the monetary policies of the central bank.
No responsible government will voluntarily let the market set the exchange
value of its currency, market fundamentalism notwithstanding. Yet central
bankers tend to be attracted to the gold standard because it can relieve
them of the unpleasant and thankless responsibility of unpopular monetary
policies to sustain the value of money. Central bankers have been
caricatured as party spoilers who take away the punch bowl just when the
party gets going.
Yet even a gold standard is based on a fixed value of money to gold, set by
someone to reflect the underlying economical conditions at the time of its
setting. Therein lies the inescapable need for human judgment. Instead of
focusing on the appropriateness of the level of money valuation under
changing economic conditions, central banks often become fixated on merely
maintaining a previously set exchange rate between money and gold, doing
serious damage in the process to any economy temporarily out of sync with
that fixed rate. It seldom occurs to central bankers that the fixed rate
was the problem, not the dynamic economy. When the exchange value of a
currency falls, central bankers often feel a personal sense of failure,
while they merely shrug their shoulders to refer to natural laws of finance
when the economy collapses from an overvalued currency.
The return to the gold standard in war-torn Europe in the 1920s was
engineered by a coalition of internationalist central bankers on both sides
of the Atlantic as a prerequisite for postwar economic reconstruction.
Lenders wanted to make sure that their loans would be repaid in money
equally valuable as the money they lent out, pretty much the way the IMF
deals with the debt problem today. President Strong of the New
York Fed and his former partners at the House of Morgan were closely
associated with the Bank of England, the Banque de France, the Reichsbank,
and the central banks of Austria, the Netherlands, Italy, and Belgium, as
well as with leading internationalist private bankers in those countries.
Montagu Norman, governor of the Bank of England from 1920-44, enjoyed a
long and close personal friendship with Strong as well as ideological
alliance. Their joint commitment to restore the gold standard in Europe and
so to bring about a return to the “international financial normalcy” of the
prewar years was well documented. Norman recognized that the impairment of British
financial hegemony meant that, to accomplish postwar economic
reconstruction that would preserve pre-war British interests, Europe would
“need the active cooperation of our friends in the United States.”
Like other New York bankers, Strong perceived World War I as an opportunity
to expand US participation in international finance, allowing New York to
move toward coveted international-finance-center status to rival London’s
historical preeminence, through the development of a commercial paper market,
or bankers' acceptances in British finance parlance, breaking London’s long
monopoly. The Federal Reserve Act of 1913 permitted the Federal Reserve
Banks to buy, or rediscount, such paper. This allowed US banks in New York
to play an increasingly central role in international finance in
competition with the London market.
Herbert Hoover, after losing his second-term US presidential election to
Franklin D Roosevelt as a result of the 1929 crash, criticized Strong as
"a mental annex to Europe", and blamed Strong's internationalist
commitment to facilitating Europe's postwar economic recovery for the US
stock-market crash of 1929 and the subsequent Great Depression that robbed
Hoover of a second term. Europe's return to the gold standard, with
Britain’s insistence on what Hoover termed a "fictitious rate" of
US$4.86 to the pound sterling, required Strong to expand US credit by
keeping the discount rate unrealistically low and to manipulate the Fed’s
open market operations to keep US interest rate low to ease market
pressures on the overvalued pound sterling. Hoover, with justification,
ascribed Strong’s internationalist policies to what he viewed as the malign
persuasions of Norman and other European central bankers, especially
Hjalmar Schacht of the Reichsbank and Charles Rist of the Bank of France.
From the mid-1920s onward, the US experienced credit-pushed inflation,
which fueled the stock-market bubble that finally collapsed in 1929.
Within the Federal Reserve System, Strong's low-rate policies of the mid-1920s
also provoked substantial regional opposition, particularly from Midwestern
and agricultural elements, who generally endorsed Hoover's subsequent
critical analysis. Throughout the 1920s, two of the Federal Reserve Board's
directors, Adolph C Miller, a professional economist, and Charles S Hamlin,
perennially disapproved of the degree to which they believed Strong
subordinated domestic to international considerations.
The fairness of Hoover's allegation is subject to debate, but the fact that
there was a divergence of priority between the White House and the Fed is
beyond dispute, as is the fact that what is good for the international
financial system may not always be good for a national economy. This is
evidenced today by the collapse of one economy after another under the
current international finance architecture that all central banks support
instinctively out of a sense of institutional solidarity. The
same issue has surfaced in today’s China where regional financial centers
such as Hong Kong and Shanghai are vying for the role of world financial
center. To do this, they must play by the rules of the
international financial system which imposes a cost on the national
economy. The nationalist vs. internationalist conflict, as exemplified by the
Hoover vs. Strong conflict of the 1930s, is also threatening the further
integration of the European Union. Behind the fundamental
rationale of protectionism is the rejection of the claim that
internationalist finance places national development as its
priority. The Richardian theory of comparative advantage of free
trade is not the issue.
The issue of government control over foreign loans also brought the Fed,
dominated by Strong, into direct conflict with Hoover when the latter was
Secretary of Commerce. Hoover believed that the US government should have
right of approval on foreign loans based on national-interest
considerations and that the proceeds of US loans should be spent on US
goods and services. Strong opposed all such restrictions as undesirable
government intervention in free trade and international finance and
counterproductively protectionist. Businesses should be not only allowed,
but encouraged to buy when it is cheapest anywhere in the world, including
shopping for funds to borrow, a refrain that is heard tirelessly from free
traders also today. Of course, the expanding application of the law of one
price to more and more commodities, including the price of money, i.e.
interest rates adjusted by exchange rates, makes such dispute academic. The
only commodity exempt from the law of one price is labor. This exemption
makes the trade theory of comparative advantage a fantasy.
In July and August 1927, Strong, despite ominous data on mounting market
speculation and inflation, pushed the Fed to lower the discount rate from 4
to 3 percent to relieve market pressures again on the overvalued British
pound. In July 1927, the central bankers of Great Britain, the United
States, France, and Weimar Germany met on Long Island in the US to discuss means
of increasing Britain’s gold reserves and stabilizing the European currency
situation. Strong’s reduction of the discount rate and purchase of 12
million pound sterling, for which he paid the Bank of England in gold,
appeared to come directly from that meeting. One of the French bankers in
attendance, Charles Rist, reported that Strong said that US authorities
would reduce the discount rate as "un petit coup de whisky for
the stock exchange". Strong pushed this reduction through the Fed
despite strong opposition from Miller and fellow board member James
McDougal of the Chicago Fed, who represented Midwestern bankers, who
generally did not share New York's internationalist preoccupation.
Frank Altschul, partner in the New York branch of the transnational
investment bank Lazard Freres, told Emile Moreau, the governor of the Bank
of France, that “the reasons given by Mr Strong as justification for the
reduction in the discount rate are being taken seriously by no one, and
that everyone in the United States is convinced that Mr Strong wanted to
aid Mr Norman by supporting the pound.” Other correspondence in Strong’s
own files suggests that he was giving priority to international monetary
conditions rather than to US export needs, contrary to his public arguments.
Writing to Norman, who praised his handling of the affair as “masterly”,
Strong described the US discount rate reduction as “our year’s contribution
to reconstruction.” The Fed’s ease in 1927 forced money to flow not into
the overheated real economy, which was unable to absorb further investment,
but into the speculative financial market, which led to the crash of 1929.
Strong died in October 1928, one year before the crash, and was spared the
pain of having to see the devastating results of his internationalist
policies.
Scholarly debate still continues as to whether Strong's effort to
facilitate European economic reconstruction compromised the US domestic
economy and, in particular, led him to subordinate US monetary policies to
internationalist demands. In 1930, the US economy had yet to dominate the
world economy as it does now. There is, however, little disagreement that
the overall monetary strategy of European central banks had been misguided
in its reliance on the restoration of the gold standard. Critics suggest
that the ambitious but misguided commitment of Strong, Norman, and other
internationalist bankers to returning the pound, the mark, and other major
European currencies to the gold standard at overly-high parities to gold,
which they were then forced to maintain at all costs, including
indifference to deflation, had the effect of undercutting Europe's postwar
economic recovery. Not only did Strong and his fellow central bankers
through their monetary policies contribute to the Great Depression, but
their continuing fixation on gold also acted as a straitjacket that in
effect precluded expansionist counter-cyclical measures.
The inflexibility of the gold standard and the central bankers’
determination to defend their national currencies’ convertibility into gold
at almost any cost drastically limited the policy options available to them
when responding to the global financial crisis. This picture fits the
situation of the fixed-exchange-rates regime based on the fiat dollar that
produced recurring financial crises in the 1990s and that has yet to run
its full course by 2005. In 1927, Strong’s unconditional support of the
gold standard, with the objective of bringing about the rising financial
predominance of the US which had the largest holdings of gold in the world,
exacerbated nascent international financial problems. In similar ways,
dollar hegemony does the same damage to the global economy today. Just as
the international gold standard itself was one of the major factors
underlying and exacerbating the Great Depression that followed the 1929
crash, since the conditions that had sustained it before the war no longer
existed, the breakdown of the fixed-exchange-rates system based on a
gold-backed dollar set up by the Bretton Woods regime after World War II,
without the removal of the fiat dollar as a key reserve currency for trade
and finance, will cause a total collapse of the current international
financial architecture with equally tragic outcomes. Stripped of its gold
backing, the fiat dollar has to rely on geopolitical factors for its value,
which push US foreign policy towards increasing militaristic and
belligerent unilateralism. With dollar hegemony today, as it was with the
gold standard of 1930, the trade war is fought through currencies
valuations on top of traditional tariffs.
The nature of and constraints on US internationalism after World War I had
parallels in US internationalism after World War II and in US-led
globalization after the Cold War. Hoover bitterly charged Strong with
reckless placement of the interests of the international financial system
ahead of US national interest and domestic development needs. Strong
sincerely believed his support for European currency stabilization also
promoted the best interests of the United States, as post-Cold War
neo-liberal market fundamentalists sincerely believe its promotion enhances
the US national interest. Unfortunately, sincerity is not a vaccine against
falsehood.
