Obama’s Politics
of Change and US Policy on China
By
Henry C.K. Liu
Part
I: The Song Stays the Same
Part II: US
Domestic Politics and China
Policy
Part:
III: The New Deal Dollar and the Obama Dollar
This article appears in AToL
on March 31, 2009
Much talk has been floating around
comparing Barack Obama to
Franklin D Roosevelt and the yet-to-be-fully-developed or -revealed
Obama
recovery plan to the New Deal. So far, the differences between the two
leaders
in crisis are more visible than the similarities. Obama’s $787 billion
stimulus
package is viewed by many economists as too small for the task and too
diffused
to tackle the immediate need of halting layoffs and promoting new job
creation.
The $275 billion home mortgage refinancing plan managed by newly
installed
Treasury Secretary Tim Geithner is beset with complexity that few seem
to fully
understand or know how to navigate. The Obama 2010 budget, by trying to
do too
much on long-term problems such as health care reform at a time of
crisis, is
being hectored by Democrat congressional committee chairmen acting like
independent political war lords. The president’s call for sacrifice by
all is
answered by a Democrat controlled Congress tacking on 8,000 legislative
special
interest earmarks to his $400 billion supplemental spending bill.
The bank bailout started by
Republican Treasury Secretary
Henry Paulson is stalled in paralysis with the Obama team, now led by
new
Treasury Secretary Tim Geithner, former head of the New York Federal
Reserve
Bank who worked closely with Paulson, refusing to admit all-out
nationalization
while unable to push through a “good bank – bad bank” arrangement to
handle
toxic assets to free up bank lending, or simply letting zombie banks,
such as
Citi, fail by market forces.
The Geithner Plan
The Geithner plan for banks is
designed to clear away “toxic
assets”, mostly complex instruments of structured finance (derivatives)
that
act as blood clogs in the vital veins of US financial system when the
credit
markets froze up. The diffused nature of these instruments and
associated
counterparty risks add up to an unprecedented state of high anxiety and
uncertainty
in financial markets as no market participant can reliably assign final
values
to these assets not only because they may be worthless, but also
because they
imply unknown counterparty liabilities of possibly consequential
dimensions.
Thus these assets are toxic in the sense that they carry potential
negative
liabilities beyond being worthless to threaten the financial survival
of
institutions that hold them.
The banks and financial institutions
that own these assets
are caught by market failure as buyers cannot be found at any price. To
continue to hold such assets at marked-to-market values will generate
huge mounting
losses that grow by the day, eventually leading to insolvency as the
availability of new capital dries up, leaving such institutions unable
to meet
their rising liabilities. Until banks can clear such toxic assets off
their
books, they will not be in a position to take on more risks by make new
loans.
Geithner’s Plan involves government
support of capital and
finance to induce private investors to take problem loans and toxic
assets off
the balance sheets of banks.
The problem with the Geithner Plan has a double edge. If
successful, private investors may reap a windfall profit by exploiting
taxpayer
capital and finance. But the plan may fail because the Treasury’s $1
trillion
earmarked for the plan may not be enough to clean up the banks balance
sheets,
at which point the Treasury may have to go back to Congress for more
money
which Congress may not be in the mood to grant if the amount needed
threatens
the bankruptcy of the nation.
Obama wasting his First Hundred Days
With more than half of the crucial
first 100 days in office
spent, the Obama administration is having difficulty continuing to
project an
image of confident determination to turn the deepest global economic
crisis of
capitalism since the Great Depression into a new era of progressive
politics
not only domestically, but also a new world order of equity and
justice. Obama
told the world during his presidential campaign that his presidency
will be one
of consequence. In his inaugural address, he proclaimed: “There are
some who
question the scale of our ambitions – who suggest that our system
cannot
tolerate too many big plans ... What the cynics fail to understand is
that the
ground has shifted beneath them ... The question we ask today is not
whether
our government is too big or too small but whether it works.”
Rahm Emanuel, Obama’s chief of staff,
famously said that a
crisis is a terrible thing to waste. A corollary is that government
intervention is an even more terrible thing to waste, which is
something that
the Obama team has yet to realize.
Obama has the rare opportunity to
reverse the Reagan
Revolution of smearing government as always being the problem, never
the solution.
There is now a growing general consensus that the abdication of
government
responsibility to regulate free market fundamentalism has been the root
cause
of the current global economic crisis, and that the free market
solution
adopted by Treasury Secretary Hank Paulson of the Bush administration
in
response to failed markets has been in itself a failure.
Midway through his first 100 days,
sensitive to criticism
that his “tell it like it is” warnings about the seriousness of the
economic
crisis, Obama shifted his rhetoric to sound like his campaign opponent
John
McCain that the economy is fundamentally sound, a line that sank the
Hoover
presidency in the 1932 presidential election. Very few people beside
the
diehard cheerleaders of free market fundamentalism at CNBC, can now
honestly
conclude from either economic data or personal experience that the
economy is
fundamentally sound. By yielding to criticism that his rhetoric was
talking
down the market, Obama is in danger of letting a serious global crisis
go to
waste. An economy that is fundamentally sound needs no fundamental
structural
reform, only an emergency treatment before returning to business as
usual. Obama needs to understand that the
market is
not the economy. The market operating through a price system is only a
partial
mirror of the economy. The task at hand is to save an economy severely
impaired
by income stagnation. Restoring the price bubble of the financial
markets that
had been detached from the real economy with future tax revenue is to
mask the
symptom while ignoring the disease. Such approach robs the market’s
ability to
self-correct imbalances and distortions caused by a dysfunctional
monetary
policy and government abdication of responsible regulation.
