This article appeared in AToL
on May 13, 2010
As a result of government bailouts and stimulus spending in
response to the global financial crisis, gross government debts around
the
world have risen to unprecedented heights by 2010 and are expected to
continue
on an upward trend for the foreseeable future as recovery remains
anemic in
many regions in the world.Ironically, the
list of countries with high sovereign debt is topped by Japan,
notwithstanding Japan’s
huge foreign currency reserve and its large export sector and
persistent trade
surplus. Japan
has been in permanent recession since the 1985 Plaza Accord pushed the
exchange
value of the yen up against the dollar without any significant effect
on
US-Japan trade imbalance in Japan’s
favor. Despite continuing trade surpluses, Japan’s
gross government debt rose from 170% of GDP in 2007 to nearly 200% in
2010 as
the Japanese government revved up spending to stimulate in vain the
structurally impaired export economy.A
similar fate will fall on all economies that depend excessively on
export for
growth as the traditional import markets in the advanced economies such
as the US
and the EU are themselves trapped in anemic growth by excessive debt
for decades
to come.
Yet the world, led by the US,
has continued to waste money on military spending in the middle of a
ruinous
financial crisis. In 2008, the world expanded a total of $1.5 trillion
on
military spending. The US
alone spent $607 billion on defense (41% of world total) while many of
its
citizens were defenseless against losing their homes through mortgage
foreclosure due to falling income. Stimulus Packages Dwarfed
by Military Spending
In 2008, Congress approved a stimulus package of $819 billion
that included regressive tax cuts, with spending to begin in 2009 and
to end in
2019. Take away tax cuts, the spending amounts to $637 billion, with
peak
spending at $263.4 billion in 2010, less than half of US
military spending in 2008.
Meanwhile, special appropriations have been used to fund
most of the costs of war and occupation in Iraq
and Afghanistan
so far. Much of the costs for the wars in Iraq
and Afghanistan
have not been funded through regular appropriations bills, but through
emergency supplemental appropriations bills. As such, most of these
expenses
were not included in the budget deficit calculation prior to FY2010.
From 2001 through February 2009, the Congressional Research
Service estimates that Congress approved $864 billion in war-related
funding
for the Departments of Defense, State and Veterans Affairs. This total
is
allocated as $657 billion for Iraq,
$173 billion for Afghanistan,
$28 billion for enhanced military base security, and $5.5 billion that
cannot
be categorized. Aside from normal military spending, about $900 billion
of US
taxpayers’ funds have been spent, or approved for spending, through
September
2010 for the Iraq War alone. Growth Needs to Come
from Development, not Trade
Not withstanding the fact that in 2010, despite the global
financial crisis, the EU and the US still remain the world’s two
largest
economies by GDP, (EU=$16.5 trillion, US=$14.8 trillion), about 50% of
world
total of $61.8 trillion, the days are numbered when theses two
economies can
continue to play the role of the world’s main consumption engines and
act as
markets of last resort for the export-dependent economies. For
sustainable
growth in the world economy, all national economies will have to
concentrate on
developing their own domestic markets and depend on domestic
consumption for
economic growth.
International trade will return to playing an augmentation
role to support the balanced development of domestic economies. The
world can
no longer be organized into two unequal halves of poor workers and rich
consumers,
which has been an imperialist distortion of the theory of division of
labor
into a theory of exploitation of labor, and of the theory of
comparative
advantage into a reality of absolute advantage for the rich economies. Wealth Should Be Shared
Equitably between Workers and Capital
Going forward, workers in all countries will have to receive
a fair and larger share of the wealth they produce in order to sustain
aggregate consumer demand globally and to conduct fair trade between
trading
partners. Capital is increasingly sourced from pension and savings of
workers.
Thus it is common sense logic that returns on capital cannot be
achieved at the
expense of fair wages. Moreover, capital needs to be recognized as
belonging to
the workers, not to the financial manipulators.
