Great structural changes in world trade and finance occur quickly – by quantum leaps, not by slow marginal accretions. The 1945-2010 era of relatively open trade, capital movements and foreign exchange markets is being destroyed by a predatory financial opportunism that is breaking the world economy into two spheres: a dollar sphere in which central banks in Europe, Japan and many OPEC and Third World countries hold their reserves in the form of U.S. Treasury debt of declining foreign-exchange value; and a BRIC-centered sphere, led by China, India, Brazil and Russia, reaching out to include Turkey and Iran, most of Asia, and major raw materials exporters that are running trade surpluses.
What is reversing trends that seemed irreversible for the past 65 years is the manner in which the United States has dealt with its bad-debt crisis. The U.S. Government is attempting to bail out the banks by re-inflating U.S. real estate, stock and bond markets at least to their former Bubble Economy levels. This is what U.S. economic policy and even its foreign policy is now all about, including de-criminalizing financial fraud. As Treasury Secretary Tim Geithner tried to defend this policy: “Americans were rightfully angry that the same firms that helped create the economic crisis got taxpayer support to keep their doors open. But the program was essential to averting a second Great Depression, stabilizing a collapsing financial system, protecting the savings of Americans [or more to the point, he means, their indebtedness] and restoring the flow of credit that is the oxygen of the economy.”
Other economists might find a more fitting analogy to be carbon dioxide and debt pollution. “Restoring the flow of credit” is simply a euphemism for keeping the existing, historically high debt levels in place rather than writing them down – and indeed, adding yet more debt (“credit”) to enable home buyers, stock market investors and others to use yet more debt leverage to bid asset prices back up to rescue the banking system from the negative equity into which it has fallen .
The Fed theorizes that if it provides nearly free liquidity in unlimited amounts, banks will lend it out at a markup to “reflate” the economy. The “recovery” that is envisioned is one of new debt creation. This would rescue the biggest and most risk-taking banks from their negative equity, by pulling homeowners out of theirs. Housing prices could begin to soar again.
But the hoped-for new borrowing is not occurring. Instead of lending more – at least, lending at home – banks have been tightening their loan standards rather than lending more to U.S. homeowners, consumers and businesses since 2007. This has obliged debtors to start paying off the debts they earlier ran up. The U.S. saving rate has risen from zero three years ago to 3% today – mainly in the form of amortization to pay down credit-card debt, mortgage debt and other bank loans.
Instead of lending domestically, banks are sending the Fed’s tsunami of credit abroad, flooding world currency markets with cheap U.S. “keyboard credit.” The hope is that lending to speculators will enable banks to earn their way out of debt. So U.S. banks are engaging in interest-rate arbitrage (the carry trade), currency speculation, commodity speculation (driving up food and mineral prices sharply this year), and buying into companies in Asia and raw materials exporters.
Countries on the receiving end of these U.S. financial measures (“restoring stability” is how U.S. officials characterize it) understandably are seeking to protect themselves. Ultimately, the only serious way to do this is to erect a wall of capital controls to block foreign speculators from deranging currency and financial markets.
Changing the international financial system is by no means easy. How much of alternative do countries have, Martin Wolf recently asked. “To put it crudely,” he wrote: the US wants to inflate the rest of the world, while the latter is trying to deflate. The US must win, since it has infinite ammunition: there is no limit to the dollars the Federal Reserve can create. What needs to be discussed is the terms of the world’s surrender: the needed changes in nominal exchange rates and domestic policies around the world.
Mr. Wolf cites New York Federal Reserve chairman William C. Dudley to the effect that Quantitative Easing is primarily an attempt to deal with the mortgage crisis that capped a decade of bad loans and financial gambles. Dudley acknowledged on October 1, 2010, that the bubble “was fueled by products and practices in the financial sector that led to a rapid and unsustainable buildup of leverage and an underpricing of risk during this period,” and that household debt has risen “faster than income growth ... since the 1950s.” But this debt explosion was justified by the “surge in home prices [that] pushed up the ratio of household net worth to disposable personal income to nearly 640 percent.” Instead of saving, most Americans borrowed as much as they could to buy property they expected to rise in price. For really the first time in history an entire population sought to get rich by running to debt (to buy real estate, stocks and bonds), not by staying out of it.