Larry Summers, Obama’s top economic
advisor, is known as a
strong defender of free markets. In a predictable Faustian declaration,
Summers
explains: “The view that the market economy is inherently
self-stabilizing,
always, has been dealt a fatal blow ... This notion that the economy is
self-stabilizing is usually right, but it is wrong a few times a
century and
this is one of those times.” The central ideological consequence of
this fatal
market failure, Mr Summers says, is that there “is a need for
extraordinary
public action at those times. … The
debate over whether you can love your country and hate your government
has been
settled with a negative answer.” Love of country is now congruent with
love of
government, albeit smart government, which to Reaganites is an oxymoron.
Obama’s New Progressivism
Obama’s new progressivism is based on
the rehabilitation of
government intervention in a failed market economy, even as his top
economist
only accepts the progressive battle cry as a temporary necessity. Even
Obama
himself has to clarify publicly that he realizes that Americans do not
envy or
resent the rich because even the American dream allows the poor to
emulate the
rich. But his stops short of proposing an income policy even when it is
obvious
that income disparity creates destabilizing imbalance between supply
and
demand. The failure of government intervention from misuse, such as
intervention to help wayward financial institutions rather than
victimized
individuals can turn the US
into a failed state and the economy into a failed market.
Need for a National Income Policy
Rather than a national income policy
to raise income for
all, Obama chooses instead an income redistribution path through
raising taxes
on the rich and cutting taxes on the poor and the middle class, whose
members
are really the working poor because of a decade of wage stagnation. An
income
policy will relieve the working poor by guaranteeing every worker a
good living
wage to be an effective consumer without unsustainable debt. After all,
it is a
very American idea that was first put into practice successfully by
Henry Ford.
Thus far, the reality is that the American dream has turned into a
nightmare in
which the poor emulate the rich by spending beyond their meager means
and
taking on unsustainable debt, not by spending rising income. Effective
income
parity does not aim at lowering the income of the rich, it aims at
raising the
income of the poor.
Back to Dysfunctional Trickling Down
While Summers is continuing Paulson’s
aim of saving free
market capitalism with temporary transitional state capitalism, Obama’s
rhetoric until recently had been couched in a far-reaching progressive
agenda
of reversing widening income disparity and unsustainable wage/price
imbalance
that have left the world with overcapacity caused by insufficient
demand which
had to be masked by excessive debt. But Obama’s March 12 speech before
the
Conference Board, a group representing the interests of big business,
was
disappointing in that it made our progressive reformer sound like just
another
garden variety “trickling down” market fundamentalist. Obama’s strategy
of
first putting out the raging financial fires before dealing with
long-term
structural reform is fundamentally flaw because the arsonist
responsible for
the raging fires is decades-long denial of the urgent need for
fundamental
structural reform. There is overwhelming prospect that if and when the
raging
fire is contained, fundamental reform will give way to business as
usual
with
celebration of the resilience of market fundamentalism. The prospect of
recurring crisis every decade will continue.
Obama’s
Progressive Initiatives
Blocked by Centrists
Obama’s
three core progressive
initiatives: universal education, universal health care and
energy/environment
transformation, if implemented without watered down compromise, will be
steps
to restore US society to its true core values, not just a new, improve
American
dream that bear little resemblance to harsh reality. Unfortunately, the
Obama
team is dominated by centrists who have now taken on the battle
standard of the
failed alliance of neoliberals in global economics and neoconservatives
in
global security. These centrists view their leader’s grand progressive
agenda
as merely a convenient temporary antidote of emergency intensive care
for a
dysfunctional and unjust economic system and a militant hegemonic
foreign
policy.
According to Summers: “It is
periodically the task of
progressives to, ironically, save the market system from its own
excesses.”
Centrists are reformers who believe that slavery can be eliminated
simply by
paying below-living wages.
The call by Summers, in his new post
as Chairman of the
White House National Economic Council, for international coordination
of
stimulus programs is being rejected by his counterparts in the EU.
Disagreements between the EU and the US over how to deal with the
global
recession is widening as EU governments show little appetite for the US
formula
of piling up more public debt to fight the collapse in output and jobs
caused
by excess private debt. European social democrats are not on the same
wavelength with the pro-big-business, pro-market approach of
Paulson/Summers/Geithner, as three market fundamentalist musketeers,
supported
by Fed Chairman Bernanke as the ever loyal D’Artignan.
EU Resistance to US Recovery Strategy
To the Europeans, shifting private
debt to public debt is
not only self deception, especially under a destructive regime of
dollar
hegemony, it is also particularly dangerous if all sovereign debts are
denominated in dollars that EU central banks cannot print, but have to
earn
through foreign trade. Government stimulus packages are funded with
future tax
revenue. It is natural that tax money is viewed by the paying public as
funds
that should be spent within each country. Government bailout to
transnational
financial institutions is likely to be used globally. Every government
is now
engaged in a race to maximize national multiplier effects of its
stimulus
programs. Thus while all governments are paying lip service to resist
protectionism against movement of goods, few has faced up to the new
form of
financial protectionism practiced by transnational institutions.