The idea that workers doing the same work are paid at vastly
different wages in different parts of the world is not only unjust but
also
uneconomic. For example, there is no economic reason or purpose, much
less
moral justification, why workers in the US
should command wages 5 times more than those of workers in China
doing the same work. The solution is not to pushdown US
wages, but to push up Chinese wages to reach bilateral parity between
the two
trading partners. International trade driven by cross border wage and
income
disparity globally will wither away from its own internal contradiction
which
ultimately will lead to market failure. Low-paid workers are the
fundamental
obstacle to growth from operative demand management at both the
domestic and
international levels. Pitting workers in one country against workers in
another
will only destroy international trade with counterproductive
protectionism,
which is
not to be confused with economic nationalism. Shift from Growth
through Export to Growth through Domestic Development
Some small countries may have no easy option other than to
depend on export for growth. These countries, such as the small Asian
tigers,
are condemned to zero growth for the coming transitional decade as the
world
economy shifts from export-led growth to domestic-development-led
growth. They
may have to seek balanced domestic growth through true comparative
advantage by
symbiotic integration in large super-national economic blocks, to shift
export
into intra-regional trade.
For example, unlike China,
Japan’s
domestic market is simply not big enough to make up for a rapid slow
down of
its huge export sector. Thus Japan
will have to find ways to further boost already saturated domestic
consumption
while shrinking its export sector, most likely facing negative growth
until the
protracted restructuring of its dysfunctional export-dependent economy
is
completed. One option would be for Japan
to integrate its oversized national economy with that of China
so that the huge Japanese export sector can be transformed into a
super-national domestic sector of a Sino-Japanese common market. Korea
also faces the same problem and may have to consider the option of
integration
into a super-national East Asian economy. However, the East Asian model
needs
to be different than that employed by the EU for what is by now obvious
reasons.
In 2010, on a purchasing power parity basis, China’s
GDP is $9.7 trillion, Japan’s
is $4.3 trillion and South Korea’s
is $1.4 trillion. An integrated East Asian super-national economy will
have a
PPP GDP of $15.4 trillion, bigger than that of the US
of $14.8 trillion.
The availability of a large domestic market with a large
population and ample land are the reasons why large countries such as
the BRIC
(Brazil,
Russia,
India,
China)
are going to be dominant core economies going forward with symbiotic
integration with neighboring smaller countries. Foreign Holders of US
Sovereign Debt China’s
foreign reserve hit $2.5 trillion in March 2010. In April 2010, Japan’s
foreign reserves fell below $1 trillion. By another calculation, at the
end of
March 2010, China’s total funds outstanding for foreign exchange were
around 20
trillion yuan ($2.93 trillion at concurrent exchange rate), showing
around $110
billion of growth compared to the end of 2009.
On February 16, 2010,
US Department of Treasury reported that Japan
boosted its holdings of US Treasuries by US$11.5 billion in December
2009, bringing
the total to US$768.8 billion, making Japan
once again the largest creditor to the US.
China,
after
briefly occupying top position, became once again the second largest
holder of
US Treasuries, having sold US$122.1 billion earlier to bring its total
to
US$755.4 billion, down from $877.5 billion in January, relinquishing
the top
position creditor back to Japan. The most US Treasuries China had held
in
reserve was $939.3 billion in July 2009, two years after the global
financial
crisis broke out in July 2007 and 5 months after Congress approved the
$787
billion stimulus package to be funded with debt.
Outside of Asia, the UK
bought $24.9 billion of US
sovereign debt during the same month, bringing its total to $302.5
billion. Brazil
bought $3.5 billion, bringing its total to $160.6 billion. Russia
sold $9.6 billion, reducing its total to $118.5 billion. Foreign
creditors,
nervous about US
stimulus spending, of future money sold the most amount of US
sovereign debt in December 2009, $53 billion, surpassing the previous
record
drop of $44.5 billion in April 2009. At the end of February 2010, total
treasuries outstanding were around $13 trillion; the amount held by
foreigners
was around $3.75 trillion.
As of March 2010, China’s
s foreign exchange reserve totaled $2.45 trillion, about 60% of which
was
invested in US securities. These securities include long-term Treasury
debt, long-term
agency debt, long-term corporate debt, long-term equities, and
short-term debt.
Hilary Clinton during her first visit to China
as Secretary of State in February 2009 urged China
to continue to buy US Treasury Securities. A month later, in March
2009,
Chinese Premier Wen Jiabao responded by stating publicly that he was “a
little
worried” about the safety of China’s holdings of US sovereign debt. In
addition, some Chinese government officials have called for replacing
the
dollar as the world’s main foreign reserve currency with IMF special
drawing
rights, harking back to Kyenes’s proposal of “bancors” for an
international
clearing union at the Bretton Woods Conference in 1943.