Strong argued relentlessly that exchange rate volatility, especially when
the dollar was at a premium against other currencies, made it difficult for
US exporters to price their goods competitively. As he had done during the
war, on numerous later occasions, Strong also stressed the need to prevent
an influx of gold into the US and the consequent domestic inflation, by the
US making loans to Europe, pursuing lenient debt policies, and accepting
European imports on generous terms. Strong never questioned the gold
parities set for the mark and the pound sterling. He merely accepted that
returning the pound to gold at prewar exchange rates required British
deflation and US efforts to use lower dollar interest rates to alleviate
market pressures on sterling. Like Fed chairman Paul Volcker in the 1980s,
but unlike Treasury Secretary Robert Rubin in the 1990s, Strong mistook a
cheap dollar as serving the national interest, while Rubin understood
correctly that a strong dollar is in the national interest by sustaining
dollar hegemony. In either case, the price for either an over-valued or
under-valued dollar is the same: global depression. Dollar hegemony in the
1990s pushed Japan and Germany into prolonged depression.<>
The US position in 2005 is that a strong dollar is still in the US national
interest, but a strong dollar requires an even stronger Chinese yuan in the
21st century. Just as Strong saw the need for a strong
British pound paid for by deflation in Britain in exchange for the carrot
of continuing British/European imports to the US, Bush and Greenspan now
want a stronger Chinese yuan, paid for with deflation in China in exchange
for curbing US protectionism against Chinese imports. The 1985
Plaza Accord to force the appreciation of the Japanese yen marked the
downward spiral of the Japanese economy via currency-induced
deflation. Another virtual Plaza Accord forced the rise of the
euro that left Europe with a stagnant economy. A new virtual Plaza Accord
against China will also condemn the Chinese economy into a protracted
period of deflation. Deflation in China at this time will cause
the collapse of the Chinese banking system which is weighted down by the
BIS regulatory regime that turned national banking subsidies to
state-own-enterprises into massive non-performing loans. A collapse of the
Chinese banking system will have dire consequences for the global financial
system since the robust Chinese economy is the only engine of growth in the
world economy at this time.
When Norman sent Strong a copy of John Maynard Keynes’ Tract on
Monetary Reform (1923), Strong commented “that some of his
[Keynes’] conclusions are thoroughly unwarranted and show a great lack of
knowledge of American affairs and of the Federal Reserve System.” Within a
decade, Keynes, with his advocacy of demand management via deficit
financing, became the most influential economist in post-war history.
The major flaw in the European effort for post-World War I economic
reconstruction was its attempt to reconstruct the past through its attachment
to the gold standard, with little vision of a new future. The democratic
governments of the moneyed class that inherited power from the fall of
monarchies did not fully comprehend the implication of the disappearance of
the monarch as a ruler, whose financial architecture they tried to continue
for the benefit of their bourgeois class. The broadening of the political
franchise in most European countries after the war had made it far more
difficult for governments and central bankers to resist electoral pressures
for increased social spending and the demand for ample liquidity with low
interest rates, as well as high tolerance for moderate inflation to combat
unemployment, regardless of the impact of national policies on the
international financial architecture. The Fed, despite its claim of
independence from politics, has never been free of US presidential-election
politics since its founding. Shortly before his untimely death, Strong took
comfort in his belief that the reconstruction of Europe was virtually
completed and his internationalist policies had been successful in
preserving world peace. Within a decade of his death, the whole world was
aflame with World War II.
But in 1929, the dollar was still gold-backed. The government fixed
the dollar at 23.22 grains of gold, at $20.67 per troy ounce. When
stock prices rose faster than real economic growth, the dollar in effect
depreciated. It took more dollars to buy the same shares as
prices rose. But the price of gold remained fixed at $20.67 per ounce.
Thus gold was cheap and the dollar was overvalued and the trading public
rushed to buy gold, injecting cash into the economy which fueled more stock
buying on margin. Price of gold mining shares rose by 600%. But with a gold
standard, the Fed could not print money beyond its holding of gold without
revaluing the dollar against gold. The Quantity Theory of Money
caught up with the financial bubble as prices for equity rose but the
quantity of money remained constant and it came into play with a vengeance. Because
of the gold standard, there reached a time when there was no more money
available to buy without someone first selling. When the selling
began, the debt bubble burst, and panic took over. When the stock market
collapsed, panic selling quickly wiped out most investors who bought shares
instead of gold. As gold price was fixed, it could not fall with
the general deflation and owners of gold did exceptionally well by
comparison to share owners.
What Strong did not figure was that when the Fed lowered the discount rate
to relieve market pressure on the overvalued British pound sterling after
its gold convertibility had been restored in 1925, the world economy could
not expand because money tied to gold was inelastic, leaving the US economy
with a financial bubble that was not supported by any rise in earnings. The
British-controlled gold standard proved to be a straightjacket for world
economic growth, not unlike the deflationary Maastricht "convergence
criteria" based on the strong German mark of the late 1990’s. The
speculation of the Coolidge-Hoover era was encouraged by Norman and Strong
to fight gold-induced deflation. The accommodative monetary policy of the
US Federal Reserve led to a bubble economy in the US, similar to
Greenspan’s bubble economy since 1987. There were two differences: the
dollar was gold-backed in 1930 while in 1987 it was a fiat currency; and in
1930, the world monetary system was based on sterling pound hegemony while
today it is based on dollar hegemony. When the Wall Street bubble was
approaching unsustainable proportions in the autumn of 1929, giving the
false impression that the US economy was booming, Norman sharply cut the
British bank rate to try to stimulate the British economy in
unison. When short-term rates fell, it created serious problems
for British transnational banks which were stuck with funds borrowed
long-term at high interest rates that now could only be lent out short-term
at low rates. They had to repatriating British hot money from
New York to cover this ruinous interest rate gap, leaving New York
speculators up the creek without an interest rate paddle. This
was the first case of hot money contagion, albeit what hit the Asian banks
in 1997 was the opposite: they borrowed short-term at low interest rates to
lend out long-term at high rates. And when interest rates rose because of
falling exchange rate of local currencies, borrowers defaulted and the
credit system collapsed.
The contagion in the 1997 Asian financial crisis devastated all Asian economies.
The financial collapse in Thailand and Indonesia in July 1997 caused the
strong markets of high liquidity such as Hong Kong and Singapore to
collapse when investors sold in these liquid markets to raise funds to
rescue their positions in illiquid markets that were wrongly diagnosed by
the IMF as mere passing storms that could be weathered with a temporary
shift of liquidity. Following badly flawed IMF advice, investors threw
good money after bad and brought down the whole regional economy while
failing to contain the problem within Thailand.
The financial crises that began in Thailand in July 1997 caused sell-downs
in other robust and liquid markets in the region such as Hong Kong and
Singapore that impacted even Wall Street in October. But prices fell in
Thailand not because domestic potential buyers had no money. The
fact was that equity prices in Thailand were holding in local currency
terms but falling fast in foreign exchange terms when the peg of the baht
to the dollar began to break. Then as the baht devalued in a
free fall, stocks of Thai companies with local currency revenue, including
healthy export firms that contracted local currency payments, logically
collapsed while those with hard currency revenue actually appreciated in
local currency terms. The margin calls were met as a result of
investors trying not to sell, rather than trying to liquidate at a
loss. The incentive for holding on with additional margin
payments was based on IMF pronouncements that the crisis was only temporary
and imminent help was on the way and that the problem would stabilize
within months. But the promised help never come. What came was
an IMF program of imposed “conditionalities” that pushed the troubled Asian
economies off the cliff, designed only to save the foreign
creditors. The “temporary” financial crisis was pushed into a
multi-year economic crisis.
Geopolitics played a large role. US Treasury Secretary Robert Rubin decided
very early the Thai crisis was a minor Asian problem and told the IMF to
solve it with an Asian solution but not to let Japan take the
lead. Hong Kong contributed US$1 billion and China contributed
US$1 billion on blind faith on Rubin's assurance that the problem would be
contained within Thai borders (after all, Thailand was a faithful US ally
in the Cold War). Then Korea was hit in December 1997. Rubin
again thought it was another temporary Asian problem. The Korean
Central Bank was bleeding dollar reserves trying to support an overvalued
won pegged to the dollar, and by late December had only several days left
before its dollar reserves would run dry. Rubin was holding on
to his moral hazard posture until his aides in the Department of Treasury
told him one Sunday morning that the Brazilians were holding a lot of Korean
bonds. If Korea were to default, Brazil would collapse and land
the US banks in big trouble. Only then did Rubin get Citibank to
work out a restructuring the following Tuesday in Korea by getting the Fed
to allow the American banks to roll over the short-term Korean debts into
non-interest paying long-term debts without having to register them as
non-performing, thus exempting the US banks from the adverse impacts of the
required capital injection that would drag down their profits.
The Great Depression that started in 1929 was made more severe and
protracted by the British default on gold payment in September, 1931 and
subsequent British competitive devaluations as a national strategy for a
new international trade war. British policy involved a deliberate use of
pound sterling hegemony, the only world monetary regime at that time, as a
national monetary weapon in an international trade war, causing an
irreversible collapse of world trade. In response to British
monetary moves, alternative currency blocs emerged in rising economies such
as the German Third Reich and Imperial Japan. It did not take
these governments long to realize that they had to go to war to obtain the
oil and other natural resources needed to sustain their growing economies
that collapsed world trade could no longer deliver in peace. For
Britain and the US, a quick war was exactly what was needed to bring their
own economies out of depression. No one anticipated that WWII would be so
destructive. German invasion of Poland on September 1, 1939 caused Britain
and France to declared war on Germany on September 3, but the British and
French stayed behind the Maginot Line all winter, content with a blockade
of Germany by sea. The inactive period of the “phony war” lasted
7 months until April 9, 1940 when Germany invaded Demark and Norway. On May
10, German forces overrun Luxemburg and invaded the Netherlands and
Belgium. On March 13, they outflanked the Maginot Line and German panzer
divisions raced towards the British Channel, cut off Flanders and trapped
the entire British Expeditionary Force of 220,000 and 120,000 French troops
at Dunkirk. The trapped Allied forces had to be evacuated by civilian small
crafts from May 26 to June 4. On June 22, France
capitulated. If Britain had failed to evacuate its troops from
Dunkirk, it would have to sue for peace as many had expected, the war would
have been over with German control of Europe. Unable to use Britain as a
base, US forces would never be able to land in Europe. Without a two-front
war, Germany might have been able to prevail over the USSR. Germany might
have then emerged as the hegemon.
Franklin D. Roosevelt was inaugurated as president on March 4,
1933. In his first fireside chat radio address, Roosevelt told a
panicky public that “the confidence of the people themselves” was “more
important than gold.” On March 9, the Senate quickly passed the
Emergency Banking Act giving the Secretary of the Treasury the power to
compel every person and business in the country to relinquish their gold
and accept paper currency in exchange. The next day, Friday March 10,
Roosevelt issued Executive Order No. 6073, forbidding the public from
sending gold overseas and forbidding banks from paying out gold for
dollar. On April 5, Roosevelt issued Executive Order No. 6102 to
confiscate the public’s gold, by commanding all to deliver their gold and
gold certificates to a Federal Reserve Bank, where they would be paid in
paper money. Citizens could keep up to $100 in gold, but anything above
that was illegal. Gold had become a controlled substance by law in the US.