Financial Nationalism and the Lehman
Brothers Bankruptcy
The transfer of funds from London
to New York by Lehman
Brothers
during the early hours of its bankruptcy filing is an example of the
problem
financial nationalism. Scores of hedge funds that had hundreds of
millions in
cash and other securities parked with Lehman’s prime brokerage
operation in
London have had their accounts frozen and the funds transferred to New
York,
leaving the United Kingdom with less money to settle the bankrupt
firm’s
liabilities.
A number of hedge funds filed formal
objections with the New York
bankruptcy court and at least one fund, New
York-based Bay Harbour Management, filed a legal challenge to the
court’s
hastily-approved sale of Lehman’s brokerage arm to Barclays Capital.
A subsequent and even more troubling
scenario arose from
legal disputes on the estimated $1 trillion in market value exposure of
derivatives
transactions that Lehman had entered into on behalf of itself and its
customers. At least three lawsuits are known to have been filed
alleging that
nearly $600 million in collateral posted by some of Lehman’s trading
partners
in derivatives transactions had not been returned as required and had
disappeared
from the United Kingdom as the bankruptcy process unfolded in New York.
The Bank of America (BoA) is seeking
to recover nearly $500
million the bank “posted as collateral to “support derivative
transactions
between BofA and the respective Lehman Entities,’’ according to a
lawsuit filed
in New York State Supreme Court that alleges the accounts at Lehman
that held
the collateral were “frozen,’’ when the investment house filed for
bankruptcy
on September 15, 2008. BoA contends that Lehman “wrongfully refused’’
to return
the collateral in violation of its agreement as a trading counterparty.
The
dispute was expected to be the first of many since it is not uncommon
for derivative
transactions to be part of a tangled web, in which trading
counterparties are
on the hook to make payments to other trading counterparties with whom
they
have no direct agreements. A derivative is a sophisticated contractual
agreement that is dependent on the performance of the notional value of
an
underlying security, such as a bond, a stock or a commodity.
The dispute between BofA and Lehman
stemmed from the fateful
decision by Lehman officials in New York
to transfer $8 billion in cash from the firm’s London
offices on the eve of the bankruptcy filing before funds were frozen in
London.
The $8 billion cash and securities sweep left Lehman’s London
offices with no money to pay employees or to provide cash to hedge
funds that
made use of the firm’s overseas prime brokerage operations.
The list of hedge funds entangled in
the Lehman bankruptcy
kept growing by the day following bankruptcy filling. Besides Bay
Harbour, the
list of hedge funds caught-up in the great $8 billion cash transfer
include,
GLG Partners, Newport Global Opportunities Fund, Amber Capital and
Harbinger
Capital Partners. Texas-based Newport Global, a nearly $700 million
fund with
close ties to private equity giant Providence Equity Partners, got
squeezed
when Lehman officials apparently failed to comply with the funds’
request to
move all its assets to Credit Suisse. Newport,
which used Lehman as a prime broker, notified Lehman on September 10, 2008, five
days before bankruptcy
filling, to “transfer assets held by “Lehman’s London
affiliate to Credit Suisse. Newport
executives had believed the transfer was completed and were shocked to
learn
that the assets were never moved before Lehman filed for bankruptcy. As
a
result, Newport’s assets
were
frozen in the wake of the $8 billion transfer. In court papers, Newport
says “if these assets are not located and recovered immediately, there
is the
very real specter of serious and irreparable harm to not only the
funds, but
also to their respective investors.”
IMF Reform
As the lender of last resort for
distressed central banks,
IMF loans are denominated in dollars. The US
contributes only 18% in funding but commands the deciding vote over the
remaining 82% contribution by all other member governments.
Current focus on the reform of the
International Monetary
Fund (IMF) is pinned on the hope that the world’s lender of last resort
can
contribute substantially to a recovery in 2010 from the greatest
economic
crisis in a century. The IMF,
headquartered in Washington D.C.,
is an international organization created in July 1944 during the United
Nations
Monetary and Financial Conference at Bretton Woods,
New Hampshire. It
is charged with the
responsibility of overseeing the global financial system by monitoring
those
aspects of macro economic policies of its 185 member states that impact
exchange rates and the balance of payments. In theory, it has been
designed as
an international organization to stabilize international exchange rates
and to
facilitate the balance of payments shortfalls of member states as an
international lender of last resort.
The performance of the IMF during the
1997 Asian financial
crisis has since been broadly and critically condemned as having
unnecessarily
exacerbated the pain for and damage to the affected economies, with its
imposition of dilapidating “conditonalities” on debtor nations, such as
privatizing industries and slashing government spending. (Please see my
September
28, 2002 AToL article: Crippling debt and bankrupt solutions) In 2008, faced with a shortfall in revenue
itself, the IMF executive board agreed to sell part of its gold
reserves and to
curb operating expenses.
The IMF hopes to at least double its
lendable resources from
$50 billion to more than $500 billion so that it is ready to help out
and
provide confidence that economies will have access to funds during the
crisis. Japan
has provided $100 billion in extra money and the European Union has
committed
EUR 75 billion. Emerging economies such as the BRIC nations, Brazil,
Russia,
India
and China,
are
expected to provide the bulk of the remaining funds.