But now that asset prices have plunged, people are left in debt. The problem is, what to do about it. Mr. Dudley argues that the economy must inflate its way out of the debt corner into which it has painted itself. Federal Reserve Chairman Ben Bernanke appears to agree.
On October 15, 2010, Mr. Bernanke explained that he wanted the Fed to encourage inflation – his of program of Quantitative Easing – and acknowledged that this would drive down the dollar against foreign currencies. He proposes to inject another $1 trillion of liquidity over the coming year, on top of the $2 trillion in new Federal Reserve credit already created during 2009-10.
The upshot of the Fed trying save the banks from negative equity is to flood the global economy with a glut of U.S. dollar credit, destabilizing the global financial system.
The international economy’s role is envisioned as a deus ex machina to rescue the economy. Foreign countries are to serve as markets for a resurgence of U.S. industrial exports (and at least arms sales are taking off to India and Saudi Arabia), and most of all as financial markets for U.S. banks and speculators to make money at the expense of foreign central banks trying to stabilize their currencies.
The Fed believes that debt levels can rise and become more solvent if U.S. employment increases by producing more exports. The way to achieve this is presumably to depreciate the dollar – the kind of “beggar-my-neighbor” policy that marked the 1930s. Devaluation will be achieved by flooding currency markets with dollars, providing the kind of zigzagging opportunities that are heaven-sent for computerized currency trading, short selling and kindred financial options.
Such speculation is a zero-sum game. Someone must lose. If Quantitative Easing is to help U.S. banks earn their way out of negative equity, by definition their gains must be at the expense of foreigners.
This is destructive of the global currency stability that is a precondition for stable long-term trade relationships. Its underlying assumptions also happen to be based on Junk Economics. For starters, it assumes that international prices are based on relative price levels for goods and services. But only about a third of U.S. wages are spent on commodities. Most is spent on payments to the finance, insurance and real estate (FIRE) sector and on taxes. Housing and debt service typically absorb 40% and 15% of wage income respectively. FICA Wage withholding for Social Security and Medicare taxes absorb 11%, and income and sales taxes another 15 to 20%. So before take-home pay is available for csonsumer spending on goods and services, these FIRE-sector charges make the cost of living so high as to render American industrial labor uncompetitive in world markets. No wonder the U.S. economy faces a chronic trade deficit!
The FIRE sector overhead has become structural, not merely a marginal problem. To restore its competitive industrial position, the United States would have to devalue by much more than the 40% that it did back in 1933. Trying to “inflate its way out of debt” may help bank balance sheets recover, but as long as the economy remains locked in debt deflation it will be unable to produce the traditional form of economic surplus needed for genuine recovery. A debt write-down would be preferable to the policy of keeping the debts on the books and distorting the U.S. economy with inflation – and engaging in financial aggression against foreign economies. The political problem, of course, is that the financial sector has taken control of U.S. economic planning – in its own self-interest, not that of the economy at large. A debt write-down would threaten the financial sector’s creditor power over the economy.
Notes
1 Paper presented at the Boeckler Foundation meetings in Berlin, October 30, 2010. I am indebted to Eric Janszen of i-tulip for bringing the Einzig quote to my attention.
2 “Stiglitz Calls for Jail Time for Corporate Crooks,” DailyFinance: http://srph.it/aRwI4I, October 21, 2010.
3 Tim Geithner, “Five Myths about Tarp,” Washington Post, October 10, 2010.
4 Martin Wolf, “Why America is going to win the global currency battle,” Financial Times, October 13, 2010.
5 William C. Dudley, “The Outlook, Policy Choices and Our Mandate,” Remarks at the Society of American Business Editors and Writers Fall Conference, City University of New York, Graduate School of Journalism, New York City, October 1, 2010. http://www.zerohedge.com/article/why-imf-meetings-failed-and-coming-capital-controls.
6 Nobel Laureate Joseph Stiglitz: Foreclosure Moratorium, Government Stimulus Needed to Revive US Economy, Democracy Now, Oct. 21, 2010.
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