Possession was punishable by a fine of up to $10,000 and imprisonment for
up to 10 years. On January 31, 1934, Roosevelt issued another
Executive Order to devalue the dollar by 59.06% of its former gold quantum
of 23.22 grains, pushing the dollar down to be worth only13.71 grains of
gold, at $35 per ounce, which lasted until 1971.
1929 Revisited and More
Shortsighted government monetary policies were the main factors that led to
the market collapse but the subsequent Great Depression was caused by the
collapse of world trade. US policymakers in the 1920s believed that
business was the purpose of society, just as policymakers today believe
that free trade is the purpose of civilization. Thus, the government took
no action against unconstructive speculation believing that the market knew
best and would be self-correcting. People who took risks should bear the
consequences of their own actions. The flaw in this view was
that the consequences of speculation were largely borne not by professional
speculators, but by the unsophisticated public who were unqualified to understand
how they were being manipulated to buy high and sell low. The economy had
been based on speculation but the risks were unevenly carried mostly by the
innocent. National wealth from speculation was not spread evenly. Instead,
most money was in the hands of a rich few who quickly passed on the risk
and kept the profit. They saved or invested rather than spent their money
on goods and services. Thus, supply soon became greater than demand. Some
people profited, but the majority did not. Prices went up faster than
income and the public could afford things only by going into debt while
their disposable income went into mindless speculation in hope of magically
bailing borrowers out from such debts. Farmers and factory/office workers
did not profit at all. Unevenness of prosperity made recovery difficult
because income was concentrated on those who did not have to spend
it. The situation today is very similar.
After the 1929 crash, Congress tried to solve the high unemployment problem
by passing high tariffs that protected US industries but hurt US farmers.
International trade came to a stand still both because of protectionism and
the freezing up of trade finance. <>
This time, world trade may also collapse, and high tariffs will again be
the effect rather than the cause. The pending collapse of world trade will
again come as a result of protracted US exploitation of the advantages of
dollar hegemony, as the British did in 1930 regarding sterling pound
hegemony. The dollar is undeservedly the main trade currency
without either the backing of gold or US fiscal and monetary discipline.
Most of the things people want to buy are no longer made in the US, so the
dollar has become an unnatural trade currency. The system will collapse
because despite huge US trade deficits, there is no global recycling of
money outside of the dollar economy. All money circulates only within the
dollar money supply, overheating the US economy, financing its domestic
joyrides and globalization tentacles, not to mention military adventurism,
milking the rest of the global economy dry and depriving the non-dollar
economies of needed purchasing power independent of the US trade deficit.
World trade will collapse this time not because of trade restricting
tariffs, which are merely temporary distractions, but because of a global
mal-distribution of purchasing power created by dollar hegemony.
Central banking was adopted in the US in 1913 to provide elasticity to the
money supply to accommodate the ebb and flow of the business cycle. Yet the
mortal enemy of elasticity is structural fatigue which is what makes the
rubber band snap. Today, dollar hegemony cuts off monetary
recirculation to all non-dollar economies, forcing all exporting nations
with mounting trade surpluses into the position of Samuel Taylor
Coleridge’s Ancient Mariner: “Water, water, everywhere, nor any drop to
drink.”
Trade
in the Age of Overcapacity
This article appeared in AToL on July 8, 2005
Neo-liberals have created a false dichotomy between
so-called command economies and market economies. The spurious distinction
is propagated by ideologue free traders in order to give market
fundamentalism an aura of truth beyond reality. Market fundamentalism is
the belief that the optimum common interest is only achievable through a
market equilibrium created by the effect of countless individual decisions
of all market participants each seeking to maximize his own private gain
and that such market equilibrium should not be distorted by any collective
measures in the name of the common good. It is summed up by Margaret
Thatcher’s infamous declaration that there is no such thing as society.
The fact is that in a world of sovereign
states, all economies are command economies. The US, the Mecca of market
fundamentalism, commands her alleged market economy in the name of national
security. While the US tirelessly advocates free trade, foreign trade is a
declared instrument of US foreign policy. President Bush
declares that “open trade is a moral imperative” to spread democracy around
the world. The White House Council of Economic Advisors is organizationally
subservient to the National Security Council. National security concerns
dictate trade policies the US adopts for its economic relations with different
foreign countries. World trade today is free only to the extent
of being free to support US unilateralism. For the US imperium,
the line between foreign policy and domestic policy is disappearing to make
room for global policy. The sole superpower views the world as its oyster
and global trade is to replace foreign trade in a global economy the rules
for which is set by a world trade organization dominated by the sole
superpower.
Free
trade and national security
US trade policy with regard to China, the
world’s fastest growing and most populous economy, is a case in point. The
US is undecided on whether China is a strategic partner or a strategic
competitor or a potential foe. National security concerns envelope the
current controversy over the bid from a Chinese 70% state-owned enterprise,
China National Offshore Oil Corporation (CNOOC), to acquire Unocal, a
US-based independent oil company, even though 70% of Unocal asset and
operations are located in Asia. The proposed deal is subject to
review and approval by the secretive Committee on Foreign Investment in the
US (CFIUS), a federal multi-agency group chaired by the Treasury Secretary
that rules on foreign investment on national security grounds. In 1988,
Congress enacted the Exon-Florio legislation authorizing the President to
suspend or prohibit foreign acquisitions, mergers, or takeovers of U.S.
companies when there is credible evidence that a foreign controlling
interest might threaten national security and when other legislation cannot
provide adequate protection. The President delegated authority to review
foreign investment transactions to an interagency group, the CFIUS.
Some members of Congress have publicly served
notice to the White House that they expect the proposed deal by CNOOC to be
dealt with as one with serious geopolitical dimensions that directly impact
US national security. The CNOOC/Unocal deal is precedent-setting
because it moves the CFIUS beyond its normal high-tech concerns into
strategic commodities. It is also a signal of a trend of more to
come.<><>
In 1989, the President ordered China National
Aero-Technology Import and Export Corporation, a People’s Republic of China
aerospace company, to divest from MAMCO, which involved a US aircraft parts
manufacturer. This was the only case blocked out of 1,500 CFIUS
notifications in 15 years.<>
In 2003, a negative review by the CFIUS caused
Hong Kong-based Hutchison-Whampoa Limited (HWL), a publicly-traded
multinational corporation, to withdraw from a joint bid in partnership with Singapore
Technologies Telemedia Ltd (STT) for Global Crossing (GC), a
distressed telecom carrier in bankruptcy, leaving STT as the sole acquirer
of GC. STT was allowed to acquire GC because Singapore is considered an
ally of the US.<>
Richard Perle, former Assistant Secretary
of Defense for International Security Policy under Reagan,
and one of the key architects of the War on Terrorism and the Iraqi
War, had to resign from the chair of the US Defense Policy Board after
it became known that he was lobbying on behalf of GC. Perle was reported to
be helping to make it possible for HWL to overcome US national security
concerns in order to buy the bankrupt GC. The FBI found at the time that
selling GC to HWL would give it control of the world’s largest fiber optic
network, and allow it to oversee existing contracts for secure Pentagon
communications. Perle was to receive a total payment of $725,000 for his
advisory work, $650,000 of which would be contingent on the sale going
through. The neo-conservatives in the Bush administration, while
aggressively militant to China on security issues, are solidly in bed with
the neo-liberals on in the US business community with regard to trade with
China.<>
According to New York Times columnist Maureen
Dowd, Perle might have had a conflict of interest in that he was Chairman
of the Pentagon’s Defense Advisory Board. Perle defended
himself: “Maureen Dowd’s view of this is very misleading. Ms. Dowd’s
recent editorial suggested that I was retained to ‘help overcome Pentagon
resistance’ to the proposed sale of Global Crossing to Hutchison Whampoa.
That is not why I was retained.” Perle asserted that “I have not been
retained by Hutchison Whampoa, nor have I been retained by Global Crossing
to represent them in any way with the US government. I have been retained
by Global Crossing to help them put together a security arrangement that is
acceptable to the US government.”
In March 2003, an exposé in The New
Yorker by Seymour Hersh that Richard Perle had improperly
represented Saudi Arabian interests. Perle, in turn, has vowed to sue Hersh
and the New Yorker for libel. In an effort to address national security
concerns, the prospective purchasers offered to place GC’s US assets within
a “secure” domestic subsidiary staffed by US persons. When that proposal
did not persuade CFIUS, the parties withdrew their application and re-filed
after formulating a new plan whereby HWL’s ownership interest in GC would
be held in trust by a proxy group of four distinguished US citizens who would
exercise HWL’s voting and corporation governance rights. This arrangement
would reduce HWL to a mere passive investor in GC, an option that caused
many foreign investors in previous deals to abandon their proposed
acquisitions. Usually, such concessions have been sufficient to garner
CFIUS approval. However, CFIUS has decided to conduct a full 45-day
investigation of the GC transaction, which implies that CFIUS was not
satisfied with the latest arrangements. Following this announcement, HWL
dropped its bid, leaving STT to proceed alone.
HWL, a venerable century-old China trade firm
dating back to the British empire, is now controlled by Hong Kong tycoon Li
Ka-shing who has just donated $40 million to University of California at
Berkley. HWL is a leading international corporation with businesses
spanning the globe. Its diverse array of holdings ranges from some of the
world’s biggest retailers to property development and infrastructure to the
most technologically-advanced and market-savvy telecommunications
operators. HWL reports consolidated revenue of US$23 billion for 2004. With
operations in 52 countries and about 200,000 employees worldwide, Hutchison
has five core businesses: ports and related services, telecommunications,
property hotels, retail and manufacturing and energy and infrastructure.In
1991, HWL acquired the United Kingdom’s busiest port, the Port of
Felixstowe, without political opposition. Reflecting its global expansion
and internationalization, Hutchison Port Holdings (HPH) was formally set up
in 1994 to hold and manage the HWL’s ports and related services worldwide.
Since 1994, HPH has expanded globally to strategic locations in 19
countries throughout Asia, the Middle East, Africa, Europe and the
Americas. Today, HPH operates a total of 219 berths in 39 ports along with
a number of transportation related service companies. In 2004, HPH handled
47.8 million TEUs (Twenty-foot equivalent unit containers).