IMF plans to sweeten a $100 billion
lending program
announced in October that failed to attract any borrower. The new
program of
less-restrictive loans is designed to boost the fund’s impaired
standing as an
authority in containing the global meltdown and to assuage member
nations
concerns about borrowing from a lender often seen as heavy-handed and
intrusive
in internal national policies to protect transnational lenders. IMF
loan
conditionality is being adjusted so that economic structural reforms
agreed
with a country will be monitored in a broad context. The change is also
applicable to low-income countries.
If successful, the new IMF program
could help many
distressed economies weather the global economic downturn. If not,
global
recovery will be delayed and the IMF will become less relevant.
Lending reforms will be followed by
further changes to
country representation at the Fund, with emerging markets and
low-income
countries being given a bigger voice. The April 2 G-20 summit in London
is expected to bring forward the process of reform of the quota systems
that
determines country representation.
Together, the G-20 represents around
90 percent of global
gross national product, 80 percent of world trade (including trade
within the
European Union), as well as two-thirds of the world's
population. It comprises 19 countries: Argentina,
Australia,
Brazil,
Canada,
China,
France,
Germany,
India,
Indonesia,
Italy,
Japan,
Mexico,
Russia,
Saudi Arabia,
South Africa,
South Korea,
Turkey,
the United Kingdom, and
the United States,
plus the European Union, represented by the rotating Council presidency
and the
European Central Bank. The Managing Director of the International
Monetary Fund
and the President of the World Bank, plus the chairs of the
International
Monetary and Financial Committee and Development Committee of the IMF
and World
Bank, also participate.
Despite major stimulus
packages announced by advanced economies and several emerging markets,
trade
volumes have shrunk rapidly, while production and employment data
suggest that
global activity continues to contract in the first quarter of 2009.
Global activity is now projected to
contract by 0.5 to 1% in
2009 on an annual average basis—the first such fall in 60 years. Global
growth
is still forecast by the IMF to stage a modest recovery next year,
conditional
on comprehensive policy steps to stabilize financial conditions,
sizeable
fiscal support, a gradual improvement in credit conditions, a bottoming
of the US
housing market, and the cushioning effect from sharply lower oil and
other
major commodity prices. Such institutional optimism is not shared
broadly.
Obama has No Plans for Monetary Reform
Most importantly, in the US,
the world’s largest economy, President Obama has yet to put forward any
plans
for monetary reform, let alone a new international finance
architecture, while
FDR’s monetary reform was the centerpiece of the New Deal, albeit it
was a
distant echo of 19th century agrarian insurgency against the
gold
standard. Since the 1997 Asian financial crisis, there have been vague
talks in
the Federal Reserve and the Treasury about the need for reform of the
existing
international finance architecture that is generally accepted as a
fundamental
cause of the current and previous financial crises, but the official
Obama
strategy appears to be that the teetering banking system must be
stabilized
first before any fundamental monetary reform can be entertained. The
question
is left begging whether the critically impaired global banking system
can be
stabilized without fundamental reform of the international financial
architecture which had cause the crisis to begin with.
FDR’s Monetray Reform
Roosevelt’s Executive Order 6102 proclaimed on
January 31,
1934 a $35-per-fine-troy-ounce dollar parity
to replace the traditional gold standard parity of $20.67 per fine
ounce, i.e.,
1,504.63 fine milligrams (or 25.8 grains 0.9 fine). To sustain the
devaluation
of the dollar, FDR suspended the rights of US citizens to own gold,
requiring
all to turn in their gold holdings to the government for payment at $20.67 per ounce.
Individuals were permitted to hold up to $100
in gold coins. Executive Order 6120, deriving its authority from the 1917 Trading with the Enemy Act which
gave the
president the power to forbid people from “hoarding gold” during a time
of war,
also forbade all private contracts to be denominated in gold. Though
the US
was not at war in 1934, FDR claimed that the economic crisis was
creating
emergency conditions equivalent to war.
Normally,
Executive Order
6120 would have been opposed by outraged the freedom-loving American
public as
the constitution stipulates that the executive branch is vested only
with the
authority to execute laws and policies enacted by the people’s
representatives
in Congress. Even the Progressives had never dared move so far as to
allow the
executive branch to make laws unconstitutionally and to impose such
unconstitutional laws on the people without their consent.
However,
by 1933, the US
judiciary branch had upheld government restrictions on freedom of
speech and
other civil liberties during World War I and Congress had surrendered
many
lawmaking powers to the executive branch, a trend that has continued
today to
the extend that the President can now routinely launch limited foreign
wars
without having first asked Congress to declare war. Historians refer to
this
development as a move toward an imperial presidency.
Most
Americans by 1934 had
been put in a situation of viewing economic and political freedom as
having
been captured by the moneyed interests at the expense of the common
people for
whom freedom had come to mean only freedom to be unemployed and left
starving.
The people were willing to give the president whatever he wanted to
save them
from oppression by the moneyed class and to restructure market
capitalism as a
more fair and equitable system.