Foreign investors had been a mainstay of the market for US
GSE debt, but uncertainty over the GSE mortgage financiers’ capital
positions
and the timing and structure of an anticipated government rescue by
September
2008 made investors reassess their risk exposures. Asian investors in
particular became net sellers of US
agency debt.
Federal Reserve custody data show that for 2008 up to July,
foreign government and private investors bought a monthly average of
$20
billion of US
agency debt issued by government sponsored enterprises (GSEs), such as
Ginnie
Mae, Freddie Mac and the Federal Home Loan Banks. Foreign purchases of
US
Treasuries averaged $9.25 billion a month. All told, average monthly
purchase
of US
public
debt by foreigners was around $30 billion.
From July 16 to August 20,
2008, foreign buyers sold $14.7 billion of US
agency debt, trimming their overall holdings to $972 billion. They
purchased
$71.1 billion of Treasuries in the same period with dollars earned from
trade
surplus. Bailing out GSEs to
Protect Foreigners’ Exposure
In his just published memoir, “On The Brink”, former
Treasury Secretary Henry Paulson revealed
that Russia
made a “top-level approach” to China
“that together they might sell big chunks of
their GSEholdings
to force the US
to use its emergency authorities to prop up these companies.”Paulson wrote he learned of the “disruptive scheme” while attending
the Beijing
Summer Olympics. “The report was deeply troubling — heavy selling could
create
a sudden loss of confidence in the GSEs and shake the capital markets,”
Paulson wrote. “I
waited till I was back home and in a secure environment to inform the
president.”
The Bank of China, the nation’s major foreign exchange bank,
cut its portfolio of securities issued or guaranteed by troubled US GSE
home
mortgage financiers Fannie Mae and Freddie Mac by 25% since the end of
June
2008. The sale by the Bank of China, which reduced its holdings of US
agency debt by $4.6 billion to about $14 billion, was a sign of
nervousness
among foreign buyers of Fannie and Freddie’s bonds and guaranteed
securities.China
holds about $400 billion of US
agency debt in total.
A month after Secretary Paulson returned from the Beijing
Olympics with the disturbing message for President George Bush, the
Treasury
on
September 7, 2008, unveiled its extraordinary takeover of GSEs Fannie
Mae and
Freddie Mac, by invoking Section (14) authority under of the 1932
Federal
Reserve Act, as amended by the Banking Act of 1935 and the FDIC
Improvement Act
of 1991, that permits any Federal Reserve Bank to conduct open market
operations under rules and regulations prescribed by the Board of
Governors of
the Federal Reserve System, to purchase and sell in the open market, at
home or
abroad, either from or to domestic or foreign banks, firms,
corporations, or
individuals, cable transfers and bankers' acceptances and bills of
exchange of
the kinds and maturities that were by this Act made eligible for
rediscount,
with or without the endorsement of a member bank, putting the
government in
charge of the twin mortgage giants and liable for the $5 trillion in
home loans
the GSEs had guaranteed.
The move, which extended as much as $200 billion in direct
Treasury support to the two GSEs, marked the government’s most dramatic
attempt
yet to shore up the nation’s collapsed housing market to try to slow
down
record foreclosures and falling home prices. The sweeping plan,
announced by
Treasury Secretary Henry Paulson and James Lockhart, director of the
Federal
Housing Finance Agency (FHFA), placed the two government sponsored
enterprises
into a “conservatorship” to be overseen by the FHFA. Under
conservatorship, the
government would run Fannie and Freddie “temporarily” until theses
entities
regain stronger footing. Some analysts have suggested that the move was
partly motivated
by the need to reassure China
and Russia
of
the safety of GSE debt to discourage them from selling their
substantial
holdings. Economic Head Wind
from Government Exit Strategies
In coming years, the global business climate can be expected
to face head wind even when the initial crisis has been stabilized by
government bailout of big distressed financial institutions, as
government
stimulus spending ends in several major economies and governments are
forced to
execute exit strategies for their extraordinary bailout measures even
amid weak
economic conditions in order to prevent inflationary pressure and
expectation
from building and to address the danger of excessive public debt.
In the US,
the Fed and the Treasury are expected to gradually withdraw stimulus
measures, such
as the ending of government aid to the auto industry, and restoring the
balance
sheet of central banks by shedding toxic asset taken from insolvent
financial
institutions. Yet the Fed and the Treasury are caught between a rock
and a hard
place. Stimulus cannot be exited unless employment picks up to restore
demand,
but stimulus packages have been ineffective in reducing unemployment.