HWL is a leading global telecommunications and
data services provider operating with a high growth strategy in 17
countries and territories. Hutchison Telecommunications
International Limited (Hutchison Telecom) has been listed on the Hong Kong
and New York stock exchanges since October 2004, but not on any Chinese
exchanges. Hutchison Telecom has a significant presence, and in many cases
is a market leader, in developed or rapidly-growing markets in eight
countries and territories, operating mobile networks in Hong Kong and
Macau, Ghana, India, Israel, Paraguay, Sri Lanka, Thailand and Vietnam. HWL
sold EUR1 billion in 10-year bonds on June 22, marking it the largest
euro-denominated bond from Asia this year. In November 2003, HWL
raised a mammoth $5 billion in euros and dollars to a gargantuan $9.5
billion from five different offerings.
When the United States gave Panama full control
of the canal on December 31, 1999, critics raised concerns about foreign
influence and control over the canal’s operation, particularly during an
international crisis. Congressman John L. Mica (R – Florida) gave a speech
on April 27, 1999 entitled: “China’s Interest in the Panama Canal” in which
he asserted: “Hutchison has worked closely with the China Ocean Shipping
Company, COSCO. . . . [which] you may remember is the PLA, and the PLA is
the Chinese Army, PLA-controlled company that almost succeeded in gaining
control of the abandoned naval station in Long Beach, California. . .
.” The offer by HWL and COSCO to purchase the decommissioned
military port of Long Beach, California failed after the US Department of
Defense raised national security concerns over the proposed sale.
A June 1997 Rand report, “Chinese Military
Commerce and U.S. National Security” stated: “Hutchison Whampoa of Hong
Kong, controlled by Hong Kong billionaire Li Ka-shing, is also negotiating
for PLA wireless system contracts, which would build upon his equity
interest in PLA arms company Poly Tech-owned Yangpu Land Development
Company, which is building infrastructure on China's Hainan
Island.”<>
Prompting the national security concern was the
alleged potential strategic reach of the Chinese military through the
financial interests of Hong Kong billionaire tycoon Li Ka-shing, whose
fortune and power were inaccurately linked by misinformed US politicians to
his alleged links to the Chinese government. Panama Ports Company, a
subsidiary of Hutchison Port Holdings of HWL, began a 25-year lease (with a
25-year renewal option) in1999 to operate port facilities at Balboa
(Pacific side of the canal) and Cristobal (Atlantic side of the canal).
This arrangement produces more efficient handling of shipping that benefits
all shipping nations, including China, which is the third-largest user of
the canal and sells more than $1 billion in goods a year through the Colón
Free Zone.
A headline in the Miami Herald on
August 25 1999 read: “Canal Deal Gives Strategic Edge to China, Critics
Charge China-Panama Canal Deal Draws Scrutiny.” According to Miami
Herald, “Li and his business empire are linked to several companies known
as fronts for Chinese military and intelligence agencies. One of the
companies has been indicted for smuggling automatic weapons into the United
States. . . . Li has also been accused of helping to finance several deals
in which military technology was transferred from American companies to the
Chinese army.”
All these accusations were subsequently proved
baseless by official US investigations. Anyone with knowledge about the
history of the business world in Hong Kong knows that Li was a favorite son
of British colonialism long before his cozying up to China. Li got his
start in business exporting plastic flowers from Hong Kong to the US in the
1950s and later became a real estate tycoon in Hong Kong with the help of
British-owned Hong Kong and Shanghai Bank (HSBC) which saw Li as a
promising leader of a new generation of the comprador class the British
were looking to nurture in post-war colonial Hong Kong. Li’s friendly
overture to China was embarrassingly belated and undeniably opportunistic, and
his sympathy for communism totally non-existent even today. Following the
mode of many other successful international businessmen, Li has donated
more than $100 million to medical research institutions in the US, Canada
and the UK.
In October 1999, the Clinton White House
publicly denied that billionaire Li Ka-shing was “working for the
communists in Beijing.” The White house press secretary labeled such
accusations as “silly” and dismissed them as “the kind of thing you see
around here from time to time.” Most US corporations active in China are
working hard to develop the same degree of cooperative relationship with
the Chinese government and its state-owned enterprises. This includes IBM,
General Electric, General Motors, Microsoft, United Technology, Boeing and
many other big name defense and space contractors. Nevertheless, the
propaganda effect on a US public long conditioned to view China with
hostility lingered.
Taiwan also has a container-handling operation
at Coca Solo, at the Caribbean end of the canal, and the Evergreen Group of
Taiwan, which runs it, also has construction, port and hotel projects
there. Ten Taiwanese companies are installed in the Fort Davis industrial
park, and the Taiwanese construction company King Hsin submitted a bid to build
a second bridge over the canal, at a cost of US $270 million. But the US is
not concerned with Taiwan because it is a virtual US protectorate.
Panama Ports Company, a subsidiary of Hutchison
Port Holdings of HWL, began a 25-year lease (with a 25-year renewal option)
in 1999 to operate port facilities at Balboa (Pacific side of the canal)
and Cristobal (Atlantic side of the canal). This arrangement benefits all
shipping countries, including China, which is the third-largest user of the
canal and sells more than $1 billion in goods a year through the Colón Free
Zone. Notwithstanding that HWL is not even a Chinese company and
its shares are not traded in any Chinese stock exchanges on the mainland,
HWl was accused of being closely linked to, or perhaps even directly
controlled by China. In reality, HWL investment in the canal is
reflective of it attraction to commercial opportunities in Panama, rather
than a threat from China to control the operations of the waterway. Taiwan
also has an extensive business presence in the canal area. Besides, the
Constitution of Panama reserves direct authority and control over the
canal. Chinese officials dismissed the idea that China is
attempting to influence or take over the Panama Canal is "sheer fabrication
with ulterior motives.” Chinese residents in Panama are descendants of
immigrants who originally formed the main source of forced labor on the
Trans-isthmian railroad. They now represent about between 4 and 8 percent
of the local population depending on the definition of ethnicity as much
integration has occurred through inter-ethnic marriages. This is about the
same number of citizens as Panama’s indigenous peoples of the Kuna, Guaymie
and Chocoe tribes. There are more US citizens living and working in China
than there are Chinese citizens in Panama. With a history of being a main
target of US embargo for more than three decades, China’s interest in Latin
America is unrestricted access to trade and natural resources for all
countries. From a Panamanian point of view, intervention by the US is a
more credible threat than a Chinese takeover.
No free
trade for oil
While the current rise in oil prices reflects
systemic dynamics in oil economics (see The Real Problem of $50 Oil - May
26, 2005 AToL), many in US political circles find it convenient to blame it
on a single component of increased demand by China and India. On
April 26, 2005, President George W Bush, meeting with Saudi Crown Prince
Abdullah at his ranch in Crawford, Texas, told the press that “the price of
crude is up because not only is our economy growing, but economies such as
India and China’s economies are growing as well,” notwithstanding that the
announced purpose of the US-Saudi summit was to get Saudi Arabia to
increase production, the short fall of which was driving oil prices up.
The Vice Chairman of Chevron, the rival bidder
for Unocal, publicly suggested that “this is sort of geopolitics we are
playing here, not commercial business.” He explained that
Chevron would put oil on the market for sale to the highest bidder whereas
a Chinese-owned CNOOC would use the oil it produces for domestic
consumption that would yield “less oil on the world market which meant
higher prices for US consumers.” Yet CNOOC’s interest in Unocal
is mainly in its natural gas reserves in Asia, which poses no national
security threat to the US. North American gas supply, counting both US and
Canada, faces no shortage. Both the US and China are rich in coal which
generates more than half of the electricity in both economies. In a public
statement, Fu Chengyu, Chairman and CEO of CNOOC reaffirmed that
substantially all of the oil and gas produced by Unocal in the US will
continue to be sold in the US, and the development of properties in the
Gulf of Mexico will provide further supplies of oil and gas for US markets.
Fu also repeated the commitment on behalf of CNOOC to retain the jobs of
substantially all of Unocal employees, as opposed to Chevron’s plan to lay
off redundant employees after the merger, especially in the Unite States. Secretary
of State Condoleezza Rice was a director of Chevron for a decade before
joining the Bush team, and even had a Chevron tanker named for her.
It’s a tossup how the CFI will eventually rule,
assuming CNOOC can put together the winning financials to request a CFI
ruling. There are reservations in China that CNOOC may be forced
to pay too much for a company that is worth less than $1 billion even at
high current energy prices. But the CNOOC/Unocal deal is an
early signal of a rising trend, which has already ignited a visible split
between anti-China forces in some faction in the US political establishment
and the pro-trade forces in the US business community which view China as a
great market the US cannot afford to pass up. To China, a negative ruling
will look as if the US will welcome China to buy as much oil as it needs at
market prices, but not will welcome it to own any oil resources even if
such resources are not critical to US national security. Yet, the history
of the US using the supply of oil as a geopolitical weapon is long and
obvious. It was a key factor behind the Japanese attack on Pearl
Harbor in 1940. Further, even on a commercial basis, the US for decades had
restricted the export of domestic oil to keep domestic prices lower than
world prices. Now it is trying to prevent China from doing the same.
And in the two decade since China began to
integrate its economy into the global economy, China has received far more
foreign direct investment (FDI) than it has made overseas. In
2004, China received $61 billion of FDI while Chinese companies invested
only $3.6 billion overseas, even when China has become the world’s second
largest creditor nation with foreign exchange reserves of over $660 billion
by the end of March 2005. Congress is heading towards a vote to
impose a 27.5% tariff on Chinese goods if China does not revalue the yuan
at the command of the US, despite Federal Reserve Chairman Alan Greenspan’s
public warning that the yuan’s revaluation would have no significant impact
on the US trade deficit and job loss and that protectionism against China
would put the US economy at risk for no discernable purpose or advantage.
There are those who argue that Chinese
companies would be welcome to participate freely in the US market if they
were not state-owned enterprises (SOE) controlled by the Chinese
government. The counter argument is that allowed Chinese SOEs to
invest abroad will accelerate the withdrawal of government control over
commerce in China. Besides, European and OPEC member state-owned
enterprises routinely participate in international mergers and acquisition.
Every US oil company, including Chevron, is also eying business
opportunities in the development of Chinese offshore oil
exploration. Many major US corporations are aggressively trying
to invest and acquire Chinese government-owned companies in China. It is
hard to argue that Chinese government-owned companies should not be allowed
to acquire US corporations in the US. Thus the argument of a two-way street
is a strong one.