The
US gold-based monetary system at the time of
the Great
Depression would not permit the debasement of money caused by increases
in the
money supply as a convenient solution to price deflation which could
cause and
did cause widespread destruction of wealth and massive unemployment. If
market
participants sensed that too many dollars were being issued by central
bank
quantitative easing or by Treasury borrowing beyond anticipated
revenue, they
could protect their wealth by redeeming dollars for gold from the
government as
a legal right and at a rate committed to by government, draining the
government’s gold holdings below the accepted Gold Standard level of a
40% gold
backing for the money supply. More money supply required more
government
holdings of gold to maintain the gold parity. New Deal principles of
temporary
deficit financing would be hampered by the rules of the Gold Standard
because
the government gold holdings cannot be increased easily and certainly
not by
money devaluation, as more money would be required to buy new gold as
money is
devalued.
Section
9 of Executive Order
6120 stipulated that anyone who refused to comply could be fined up to
$10,000
($1,533,653 in 2007 money) or be sentenced
to a maximum of 10 years in prison, or both. But foreign governments
still
could trade in their US dollars for gold but only at $35 an ounce
instead of
the Gold Standard rate of $20.67 per ounce. Since international trade
at the
time did not generate large foreign holdings of dollars, and the dollar
was not
the prime reserve currency and other currencies were also backed by
gold at
various rates, the impact while not insubstantial was still limited.
The gold Standard Act had been
enacted in 1900 for the US
under President William McKinley who defeated William Jennings Bryan,
the
brilliant populist orator, a backer of free silver, who stampeded the
Democratic convention with one of the most famous speeches in US
political history:
There
are two ideas of government.
There are those who believe if you just legislate to make the
well-to-do
prosperous, their prosperity will leak through on those below. The
Democratic
idea has been that if you legislate to make the masses prosperous,
their
prosperity will find its way up and through every class that rest upon
it. …
Having behind us the producing masses of this nation, and the world,
supported
by the commercial interests, the laboring interests and the toilers
everywhere,
we will answer their demand for a gold standard by saying to them: You shall not press down upon the brow of
labor this crown of thorns, you shall not crucify mankind upon a cross
of gold.
For the first time since 1860, the
1900 election turned on a
clear issue of major importance between the two political parties. The
question
of free silver had become symbolic of the conflict between capitalism
and
agrarianism, between the Hamiltonian concept of a nation dominated by
big
corporations and the wealthy elite who controlled them, and on the
other side,
the Jeffersonian ideal of economic democracy behind populist
agrarianism.
McKinley’s victory was a definitive
triumph of the
Hamiltonian model, as Henry Adam observed: “The majority at last
declared
itself, once and for all, in favor of a capitalistic system with all
its
necessary machinery.” One of the
necessary machinery is the integration of business and government. In
recent
decades, titans of investment banking and industry had been running the
US
Treasury under both Democratic and Republican administrations. Larry
Summers
was the first academic economist to run the Treasury and Tim Geithner
is the
first technocrat to do so. Both are strong supporters of neoliberalism.
No
labor leader has ever run the US Treasury.
Labor, on whose back wealth is
created, has never commanded
control over monetary policy in the history of the US,
despite that fact central banking was adopted by Congress to maintain
the value
of money with the accompanying objective of promoting full employment.
Since
1913, when the Federal Reserve was established, US
labor has been at the dictatorial mercy of capital. Wealth, instead of
being
created and enjoyed by independent labor, has been separated from its
creator
to become capital, the requisite master for creating jobs in an
economic system
of contract labor. In the current financial crisis in free market
capitalism,
protesters against taxation on capital gain argue against “punishing”
capital,
without which jobs allegedly cannot be created. Such protests are in
essence
calls for punishing labor to keep unruly capital from self inflicted
losses.
By February 1933, a little over two
years after the market
crash of October 1929, depositors were still withdrawing money from
banks in
such panic quantities that state governments had to intervene to arrest
widespread bank failure. Michigan
declared a bank holiday on February
14, 1933 and by the time FDR took office on March 4 all
states had
taken similar actions to create a national bank holiday.
The new president immediately took
control of the entire
national banking system. Congress passed the enabling Gold Reserve Act
of 1934
on January 30, and FDR issued his devaluation proclamation on January
31, in
less than 24 hours. FDR forbade US citizens to buy or own gold and
devalued the
dollar 60% by making gold valued at $35 an ounce, up from $20.67 an
ounce
established by the Gold Standard, and kept interest rates at historical
low
levels. Still, US
export trade did not rise with dollar devaluation against gold, nor
employment
in the domestic private sector picked up. Most of the drop in
unemployment was
absorbed by the expanded public sector. The US
economy did not revive until the US
entered WWII with the US
adopting national planning for war production. (Please see my June 13, 2002 AToL article: National
planning and
the American myth)
Britain’s
Gold Standard
Winston Churchill, as Chancellor of
the Exchequer in the Conservative government,
returned Britain,
a
fading superpower after World War I, to the gold standard in 1925,
again
devaluing silver against gold, although a higher gold price and
significant
inflation had followed the wartime suspension of the gold standard.
Under the
gold standard, the US fixed the price of gold at $20.67 per ounce from
1834
until 1933; Britain fixed the price at 3 pounds 17 shillings and 10.5
pence per
ounce until WW I, and restored it in 1925. The exchange rate between
dollars
and pounds - the “par exchange rate” - necessarily came to $4.867 per
pound
sterling during these periods. Currency speculation did not and could
not exist.