So far,
the main effect of stimulus spending has been to save the insolvent
financial
sector from total collapse, not to create new jobs. Speculative Profit
from Exit Strategy Arbitrage
Central banks and finance ministries around the world would
need to coordinate the timing of the ending of the near-zero interest
rate
regime to prevent extreme volatility and speculative arbitrage in the
exchange
values of their respective currencies and to dampen “carry trades” by
banks
eager to profit from cross-border interest rate arbitrage. This
coordinated
exit would be extremely difficult to manage because national economies
are not
likely to recovery at the same pace, and national policies tend to be
governed
more by domestic politics than by international coordination.
For the European Union, national GDP figures for Q4 2009
were disappointing: Germany
posted zero growth even against weak expectations of 0.2%; Italy
posted negative 0.2% contraction against expectations of 0.1% growth;
and the Netherlands
posted 0.3% growth against expectations of 0.5%. Eurozone GDP grew just
0.1%,
merely one third against weak expectations of 0.3%, bringing GDP
contraction
for the full year to negative 2.1% against expectations of only a
negative 1.9%.
In France,
January 2010 retail sales fell 2.4% on the month, food fell 4.4%, auto
fell 5.1%
autos, apparel fell 2.7%, with supermarkets falling 4.1% and
hypermarkets particularly
hard hit, falling 3.8%. This drop is exacerbated by a rise in inflation
rate to
1% in December 2009. Given that of the 0.6% GDP growth in Q4 2009,
0.9%%
stemmed from a rebound in consumption (+8% in automobiles), this hardly
augurs
well for GDP in 2010. Q2 2010 GDP will be worse because of the
sovereign debt
crisis in Eurozone. Sovereign Debt Crisis
After Japan whose government debt reaches nearly 200% of GDP
in 2010, the PIIG economies (Portugal, Italy, Ireland and Greece) of
the
European Union (EU), all show projected 2010 public debt above or
headed for
100% of GDP, with Italy leading the pack at 127%, Greece at 120%,
Portugal at
90% and Ireland at 65%.
The EU as a whole is not in any better fix at the end of Q4
2009, with public debt at 80% of GDP, slightly below the US
at 90% and above the UK
at 75%.
The PIGS (Portugal,
Ireland,
Greece
and Spain)
are
visibly in hopeless trouble. But even in other EU countries normally
considered
financially more solid, public debt levels are unsustainably high:
Italy’s is
at 127% of GDP and Belgium’s at 105%. Banks in Austria
face deep exposure to recession-hit Eastern Europe.
Normally, sovereign debt denominated in the national
currency needs never default because the government can always print
more money
to meet public debt service requirements. While sovereign debt
denominated in
national currency does not face default risk, it does face risks of
currency
devaluation and inflation. Excessive sovereign debt can also cause
hyperinflation with the collapse of the exchange value of the
denominated
currency, but outright default can always be avoided by central bank
quantitative easing to meet debt service of sovereign obligations. A sovereign government only faces default on
sovereign debt denominated in foreign currency that it cannot print and
must
earn from export or purchase through the foreign exchange market.
The US,
through dollar hegemony, can print dollars without fear of inflation
because
low cost import keeps US
inflation low and her trading partner must buy US sovereign debt with
their
dollar denominated trade surplus to finance the US
trade deficit. (Please see my April
11, 2002 AToL article: Dollar Hegemony)
The Euro Preempts
Monetary Sovereignty of Eurozone Member States
Eurozone member states (16 nations within the 27-member EU) who have
sadopted the euro are in an unusual situation – being constituents
of a European Monetary Union (EMU) without a political union. Sovereign
states within
the Eurozone by
agreement have to denominate their sovereign debts in euros, which is a
super-national
currency of the EU governed by treaty conditions that prevent
individual sovereign
states within the union to print euros at will to meet their separate
monetary
needs. At the same time, the European Central Bank (ECB) conducts its
monetary
policy for the benefit of the European Union, not for the needs of the
constituent economies which are expected to conduct their respective
fiscal
policy in accordance with the rules pf the European Monetary Union
(EMU) to
support the monetary policy of the ECB.