British Nuclear Fuels plc (BNFL), owned by the
British government, acquired without controversy Westinghouse Electric
Company, the commercial nuclear power businesses of CBS in 1999.
(Westinghouse acquired CBS in 1995). Britain is of course an
ally of the US.
On a trip to China last April to discuss
high-stakes issues of terrorism and North Korea nuclear proliferation, Vice
President Dick Cheney made a pitch for Westinghouse’s nuclear power
technology. At stake could be billions of dollars in business in coming
years and thousands of jobs in the US. The initial installment of four
reactors, costing $1.5 billion apiece, would also help narrow the huge US
trade deficit with China. China’s latest economic plan anticipates more
than doubling its electricity output by 2020 and the Chinese government,
facing enormous air pollution problems, is looking to shift some of that
away from coal-burning plants. Its plan calls for building as many as 32
large 1,000-megawatt reactors over the next 16 years.
The US Department of Energy reported in March
2005 that Chinese industries were energy intensive with significant
economy-wide waste. The country uses three times more energy per dollar of
its GDP than the global average and 4.7 times more than the United States.
Westinghouse faces French and Russian competition in contracts for third
generation China National Nuclear Corporation (CNNC) plants at Sanmen
(Zhejiang) and Yanjiang (Guandong) to be awarded this year. Recognizing
that nuclear technology sales to China would help address massive US trade
imbalance with China, the US Nuclear Regulatory Commission has cleared the
transfer of technology while the US Export-Import bank has approved $5
billion in loan guarantees for the Westinghouse bid. Domestic political
opposition to US participation in the China nuclear power program is
mounting to stop the pending deal. Meanwhile, Chinese planners are warning
investor to exercise caution to avoid blindly over-investing in the Chinese
energy sector.
The reason the US never got excited about
Japanese and German acquisition of US assets is that these countries, as
once-defeated nations and now-subservient allies, know their place in the
pecking order in geopolitics enough to voluntarily restrict their
acquisitions to non-strategic real estate, and stay clear of strategic
sectors such as oil. The Japanese and Germans have dutifully
kept themselves restricted to oil trading and refrained from aspiring to be
owners of oil assets, a sector reserved exclusively for Anglo-US interests
as war trophies. But the Chinese, encouraged by US neo-liberal
advisors to imitate the US model of globalized business strategy, are
beginning to accept the propaganda of free trade to assume the audacity of
daring to buy into US strategic assets with the fiat dollars they earned in
their trade surpluses with the US. China appears to be tired of
merely holding US papers, and want some real asset for a change in return
for shipping real wealth created by cheap Chinese labor to the US. The
zealous convert, who has become a fervent believer in the God of free
trade, is challenging the Pope. US policymakers are beginning to realize
that a capitalist China in a neo-liberal world order is by far more of a
threat to US national interests as a superpower than a communist China in
the Cold War.
The June 24, 2005 Wall Street Journal reported
that celebrated economist Kenneth Courtis, Vice Chairman of Goldman Sachs
Asia and outside director of CNOOC, caused a postponement of the initial
planned $16.7 billion offer in April. The delay opened the way
for Chevron to strike a deal to buy Unocal instead, causing CNOOC to have
to bid in June $2 billion more than it had contemplated in its initial
offer in April. Courtis, an expert on Asian economies, had been humbled
by facts divergent from his optimistic pronouncements on the Japanese
economy at its strongest in 1989 with regard to strong future prospects,
which promptly began in a downhill slide ever since. His bullish
projections on the continuing growth of Asia just before the Asian
financial crisis of 1997 proved to be another embarrassment. But economists
are like cats with nine lives who can afford to leave clients who followed
their bad advice to perish while they themselves move on to new theories. Courtis,
the free-trade enthusiast, resurrected his tarnished reputation by playing
a revisionist role against market fundamentalism in the decision of the
Hong Kong government to make a defensive “market incursion” to ward off
manipulative speculation of the Hong Kong market by overseas hedge
funds. The Hong Kong Monetary Authority, with a war chest of
over $100 billion, easily demolished the hedge funds by using $18 billion
in three days to stabilize the Hong Kong equity market where the normal daily
trading volume was only around $1 billion. For three days, Hong Kong,
consistently voted by the Heritage Foundation as the world’s freest market
economy reverted back to a command economy to protect its stock market from
the destructive effects of manipulation by hedge funds on the fixed
exchange rate of its currency.
While no outsider knows why Courtis reclused
himself on the CNOOC decision, it would not be unreasonable to suspect that
geopolitics was part of the consideration. For a Chinese
state-owned enterprise to buy a US oil company might have been a bridge too
far at this time in view of rising hostility in US domestic politics toward
China. After all, do the Chinese, with thousands of years of
sophisticated political culture, and decades of exposure to Marxist
theories, not know that free trade is merely a slogan in US
policy? Or is China, advised by US neo-liberals, simply making
the US face its own music?
General
Motors and China
China has also become something of a whipping
boy in the US debate about job loss to nations with super-low wages, based
on a misguided conclusion, springing from the recent growth of China's
trade surplus with the United States to $124 billion in 2004. Total US
trade deficit for 2004 with all countries was $666.2 billion in 2004, $164
billion of which was in oil import at an average price of $32 per barrel.
What has happened is that other Asian exporting economies, notably Japan,
Korea, Taiwan and Hong Kong, have moved much production to mainland China
on products destined for export to the US. So China’s trade surplus with
the US has soared while US balance of trade with other Asian economies has
flattened or dipped slightly.
The Chairman of Toyota Motor Corporation,
Hiroshi Okuda, is urging Japanese automakers to raise prices or find other
ways to level the playing field for ailing US rivals General Motors and
Ford in hopes of heading off a possible protectionist backlash in the
crucial North American market. The world’s largest automaker, General
Motors, had $52.6 billion in cash and marketable securities on its balance
sheet at the end of the first quarter 2005, even as it reported a $1.1
billion net loss for the quarter. The GM finance unit, GMAC, made $729
million profit in the first quarter. And even though GMAC commercial paper
was cut to junk bond status along with the debts of the rest of the
company, the finance unit still has sufficient access to cheap capital to
keep posting strong profits going forward. But GM has serious enough
problems that its executives would not even project when it might return to
profitability. The downgrade to junk bond status is one warning sign.
Another is its market capitalization sliding below $19 billion, well below
its cash on hand of $52 billion, with a debt of $300 billion. This means
investors are saying that the company has negative value if its cash is
taken out. By contrast, and as an indication of a bubble economy, Google’s
market capitalization, less than 11 months since its IPO, has topped $81
billion, trading at 50 times estimated earnings, compared to 22 times for
Time Warner, 21 times for Disney and 19 times for Viacom. Google
sales in 2004 totaled just $3.2 billion while Time Warner stood at $42
billion. GM sales in 2004 totaled $193.5 billion with net income of $2.8
billion, yielding a market capitalization of only 6.8 times of earnings.
The problem is that GM’s key
product -- its gas-guzzling sport/utility vehicles -- are seeing declining
demand that has forced the company to step up the cash-back offers
needed to maintain sales. That
should not have been a surprise, given rising gasoline prices that are not
expected to moderate because of a shortage of refining capacity. But GM has
not responded effectively to sudden market changes. Instead of introducing
new vehicles to fit new market conditions, it has tried to keep sales of
unpopular vehicles strong through ever-increasing financial incentives. It
is very unwise for a high-cost producer to lead a price war. The result was
financial loss accompanying market share loss to more cost-effective
foreign competitors.
GM is in talks with the United Auto Workers union (UAW) over its health
care costs, which cost GM an average of $1,500 more per vehicle than that
of foreign competitors, even on cars and trucks made at the Japanese
automakers’ US plants. Some
observers thinks the best alternative could be to file for bankruptcy
protection, and try to have the court force health care savings and other
cutbacks on the UAW. Another alternative is that only the auto operations
file for bankruptcy, thus preserving the corporation’s finance unit and
other assets, such as its horde of cash. The rating agencies and stock
market are sending a clear message that they think GM will continue to lose
money for the foreseeable future and eventually go bankrupt. Bankruptcy is
a defensive strategic option or an unavoidable eventuality.
But even the profitability of GMAC, the finance unit, would be under threat
as the Fed raises short-term interest rates. The rising cost of funds will make
it more difficult for GMAC to offer attractive financial incentives to sell
unpopular GM cars. GM
has been following the strategy of GE to try to turn itself into a global
finance company which incidentally also manufactures, selling its
uncompetitive manufactured products with aggressive compensatory vendor
financing. This finance game has overtaken the entire US economy where all
the profit is being made by the financial sector, while its manufacturing
base in the US falls into decay through outsourcing to low-wage locations
overseas. GM’s strategy
now is to be the finance and marketing arm of an auto sector in the process
of being relocated from Detroit to China, while maintaining its profit
margin from finance.
When the outspoken Toyota chairman said he feared the possibility that U.S.
policy could turn against Japanese auto makers if domestic giants such as
GM and Ford were to collapse, he was not being truly outspoken. “Many
people say the car industry wouldn’t revisit the kind of trade friction we
saw in the past because Japanese auto makers are increasing local
production in the United States, but I don't think it’s that simple,” Okuda
said in a press conference, “General Motors Corp. and Ford Motor Co. are symbols
of U.S. industry, and if they were to crumble it could fan nationalistic
sentiment. I always have a fear that that in turn could manifest itself in
policy decisions,” speaking as the head of the nation's biggest business
lobby, the Japan Business Federation. But what was not said was that
Toyota has a more serious hidden apprehension than a revival of US
protectionism from the collapse of GM or Ford. What Toyota really wants is
to keep GM manufacturing in the US where it can never achieve cost competitiveness,
and not move its manufacturing to China with a new business paradigm to
compete with Japanese auto makers there.
Okuda raised eyebrows and invited criticism on both sides of the Pacific
with his call for fraternal aid to U.S. auto makers, such as by raising
Japanese product prices, as US producers reel under massive health-care
costs and sliding sales. It is a call for price signaling if not outright
price fixing. According
to US anti-trust laws, inviting competitors to match your price increases
can be illegal price signaling, says lawyer Jim Weiss, former head of an
antitrust unit at the Justice Department.