Churchill followed tradition by
resuming conversion payments
at the pre-war gold price. For five years prior to 1925, old price in
pound
sterling was managed downward to the pre-war level, causing deflation
throughout those countries of the British Empire
and
Commonwealth using the pound sterling. But the rise in demand for gold
for
conversion payments that followed the similar European resumptions of
the Gold
Standard from 1925 to 1928 meant a further rise in demand for gold
relative to
goods and therefore the need for a lower price of goods because of the
fixed
rate of conversion from money to goods.
Because of price deflation caused by
the Gold Standard and the
predictable depression effects, the British government finally
abandoned the Gold
Standard on September 20, 1931.
Sweden
abandoned the Gold Standard in October 1931; and other European nations
soon
followed. Even the US government, which at the time possessed most of
the
world’s gold, moved to cushion the effects of the Great Depression by
raising
the official price of gold (from about $20.67 to $35 per ounce) and
thereby
substantially raising the equilibrium price level in 1933-4.
The FDR Gold Parity Dollar
The deflation in the years of the
Great Depression
disconnected the Roosevelt gold-based dollar
held by
foreigners with the de facto domestic fiat dollar of January 1934. The
Consumer
Price Index for January 1934 was 132 with July 1914 set as 100, making
the
January 1934 dollar worth 75.75 cents of gold standard dollar of 1914.
For this
reason, the domestic dollar of January 1934 was endowed with 132 cents
(100/75.75= 1.32) in 1914 gold standard dollar at $20.67 per ounce. In
terms of
the Roosevelt dollar with its gold parity of
$35 an
ounce, it was endowed with 223.5 cents. But up to 1934, before Roosevelt
devalued the dollar, it was convertible through central banks at $20.67
per
ounce of gold to yield 100 cents. Foreigners could buy US goods and
assets with
100 cents that would cost US
citizens 223.5 cents. This explained why investment in the US
from Gold Standard economies grew during 1914 and 1934 until the Great
Depression finally set in after the market crash of 1929.
The Roosevelt
dollar became a two-tier
currency whose purchasing power at home did not match its set gold
parity
abroad at $35 per ounce. At home, it was a de facto fiat monetary unit,
not
convertible to gold; and abroad, it was convertible to gold at $35 per
ounce,
devalued from the Gold Standard of $20.67 per ounce.
When this “international gold bullion
standard” was set up
on January 31, 1934, a gold
standard without redemption of currency in gold coin, the
Roosevelt dollar was worth 132 cents at $20.67 per ounce of gold abroad
and
223.5 cents at home in terms of its own gold parity of $35 per ounce.
At home,
the dollar was loosing purchasing power steadily, while abroad it
stayed
constant against gold because at home it was not convertible to gold
while
abroad it was. On Christmas Day 1942, because of wartime price control,
the fiat
dollar, descending from 223.5 cents level of January 1934, finally met
its
foreign twin when it reached 132 cents level. But the reunion was to
last three
months only, after which US
prices began to rise even under price control.
The two-tier Roosevelt
dollar, while fixed
in value against gold abroad, continue to lose purchasing power at
home. On
July 22, 1944, when the Bretton Woods agreements were signed, the
dollar was worth
only 95 cents at home as registered by the CPI, while abroad the same
dollar is
still worth 100 cents against $35 gold. On August 4, 1945, President
Truman
signed into law the Bretton Woods regime, approved by US Congress as a
simple
bill that required only a majority, not a treaty that would require a
2/3
majority in the Senate. The next day, Truman authorized dropping the
atomic
bomb on Hiroshima. CPI for
August
1945 put the dollar as worth only 93 cents at home while abroad it was
still
worth 100 cents.
By August 1947, when the
International Monetary Fund (IMF)
born of the Bretton Woods regime became fully operational and member
countries
pegged their currencies within 1% of their official par values to the
100-cent
dollar, convertible to gold at $35 per ounce, the dollar was worth only
75
cents at home after war-time price control was lifted. Under the
Bretton Woods
agreements, the currencies of the IMF member countries were to be
defined pro
forma in weight of gold, and those “gold parities” were to be
translated into
par values against the US dollar, whose gold parity at $35 per fine
troy ounce
was 888.67 milligrams (or 15 and 5/21 grains 0.9 fine). The currencies
of the
IMF member countries became convertible to dollars at “fixed but
adjustable par
values”, while only dollars were made officially convertible to gold,
but not
to individual US citizens, only to foreign central banks.
The Bretton Woods regime became a
rigged system of exchange in
which 75-cent fiat dollars could be cashed for 100-cent
gold-convertible
dollars. As the dollar was the sole reserve currency for international
trade
under the Bretton Woods monetary regime, the US
enjoyed a 25% premium in all world trade. The same US
goods commanded a higher price against gold overseas than at home. As
the US
after WWII was the only exporting nation to war-torn countries around
the
world, what cost 75 cents in fiat dollars in the US
would sell for 100 cents in gold at $35 per ounce. While this greatly
enhanced
profitability of US exporting corporations, it also discourage US
companies to
bring their overseas dollars home where the dollar would be worth less
because
US citizens could not convert dollars into gold. This created what
later came
to be known as euro-dollars, dollars that stayed permanently overseas
to
preserve a higher exchange value.