Many have warned that operating a monetary union without
having first establishing a political union was putting the monetary
cart
before the geo-economic horse. By joining the EMU, a member country
agrees to
observe its monetary and fiscal rules regardless of what is needed by
its
national economy. Since EMU member states are at different stages of
development with different socioeconomic conditions, EMU monetary and
fiscal
rules are not suitable for all members all the time.
EMU member states, such as Greece,
know that adopting a stable currency that is not controlled by their
own
central banks implies a voluntary compromise in national sovereignty on
monetary affairs. Normal sovereign options, such as devaluation of the
national
currency or an accommodative inflationary monetary policy are not
available options
for EMU member states. A single monetary policy for the euro is
implemented solely
by the ECB and it is the responsibility of each country to adjust its
fiscal
and economic policies to meet the “one size fits all” monetary criteria
of the
EMU.
Participation in the EMU does bring financial and economic advantages
to the member states. The benefits of joining a stable large economic
area with
no monetary, economic and financial borders are great for the strong
economies,
but they are greatest for countries with historically weak economies
that before
joining were unable to achieve such conditions and were denied access
to such a
large market. Financially, adopting the euro allows previously weak
economies,
such as Greece,
to enjoy easy access to loans at lower long-term interest rates.
Unfortunately, instead of delivering on their commitments made
at the time of entry to the EMU to reduce public debt levels, many new
member
states have used potential benefits not to strengthen their economy but
to
engage in a frenzy spending of easy money. Future of Euro at
Stake
Monetarists point out that the crisis these economies face
currently is not caused by any natural “external shock”, such as an
earthquake,
but is the result of bad, even deceptive national policies pursued over
many
years masked by fraudulent data. They warn that bailing out these
wayward
economies, such as Greece,
would reward poor behavior and create moral hazard of a dimension that
will
threaten the EMU itself and even the future of the euro.
According monetarist logic, financial assistance to EMU
member countries that have persistently violated the terms of their
participation
in the union would impair the credibility of the whole monetary
framework of
the EMU. By its construction, the EMU is a “no transfers” union of
sovereign
states. Transferring taxpayer money from sovereign member states that
diligently obey EMU rules to those that regularly violate them would
create antagonism
towards the EMU based in Brussels
and between euro area countries. For the people in eurozone, such
antagonism would
undermine a necessary but still fragile sense of super-national
identification
with the larger aim of pan-European integration. Financial Crisis
Made in the USA
Yet, while the current financial crisis facing the EMU was
not caused by any external shock in the form a natural disaster, it has
been
undeniably caused by an external shock created by and originated from United
States. As Nobel laureate economist
Joseph
Stiglitz, an American, rightly observes, the global financial crisis
comes with
a “Made in the USA”
label. The allegedly irresponsible member states of the EMU got into
financial
trouble merely by acting according to the brave new rules of the
neoliberal
no-holds-barred games promoted globally by US
market fundamentalists and supported by easy money monetary stance of
the US
Federal Reserve.Destabilizing
instruments of financial market innovation has been the main US export
since
the end of the Cold War. European Union
Centrifugal Fracture
The end of the Cold War removed the geopolitical gravity of
a united Europe driven by a garrison mentality
against
communism. With the fall of the Berlin War, Europe’s
unification gravity came increasingly against an immovable
socioeconomic wall.
Necessity for doctrinal political survival was preempted by doctrinal
quest for
economic growth. Yet the gap of national differences is too wide to
prevent a
centrifugal fracture of the virtual union in the absence of an external
enemy
threat. Further, the European Union (EU) after the Cold War has
transformed
itself from a grateful ally of the US
against a threatening USSR
to a potential challenger of US
global economic dominance. Germany,
the magnet that has held the EU together and generated most of its
dynamic growth,
is now driven by domestic politics that pushes for a return to
nationalistic
insulation against the European disease of social welfare inadequately
sustained
by economic productivity. German public opinion is moving toward to
separating
the disciplined nation state from nebulous European common interests.
German
taxpayers are not prepared to take on the role of unconditional
underwriter of
credit for the EU’s problematic, free-spending member economies. The
potential
pain of a failure of the European Union for the stronger member
economies such
as Germany
and France
is now balanced by the pain of maintaining an unwieldy union of wayward
members. Europe Union politics is now dominated by tactical nationalist
maneuvers at the expense of strategic goals towards full union. May 11, 2010