GM has announce plans to cut at least 25,000 manufacturing jobs and close
more US assembly and component
plants over the next few years. Both GM and Ford have been cutting back
output as they lose sales to Asian brands led by Toyota, which now controls
13.4% of the US car market, the world’s biggest to date. But the China
market is looming large as a new opportunity for GM, which ended 2004 with
a market share of 9.3% in China. The
GM China Group includes seven joint ventures and two wholly owned
enterprises in China. In 2004, GM’s vehicle sales in China grew 27.2% on an
annual basis to 492,014 units, an all-time high. China’s market is still in its
infancy, with less than 5 percent of the population able to afford even a
tiny car. GM Chairman and CEO Rick Wagoner predicts China will overtake
Japan as the world's second-largest car market within five years.
Detroit Free Press columnist Tom Walsh reports that in 2003, GM and its
Chinese partners made $2,267 per car sold in China while in North America,
GM made about $145 per vehicle. GM and its Chinese partners had a combined
net profit of nearly $875 million, or about $2,267 per vehicle sold in
China. In North
America, GM's net profit last year was only $811 million on sales of 5.6
million cars and trucks in the United States, Canada and Mexico, or about
$145 per vehicle. That
means GM China was nearly 15 times more profitable, per vehicle sold, than
GM North America. GM, for example, is selling Buick Regal models in
China for more than $40,000 that are less powerful than a 3.8-liter, 4-door
Regal sedan that costs about $24,000 in the US.
“GM is making money hand over fist in China, selling cars as fast as they
can make them, at very attractive prices,” says Kenneth Lieberthal, a
University of Michigan professor and China expert who was senior director
for Asian affairs on the National Security Council under President Bill
Clinton. “Most of the jobs lost to Asia were lost years ago. Now they're
moving around Asia,” says Lieberthal. “If what’s good for General Motors
is good for America, as former GM President Charlie Wilson once said,
China’s emergence as an economic powerhouse can’t be all bad,” writes
columnist Walsh.
Okuda told the press: “If you think about GM's current output volume and
vehicle lineup, laying- off 25,000 to 30,000 employees is inevitable.” But
within a decade, GM could be again the world’s largest profitable car producer
if its China strategy is successful. And its success is dependent on
whether GM can become a truly multinational corporation instead of merely a
transnational US corporation active in China. Chinese consumers will
relieve the global overcapacity problem in the auto industry, but they
cannot do so if transnational corporations continue keep robbing them of
the consumption power by keeping Chinese wages low to siphon profits home.
GM has been closing and idling plants over the past four years and
will have to cut its annual North American assembly capacity to 5 million
vehicles by the end of 2005 from 6 million in 2002. Meanwhile, top Japanese
auto makers are adding jobs and assembly lines in North America to meet
shifting demand there at the expense of GM and Ford, but not the US
economy, prompting executives, including Toyota President Fujio Cho, to
dismiss concerns that their success would reignite a political backlash.
Thus Okuda’s concern is not about US protectionism, a concern refuted by
Toyota’s own president. It is about GM plans in China.
Car companies now are merely brand-name designers and assemblers of a
generic world car. All
cars today are assembled from parts produced all over the world where they
can be produced at the lowest cost. Different band-name designs package the
same world car for varying appeals in different market segments, some for
speed and power, some for styling and luxury, some for economy, etc. As US
car-assembling giants face market resistance, US auto-parts companies have
begun to fall like rows of dominoes, made worse by rising material and
energy prices and uncompetitive wages. Recently, auto-parts supplier
Collins & Aikman Corporation was the latest to file for bankruptcy
protection, lining up behind fellow suppliers Meridian Automotive Systems,
Tower Automotive Inc. and Intermet Corporation. Whether those companies and
the others that might join them at the bankruptcy court will recover – and
what form they will take after bankruptcy – is an open question. A restructuring
of the entire US auto manufacturing industry and its supplier network is
shifting the center of gravity outside the US, possibly to
China. Japan has its own ambitious plans for China where Japanese car
makers have already invested over $5 billion. Honda Motors just announced
that its joint venture in China has begun exporting made-in-China Hondas to
Europe. This is why the Japanese, with their own ambitious plans in China,
are thinking about helping Detroit, to keep a terminally ill competitor on
anemic life support, not to ward off US protectionism, but to pre-empt
unwanted US competition in China. A trade war between the US and China will
play directly into Japanese hands, not to mention the EU.
The sudden decline in the popularity of SUVs - where US auto companies have
for more than a decade clocked big profits in the era of cheap oil - has
joined with rising material costs, mounting worker benefits costs and
expensive unionized workforces to eat into huge chunks of the sector’s
profits. Add to that the relentless pressure from foreign automakers, and
the result has been a steep slide for any company that relies on the
Detroit automakers for its bread and butter. In April, while North American
auto sales rose, both GM and Ford sales of SUVs dropped – as did their
total sales.
As the supply sector shrinks along with declining US automakers market
share, an industry that once seemed ripe for consolidation is now plagued
by the question of who would want to acquire companies in a sector that has
had such hard time making money lately and in the foreseeable future. The
pool of likely acquirers from within the sector is also dwindling as
virtually the whole sector slides in concert. It is hard to consolidate
when earnings are weak to non-existent, balance sheet weak, with no access
to capital markets and equity merger and acquisition funds dry up. Buying
auto-supply companies that are dependent on the struggling US automakers
for its business is not the most attractive business proposition at this
time for other companies. The only exception is a Chinese acquirer who may
buy to facilitate opportunities in the Chinese domestic market and eventual
entrance to the US market to increase long-term global market share rather
than immediate return. But with current political controversy over Chinese
acquisition of Maytag and Unocal, China will likely adopt a wait and see
posture to see how US domestic politics on free trade plays out. This delay
will make bankruptcy more likely to a host of distressed US companies in
many sectors besides autos.
With General Motors’ significant cash reserves, it could be several years
before the company is forced to face the music, despite its dwindling
market share and mounting loss. With over $50 billion in cash, even with
losses at the rate of $5 billion a year, it will take 10 years before GM
runs dry. Long before that, GM’s China strategy may already bear fruit if
no trade war erupts to derail its plan.
The steel and airline industries have dumped under-funded pension plans on
the federal government’s Pension Benefit Guaranty Corporation (PBGC). The
auto industry may be next. Beyond the airline industry, the federal
insurance program faces tremendous exposure from the auto sector. PBGC says
the pension assets of auto makers and parts companies fall short of the
pension promises they have made to workers by up to $50 billion, more than
the $31 billion shortfall in the airline industry’s pension plans. A Credit Suisse First Boston
analysis of pension plans in 54 US industries, based on 2003 public
filings, ranks the auto industry’s plans the weakest of all. Half-dozen
auto-supply companies recently sought Chapter 11 bankruptcy protection,
which is likely to result in $837 million in unfunded pension obligations
being transferred to the PBGC. A total of 26 companies in the auto industry
have pension plans with assets that fall at least $50 million short of
obligations.
The company that worries the PBGC most to date is Delphi Corporation, the
Troy, Michigan, parts operation of GM that was spun off in 1999. Delphi’s
plans have pension obligations valued at $11.4 billion but assets of only
$7.4 billion. Delphi relies on GM for about half of its $28 billion in
annual revenue and is saddled with high labor and raw-materials costs at
the same time that GM's production is falling. PBGC calculates pension
liabilities based on what it would cost to pay retirement benefits if the
plans were terminated; companies give snapshots of the current health of
their plans, often a rosier view. PBGC says that if Delphi were to turn
over its pension plan to the agency today, the under-funding would total
$5.1 billion rather than the roughly $4 billion indicated by Delphi. UBS
suggested in a recent report that Delphi should consider a Chapter 11
filing, in part to shed its pension obligations and to pressure the United
Auto Workers to help it cut costs. “Bankruptcy has become a management tool
these days,” the UBS report noted.
Bush administration proposals to bolster PBGC finances could intensify the
pressure on companies with low credit ratings. The plan calls for flat-rate
premiums for companies to jump to $30 annually from $19 for each employee
covered by a pension plan, and higher for companies with low credit
ratings. It also seeks to limit the ability of financially weak companies
to make new pension promises to workers.
Overcapacity and trade
Tapping into a growing China market will significantly contribute to less
painful resolutions of these problems, both for the auto giants and for the
government pension agency. This
is one of the reasons why Greenspan says anti-China protectionism hurts the
US economy more than it helps and why the White House is dodging the
CNOOC/Unocal controversy. In
an age of global overcapacity, the economies with large population and
massive untapped consumer power hold the key to the future. This presents a dilemma for US
policy toward countries like China and India. On one level, the world
economy needs to develop these populous markets to relieve global
overcapacity; on another level, the rise of income necessary for such
expanded consumption translates into a leveling of the power differential
long enjoyed by the world’s sole superpower. Suddenly, the needs of the global
market to overcome global overcapacity with new consumers are turning
against the traditional security and economic interests of the US. In response, the US is turning
back towards its own history of command economy. Emotional debates have
emerged within US policy circles on the merits of globalized neo-liberal
market fundamentalism versus the need for protectionist economic
nationalism.
In some economies, such as the US, policymakers traditionally achieve their
command objective through macro management while in others economies, such
as Japan until the 1980s, Korea and Taiwan even today, policymakers prefer
to do so through micro management. China has recently moved towards macro
management of its economy, reportedly with some success, while the US, as
exemplified by the ruling authority of FICUS that leads to presidential
actions, appears to be reverting to a micro approach to deal with command
economy objectives on a case by case basis. Policymakers in self-proclaimed
market economies normally manage their policy objective through monetary
and tax policies in accordance to macro-economic theories, but even then
they do so with national objectives in mind. Such national objectives are
known as national interests in policy nomenclature. For example, the Fed
defers to the Treasury on determination of the proper exchange rate for the
dollar. When market forces move against the Treasury’s view on dollar,
moving it either too high or too low in relation to other currencies, the
Fed supports the Treasury as a matter of national security in its effort to
intervene in the market to bring the dollar back in line, or at least
moderate the volatility. All nations employ industrial policy when it comes
to defense and defense related sectors. And as military/civilian dual-use
definition expands, more and more of research and development, high tech
production, heavy manufacturing and strategic materials are removed from
free trade to rely on government subsidies and procurement contracts. Dual use restriction is one of the
major factors contributing to trade imbalances between the US and China.
Beyond dual use technology, the US has very little to sell. Free trade in
the US perspective is not remotely the same as freedom to trade.