During the 1960s, as US
commitments abroad drew gold reserves from the Federal Reserve,
confidence in
the dollar weakened, leading some dollar-holding countries and
speculators to
seek exchange of their dollars for gold. A severe drain on US gold
reserves
developed and, in order to correct the situation, the so-called
two-tier system
was created in 1968. In the official monetary tier, consisting of
central bank
gold traders, the value of gold was kept at $35 an ounce, and gold
payments to
non-central bankers were prohibited. In the free-market tier,
consisting of all
nongovernmental gold traders, gold was completely demonetized, with its
price
set by supply and demand. In 1971, President Nixon abandoned the
Bretton Woods
regime and disconnected the dollar from gold altogether as he restored
the
right of US citizens to own gold.
Foreigners thought erroneously they
were getting rich by
holding US dollars but in effects their economies were slipping into
the
control of the US
because whoever controls the currency of an economy also controls the
economy,
as Gresham’s Law states: “Bad
money drives out the good.” When wealth is denominated
in fiat
dollars, the US
essentially owns that wealth; foreign holders of that wealth are merely
acting
as temporary agents of the US.
(Please see my September 26,
2008
AToL article: History
of
Monetary Imperialism)
Obama and China’s
RMB
On the second day of the new Obama
administration, Tim
Geithner, President Obama’s choice for Treasury secretary, in his
Senate
confirmation hearing supported by written testimony, accused China
of “manipulating” its currency and pledged “aggressive” diplomatic
action to
drive Beijing into action
if
confirmed as Treasury Secretary. The comment, a politically loaded term
calculated
to raise tensions with China, appeared to be a direct appeasement to
Democratic
Senator Schumer whose pet issue has been for “tough approach to force China to stop
currency manipulation or risk being sapped with large (20%) tariffs on
its exports.”
It is a “lets get China” to force her to stop beating her grandmother
issue, as
most trade economists, including Larry Summers who is now the top
economic
advisor for Obama, consider the exchange rate issue as an ignoratio elenchi (irrelevant
conclusion), the informal
fallacy of presenting an argument that may in itself be valid, but does
not
address the issue in question.
Geithner’s testimony marked the Obama
administration’s first
public pronouncement in what will be one of its most critical
international economic
relationships. It is an indication of the gap between US
foreign policy and domestic politics. It is also an indication of
Obama’s less
than forceful leadership. Geithner claimed he was merely repeating
Obama’s
views with which he was no doubt very familiar. The connection between
Obama
and Geithner went back a long way to an early genreation, During the
early
1980s, Geithner’s father, Peter, oversaw the Ford Foundation’s
microfinance
programs in Indonesia
being developed by Ann Dunham-Soetoro, Obama’s mother.
In a written response to questions
from concerned senators,
Mr Geithner, whose nomination was supported by a clear majority of the
Senate’s
finance committee despite minor personal income tax problems, said:
“President
Obama – backed by the conclusions of a broad range of economists –
believes
that China
is
manipulating its currency.” Mr Obama would “use aggressively all the
diplomatic
avenues open to him to seek change in China’s
currency practices”, Geithner added. Thus the position was not just to
buy
confirmation votes.
The price of long-term US Treasury
bonds fell after Geithner’s
remarks, with some traders concerned that Beijing
might ease up its purchase of US debts and assets. China
is the largest foreign holder of US Treasuries. More than $3 trillion
of the
$5.5 trillion US Treasury market is held by foreign investors, with China
being the biggest, holding $727.4 billion in December 2008, with Japan
in second place with $626 billion. China
reportedly holds $1.5 trillion in dollar denominated assets out of
nearly $2
trillion in foreign exchange reserves. Beside Treasuries, China
at the end of 2008 held $600 billion in agencies debt (Fanny Mae), 150
billion
in corporate bonds, $80 billion in bank deposits and $40 billion in
equities.
The spectacular growth in China’s
foreign currency reserves appears to be moderating as the inflow of
speculative
“hot money” started to reverse flow out of the Chinese economy in the
fourth
quarter of 2008. China’s
foreign reserves rose by $40.4 billion in the fourth quarter of 2008 to
$1.946
trillion, well below the total trade surplus and foreign direct
investment over
same period a year earlier, indicating a substantial outflow of
short-term
capital.
While China continues to register
trade surpluses from a
sharper fall in imports even as export falls, and her foreign reserves
still
expected to rise above $2 trillion in 2009, the period of explosive
export
growth is expected to end and growth of foreign reserves is expected to
moderate. Some analysts are suggesting that China’s
liquidity cycle may be ending after a six-year boom as current policy
continues. This projection can be rendered inaccurate substantially by
impending and further government stimulus measures to deal with the
impact of
the global financial crisis on the Chinese economy.
Obama Flirting with Bankruptcy for
the US
The Obama administration will face
budget deficit of over $3
trillion in 2009 and a still higher deficit in 2010 and beyond as it
tries to
re-monetize up to $2.5 trillion of practically worthless toxic assets
with
yet-to-collect taxpayer money. Globally, the dollar-denominated
financial
system has seen its equity market capitalization value fall by between
40-60%
by February 2009. The Dow Jones Global Total Index of all publicly
trade
companies, a comprehensive benchmark series designed to measure the
performance
of global equity markets with readily available prices covering 65
countries
and nearly 13,000 securities peaked at 4480.66 on October 11, 2007. Since then, it has
fallen more than
half to 2206.14 by January
20, 2009.