Market Economies and Privatization
The idea that market economies are governed by the unseen hand of the
market is pure fantasy. The US has been relying on its petroleum reserves
to moderate the rise in oil prices since 1973 and China is only beginning
to realize the need of a national petroleum reserves. And the idea that market forces
always produce the best possible social outcomes or the best protection of
national security is blatantly false. Without government control, markets
merely become command economies that are commanded by powerful special
interests. The aim of government command in all economies is to protect the
interests of all the people fairly within the nation and to protect
national interests beyond a nation’s borders. No nation will allow the
market to threaten its national interests or security. The idea that market
economies require privatization to operate effectively is also pure
fantasy. Markets can operate quite well in socialist economies. All it
needs is a different framework from capitalist economies. Some economies
are privatized more than others. Even in capitalist economies,
privatization is never total. Mutual funds are a sector of voluntary
collective ownership. The insurance sector in the US used to be
predominantly mutually organized companies, as were credit unions. They
operated very well until laws protecting them were rescinded for
ideological rather than economic reasons.
Privatization of social security is an oxymoron. It is either private
security or social security, but not both simultaneously. Historically, social security was introduced
in the US after private security failed the average US worker in the 1930
depression. How on earth can private security in a market economy be
expected to save social security when social security grew out of the
failure of private security in a business cycle? There is an iron law of the market: that when sellers
outnumber buyers, prices go down. Now,
actuary problems of social security arise when the number of living retirees is growing faster than
the number of tax-paying young workers, causing a bigger draw on the social
security trust fund than concurrent contributions. So if young workers buy stocks during
their working years to provide for their future
retirement and retirees must sell the shares they have accumulated over
their previous earning years in order to live in retirement, and if
retirees outnumber young
workers by a wider margin with every passing year, how is the market going to rise with
more sellers than buyers?
Even in the privatized sectors in capitalist economies, the government
still decides what is profitable. In fact, it even decides what profit is,
and how much to tax it. Much of the recent issues on corporate fraud have
to do with illegally booking debt as profit to mislead the market. Free
markets are free only to the extent within the rules of the game set by
government. When governmental rules stay for long periods, they become
invisible tradition and are accepted by market participants as natural
conditions. Generally
accepted accounting principles (GAAP) have a large measure of
government-defined concepts and measures in them. Most governmental rules
that can be changed easily without political difficulty are changed rather
forthrightly. What are
left are rules that for all kinds of political reasons cannot be changed
easily by government. War
provides opportunities for governments to change these undesirable,
obsolete or dysfunctional rules that are politically difficult to change in
peace time. The private sector cannot launch wars to bring about preferred
rules for enhancing profitability, but it can co-opt government policy
toward war. This is the
economic basis for all wars.
Trade
Related Aspects of Intellectual Property Rights (TRIPS)
This article appeared in AToL on August 5, 2005
Intellectual
property rights has been blown up to be the wide open virtue empire
building arena by TRIPS
Property rights are a social institution, not a natural
phenomenon. Intellectual property is an invention of the
knowledge-based economy. Both free traders and protectionists in the US
agree on the need to protect US intellectual property (IP) rights globally
in general and in China especially. Of course a protectionist regime has
less, if any, leverage at its disposal for combating the violation of
intellectual property rights outside its borders. The Uruguay Round in 1986
produced the WTO Trade Related Aspects of Intellectual Property Rights
(TRIPS) agreement. It is supposed to be an attempt to narrow the
discrepancy in ways these rights are protected in different countries
around the world, and to bring them under common international rules. It
establishes minimum levels of protection that each government has to give
to the intellectual property of fellow WTO members. In doing so, it
attempts to strike a balance between the long term benefits and inevitable
short term costs to global society at large. Society benefits in the long
term when IP protection encourages creation and invention, especially after
the limited period of protection expires and the creations and inventions
enter the public domain. National governments are allowed to reduce any
short term costs through various exceptions, for example to tackle critical
time-sensitive public health problems. The WTO dispute settlement system is
designed to settle international trade disputes over IP rights before such
disputes translate into political tension.
Yet ideas and knowledge are increasingly important, even dominant, parts of
trade. Because technological underdevelopment in many countries is
traceable to the historical legacy of Western imperialism, TRIPS can be
viewed as condoning hidden trade-restricting tariffs imposed on the world
by the technologically-advanced economies to perpetuate cultural
imperialism. Prices of goods that carry IP rights invariably enjoy
astronomical margins of profit over production cost. This high margin is
rationalized by the claim that most of the cost of new medicines and other
high technology products lie in the amount of invention, innovation,
research, design and testing involved, not production cost.
The current high margin is designed to not only repay past research and
development costs, but to finance on-going such costs to sustain an
uninterrupted future stream of inventions. This means the technology gap
between rich and poor economies will be widened with time under TRIPS. Only
established mega drug companies operating with a de facto economic monopoly
through astronomical price mark-ups can afford to develop new drugs. With
all the talk about the need for competition policy, IP rights protection is
shaping up to be the most anti-competitive regime in world trade. Further,
in many advanced economies, such research and development costs are
subsidized by government funding or tax deductions, paid for by the general
public. Yet patent earnings seldom, if ever, flow back into private bank
accounts of individual taxpayers in the form of tax rebates.
Films, music recordings, books, computer software and on-line services are
bought because of the information and creativity they contain, not because
of the plastic, metal or paper used to make them. The cost of material and
printing is a miniscule part of the price of these products. The
bulk of the price goes to pay for advertising, distribution and only
finally fees for licensing IP rights of the creators. Much of the revenue
from IP rights goes to middleman organizations rather than original
creators, weakening the argument that its protection encourages invention.
Many products that used to be traded as low-tech goods or basic commodities
now contain a higher proportion of invention and design in their value -
for example brand-name clothing or genetically-modified new varieties of
plants and produce. Creators are given the right to prevent others from
using their inventions, designs or other creations - and to demand payment
in return for others using them. These “intellectual property rights” take
a number of forms. For example, books, paintings and films come under
copyright; inventions can be patented; brand names and product logos can be
registered as trademarks; and so on. Governments have given creators these
rights as incentives for producing ideas that will benefit society as a
whole.
But often, intellectual property rights are abused to protect
trade-restraining monopolies. In such cases, both the definition of
intellectual property and the enforcement of its protection can be unjust
and oppressive. When copies of Louis Vuitton bags of same quality can be
sold at a fraction of the price of the original at a profit, it is
empirical evidence that the profit margin of the original is excessive. If
the copies are of inferior quality, then they are caricatures and arguably
not a violation of intellectual property rights. Fakes that are sold as
fakes do not qualify as theft of the original. It is not illegal in any
country to sell copies of the Mona Lisa as copies. The reason behind
widespread intellectual property rights violation is because unjust and
oppressive laws invite popular resistance.
The extent of protection and enforcement of intellectual property rights
varies widely around the world according to varying stages of economic
development in different countries. As intellectual property
became more important in trade, these differences became a source of tension
in international economic relations. New internationally-agreed trade rules
for intellectual property rights are supposed to be a way to introduce more
order and predictability, and for disputes to be settled more
systematically before they translate into political tensions. But they can
also be viewed as a new form of rule-based knowledge
imperialism. There exist an inherent inconsistency and conflict
of interest for an industrial standard to claim protection of intellectual
property rights because the condition for being accepted as industry
standard is that all in the industry can use it freely. An industry
standard that demands payment of fees for its use is a monopoly.
The argument that protection of intellectual property rights is
indispensable for economic growth has no basis in history. The
socio-economic and political history of the US was shaped by the widespread
piracy of a simple pattern held by Eli Whitney (1765-1825) on the cotton
gin, the widespread use of which had immense socio-economic and political
repercussions. Little cotton had been produced in America prior to 1793.
During the colonial period, the main crop was tobacco, but tobacco farming
had ceased to be profitable as a result of soil exhaustion. The tedious
process of separating short cotton fiber from the seeds had to be done by
hand and took too much time to be profitable even in a slave economy. A few
planters grew a long-staple strain called Sea Island cotton that was easier
to separate, but this only grows in coastal areas, not inland, where only
short-staple cotton can be grown. Whitney’s cotton gin made it possible to
grow short-staple cotton inland for profit. The cotton kingdom then
stretched quickly over a vast area from Georgia and South Carolina westward
as far as Texas. With the growth of the British textile industry, cotton
growers in the US were assured of a market for all they could produce. But
cotton growing was labor-intensive, which perpetuated the south's slavery
economy, which until the arrival of the cotton gin was fading as an
economic institution because of a dwindling need for cheap labor. Also,
cotton, unlike rice and sugar, was a more democratic crop, being equally
profitable for large landowners with hundreds of slaves and for small
farmers with a couple of hundred acres and two or three slaves. Right up to
the Civil War, half of the cotton was grown by small farmers with fewer
than six slaves each. The widespread piracy of the cotton gin pattern
created a socio-economic condition that became one of the key causes of the
Civil War. Thus for the South, the civil war was in essence a
people’s war against the big business interests of the North.
In recent years, the US judiciary and some highly-placed US government
economists have been claiming that in the knowledge-based economy,
antitrust laws may threaten economic liberty, turning antitrust on its
head. The US Appeals Court’s decision (District of Columbia circuit) on
Microsoft in July 2001 raised the issue with timely urgency. The justices
acknowledged that tying browsers (Internet Explorer) or other add-on
programs to computer operating systems (DOS-based Windows) may not be bad
for economic freedom. The court, while upholding a lower court’s finding
that Microsoft had engaged in unlawful monopolistic acts, said broadly that
it is unclear how the “current monopolization doctrine should be amended to
account for competition in technologically dynamic markets.” And given
these conditions of uncertainty, courts must demand “considerable
experience with certain business relationships,” such as software packages
that bundle services together, before jumping to the conclusion that they
are unlawful. The court said that in the future, all cases of tying
involving platform software (upon which other computer programmers build)
should be judged by a higher standard of proof.
Existing antitrust law requires only the "per se" test, which
merely requires proof of the existence of a tie involving a dominant
producer. But the court now says that platform-software cases must be
judged by the “rule of reason,” which requires courts to balance the
pro-competitive aspects of the tie against the anti-competitive ones. The
new standard will almost certainly make it harder for government regulators
to prove illegal tying in platform-software cases. This may make it easier
for software firms to defend themselves when they bundle services together
and offer them as one product. Thus whichever firm manages to establish an
“industry standard” in one module can force the market to accept its
bundling in a clearly anti-competitive manner.
The court defended its deliberate indecisiveness at least partly on the
grounds that no one else had yet decided how the monopolization doctrines
of the old economy should apply to the new. It feared that a ban on
bundling, unless carefully considered, might “stunt valuable innovation.”
And in general, the court noted, “we decide this case against a backdrop of
significant debate among academics and practitioners over the extent to
which ‘old economy’ monopolization doctrines should apply to firms
competing in dynamic technological markets characterized by network
effects.”
While the market has decidedly punctured the myth of the new economy being
exempt from laws of financial gravity, the court appears to be still a
willing victim of self-delusion. Microsoft's operating system, the
cumbersome and memory-gluttonous DOS, aside being a long way from the most
innovative, became the industry standard by its dubious grafting on to
Windows, which was not an original Microsoft innovation but somehow became
Microsoft’s legal intellectual property. Moreover, the fee charged by
Microsoft for Windows is outrageously excessive compared with typical
pattern fees. Microsoft does not merely demand a copyright fee for the use
of its pattern, it forbids all others from manufacturing Windows, which
must be bought from Microsoft as a product, additional copies of which
Microsoft can produce with no significant additional cost.
In some markets, customers might in fact want one company to dominate
because if it does, it will set a standard everyone can follow and that
will make the product more valuable to all. The court's difficulty was that
no one knew how to apply antitrust principles to such markets. But an
industry-standard operating system for computers is very similar to an
industry-standard gauge of railways. Should the company that adopted a
gauge that became the industry standard be permitted to prevent other firms
from manufacturing rolling stock of the gauge without paying the company a
fee?
The court cited the overused example of the traditional telephone system.
The more people who subscribe to it, the more calls all consumers may make
or receive. Each individual phone user thus benefits from the network in
proportion to the number of other people who use it. Once a product like
that, or a standard, achieves such wide acceptance, consumers definitely
want the supplier of that product to be bigger rather than smaller. Under
those circumstances, antitrust laws should intervene only cautiously, to
avoid making matters worse for the consumer. But this is a confused
argument. The issue is not that industry standards are themselves
anti-competitive. The issue is that a single firm’s ownership of industry
standards is anti-competitive. The law should recognize that the benefits
of being an industry standard must be balanced by responsibilities and
obligations to the industry and the community at large.
For example, the Queen’s English has become the international language of
finance. Should all bankers and financiers pay a fee to the Queen of
England for the use of her language in loan documents? Industry standards
imply socialization. It is a very sound principle that if a standard is
adopted industry-wide, that standard is owned by all users and must be
freely available to all. Microsoft can bundle all it wants to serve the
public better, but it should then make Windows free to all users and charge
only for its new add-ons to compete with those offered by other firms.
The court concluded, amazingly, that in the end, the goal of US competition
law is not to promote competition for its own sake but to promote
efficiency. This is a very peculiar attitude for an US court, for the whole
US argument against monopolistic planned economy is its alleged
inefficiency. Larry Summers, former US Treasury secretary and now president
of Harvard University, when he spoke to antitrust lawyers at a 2001 meeting
of the American Bar Association was at pain to stress the point that
monopolies may be good. “First, do no harm,” he advised, borrowing from the
Hippocratic Oath. Where the need for common standards naturally leads to
monopoly power, he argued, antitrust enforcement actions may divide those
markets in ways that will harm efficiency and the consumer. “We shouldn’t
jump too quickly to the conclusion that because something increases
competition it is necessarily good,” he said. But that is a socialist
argument against a competitive society versus a cooperative society. Funny
he did not say anything against the deregulation of airlines and energy.
“The nature of competition is going to shift in the knowledge-based
economy. The real question is whether there will be an enduring monopoly in
something that is inferior,” he said, adding that the history of the
software market made that seem unlikely. Unlikely? The DOS-based Windows
software is universally considered by programmers as a grossly inferior
product; the only advantage in using it is that it is an industry standard.
For neo-liberals, the only time a monopoly is good for the consuming public
is when the entire industry has become uneconomic by deregulation, such the
rail industry. Unfortunately, this is becoming commonplace in energy, air
transportation, health services, telecommunications and the entire new
economy. There is no data to support the contention that Microsoft bundling
has been good for consumers. It has been good only for
Microsoft. Microsoft has spent more than $3 billion in recent
years settling lawsuits by rivals, including a $1.6 billion deal with Sun
Microsystems Inc. in 2004 and a $750 million truce with America Online, now
part of Time Warner Inc., in 2003. In a settlement announced on
June 30, 2005, IBM will get $775 million in cash and $75 million worth of
software from Microsoft to settle claims still lingering from the federal
government’s antitrust case against Microsoft.
The Agreement on TRIPS, the subject of Annex 1C of the agreement
establishing the World Trade Organization, is the latest translation of cultural
imperialism into economic imperialism on a global scale. The Schumpetrean
"creative destruction" that US Fed Chairman Alan Greenspan
tirelessly celebrates, is increasing distorted from the specific idea of a
better mouse trap, to the systemic appropriation of the broad notion
linking mice to traps. In the US, the self-proclaimed bastion of democracy,
the creative destruction of economic democracy through the rule of law is
in full force. Not only do the poor economies not have a fighting chance
under TRIPS, even the people in the advanced economies are quietly put in
technological servitude by the new patent regime. The notion
that an individual should be granted permission to stake a personal claim
on a nation’s natural resource (such as gold, oil and other mineral rights)
is undemocratic enough, but now intellectual property rights are defined
way beyond any reasonable personal efforts, such as writing a book or a
symphony (covered under copyrights), to thoughts while shaving that really
amount to wholesale robbery from the public domain. On a corporate level,
intellectual property rights has become an economic weapon of mass
destruction, preventing creativity from ever seeing sunlight. US annual
revenue from patent licenses now exceeds $100 billion, which is larger than
the foreign exchange reserves of most countries. Through TRIPS,
US patents gain global status without the burden of sharing patent fees
with other governments.
Patents originally were intended to protect the lone inventor, the pioneering
genius in a garage, against the predatory exploitation of big companies. In
today’s reality, the opposite is usually the case. As basic industries such
as electricity, telecommunication and broadcasting developed in the 20th
century, the great corporations learned to create arsenals of interrelated
patents to use as sword and shield by systemic patent. The recent
advertisement campaign of Mercedes-Benz in the Wall Street Journal is built
around a theme that there is only one Mercedes, the car with 10,000 plus
patents. Patent battles have become a strong catalyst for
mergers, reducing competition in many domains. The largest corporations,
with gigantic patent portfolios, routinely enter into cross-licensing
agreements with their largest competitors. Companies
without portfolios of their own have to pay cash, representing a hidden tax
within the high-tech economy. And the costs are
skyrocketing. Revenues in the United States for patent licenses
were about $15 billion in 1990; eight years later they had soared to more
than $100 billion. In 1999, IBM alone took in well over $1 billion from
licensing and received a record 2,756 new patents. MSFT’s revenue would
dwindle by 80% if its patent and copyrights are suddenly invalidated. A
Boeing software engineer has patented a basic method of correcting the
century in dates stored in databases and sent a threatening form letter to
700 of the nation's largest corporations (including The New York Times),
demanding one-fourth of a percent of their total revenues, on the
assumption that they probably have used the same method.
The four key elements in the issue of fair value in global trade are IP,
technology, information and pricing. In classical exchange
theory, price is determined by cost and demand which under free trade
conditions will reach equilibrium to provide the optimum price and the
largest sales. But free trade is a myth, and the US is the leading opponent
of it in practice while being the leading proponent of it in
rhetoric.
The rationale for IP protection is that it is needed to subsidize the
coming stream of new technology. But as the Microsoft anti-trust
case demonstrates, IP inhibits new technology more than it is generally
recognized. The same is evident in medical drugs. The
only arena this inhibition does not exist is in military technology where
the technological imperative still governs at the expense of price
sensitivity. The fundamental criterion for a free market is the equal
availability of information to all participants. When information
is packaged and sold as commodities, free market becomes the casualty. When
two economies of uneven stages of technological development trade
bilaterally, the concept of countervailing trade surplus in favor of the
less advanced economy is simple justice. Otherwise it would be
structural economical imperialism. More and more developing
nations are finally taking this view in their trade negotiations with more
advanced countries.
As for intellectual pirating, this is a serious and controversial issue.
The reason it is so widely practiced by most less-advanced economies is
that there is a widespread view that the current intellectual property
rights regime is not fair toward late comers. China is only the latest to
join the club. The US as a young nation participated fearlessly in
intellectual piracy until it became technologically matured. The same is
true with Japan, Korea and Taiwan. Europe was notorious for its
brazen theft of early technology from other cultures. To be fair, China
should be entitled to claim retroactive IP rights on the compass,
gunpowder, paper making, silk production, printing, etc., for a period of
50 years starting now, to compensate for her loss due to the absence of an
international IP regime during her epoch of high inventiveness. The Arabs
should be compensated for Arabian numerals without which modern mathematics
would not develop. When a law is unjust, it invites widespread violation.
How about an international affirmative action program for IP or IP amnesty
for the underdeveloped Third World for 50 years? It will speed up global
development and the advanced economies will also benefit more than they
will lose as a result.
Michael Hardt and Antonio
Negri demonstrate in their book that empire can be the new political
order of globalization. This is a problematic position. It is possible to
recognize the contemporary economic, cultural, financial and legal
transformations taking place across the globe in the form of empire
building. Hardt and Negri contend that these development should be seen in
line with historical understanding of Empire as a universal order that
accepts no boundaries or limits. Their book shows how this emerging Empire
is fundamentally different from the imperialism of European dominance and
capitalist expansion in previous eras.
Yet empire is a institutional structure based on
power. Its growth draws on the containment of national sovereignty in the
Westphalian world order of sovereign states based on the principle that
nations inherently possess sovereign rights. Westphalian sovereignty is
the principle of international law that each nation
state has sovereignty over its territory and domestic affairs, to
the exclusion of all external powers, on the principle of non-interference
in another country's domestic affairs, and that each state (no matter how
large or small) is equal in international law. The doctrine is named after
the Peace of Westphalia, signed in 1648, which ended the Thirty
Years' War, in which the major continental European states – the Holy
Roman Empire, Spain, France, Sweden and the Dutch
Republic – agreed to respect one another's territorial integrity.
As European influence spread across the globe, the Westphalian principles,
especially the concept of sovereign states, became central to international
law and to the prevailing world order. The Westphalia principle gave
legitimacy to colonies of European Empires around the world to exercise
self determination based of United Nation charter of human rights at the
end of WWII.
National sovereignty is today a progressive
mechanism for small and weak countries to oppose big power encroachment of
national sovereignty in the name of globalization and regional integration.
It is the veto power of the world’s weak to protect indigenous culture and
independence. The most important characteristic of positive regional
integration is the voluntary participation of nation states. It is this
voluntary characteristic that makes possible regional integration without
empire.
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