On October 31, 2007, the total market value of
publicly-traded companies around
the world was $62.6 trillion. By December 31, 2008, the value had dropped nearly
half to $31.7
trillion. The gap of lost wealth, $30.9 trillion, is
approximately the
combined annual Gross Domestic Product of the US,
Western Europe, and Japan.
Asian shares lost around $9.6 trillion in 2008, according to the Asian
Development Bank.
The financial structure of most
assets normally carries a
debt to equity ratio of between a conservative 3:1 and an aggressive
10:1. With
a fall in market value of over 50%, even conservatively leveraged
assets are
now substantially underwater, meaning they have substantial negative
equity. Family net worth hit a record high
of $64.36
trillion in 2nd quarter of 2007. By 4th quarter
2008, it
fell to $51.48 trillion, a loss of $12.88 trillion.
To restore the wealth lost in the
current financial crisis,
the Treasury would have to monetize some $30 trillion of toxic assets,
almost
ten times what the Geithner Treasury is currently contemplating, and
twice the
size of current US
annual GDP. Add to that about $10 trillion of value lost in the
collapse of
commodity prices and another $10 trillion in real property values, and
we have
a wealth loss of $50 trillion. According
to the Bank of International Settlements, the total outstanding
notional value
of derivatives as of June 2008 was $684 trillion. Each percentage point
loss
can cost $6.8 trillion to investors. No one knows what the final loss
will be
in derivatives when fully unwounded.
Obama’s Stimulus Package Will Not
Create Jobs
The Federal Reserve can absorb some
of the loss to keep
mark-to-market value of these instruments from falling further. But
that would
require such massive injection of new money that the time when prices
stop
falling will be the time hyperinflation starts. Thus either way
deflation from
market loss continues, first from falling prices and then inflation
take over
from falling value of money. This is why the Obama stimulus package
will not
create jobs at any substantial scale, because all the good money is
essentially
going to monetize bad assets, with little financial energy left to have
significant job creation impact.
Global assets under management (AuM)
have shrunk 8% from
2007 to 2008, from $110 trillion to $100 trillion. The reason global
AuM shrank
only by $10 trillion while the equity markets fell 50% losing $30.9
trillion
was because much AuM was invested in US Treasuries and other top rated
fixed
income instruments in a flight to safety. Equity funds AuM have fallen
from $6
trillion to $3 trillion. Investment managed by hedge funds has fallen
by over
50% from $2 trillion to $1 trillion. China,
as the largest foreign holder of US Treasuries, will impact US
financial market materially if Chinese policymakers have to reduce China’s
foreign reserves due to rising outflows of foreign capital, or as
countermeasures against ill-advised US
trade sanctions.
China’s
Dollar Holdings
In the first half of 2008, Chinese
foreign reserves rose by
$280.6 billion, largely due to capital inflow on expectation the
renminbi (RMB)
would continue to appreciate by policy pressure from Washington.
However, those flows began to reverse in the fourth quarter at a time
when the
offshore currency market was signaling pending RMB depreciation.
Calculating how much money left China
using the reserves data is complicated because of exchange value
movements in
the currencies in which China
is invested and changes in reserve requirements for Chinese commercial
banks,
some of which are held in foreign currencies. Nevertheless, in the
fourth
quarter of 2008, China
saw capital outflows of $45-70 billion a month on average.
Slower or negative growth in foreign
reserves will mean China
will have less funds to buy new dollar assets in 2009 but that does not
necessarily mean weaker demand for US Treasuries. Capital outflows from
China
are likely to go into US Treasuries, given the risk-averse mood in
capital
markets. A short circuit of dollar funds released by the Treasury and
the
Federal Reserve may be created by US recipients of government funds
investing
in US Treasuries to de-leverage, leaving the US
in a perpetual liquidity trap. Near-zero return on US sovereign debt
will force
market participants, including China, to seek alternative investments
in their
own domestic markets, particularly if monetarily-induced inflation is
no longer
a serious problem in most non-dollar economies with heavy export
reliance
because of deflationary pressure from the global financial meltdown.
China’s demand for Treasuries was
augmented in early 2008 by
Chinese sale of US government sponsored enterprise (GSE) debt (such
Fannie Mae
and Freddie Mac) before the issuing entities were nationalized. Heavy
hot money
outflow created sell-offs in the Chinese equity and real estate
markets, but it
also provided opportunities for China
to expand Chinese money supply to stimulate the Chinese economy without
causing
inflation. The net effect was a replacement of foreign capital by
domestic
capital. The Chinese stimulus package will also accelerate China’s
strategy to upgrade its economy, increasing investment in physical and
social
infrastructure and welfare benefits. Market forces are likely to
reverse
direction to depreciate the Chinese currency, making Washington’s
pressure on China
to further appreciate the Chinese currency through government
intervention an
anti-market demand.
The Split
between the White House and Congress on Economic Policy Towards China
Geithner, as nominee for Treasury
Secretary, in his Senate
confirmation hearing stopped short of pledging that the US Treasury
under his
direction would formally name China
as a currency manipulator in its annual currency report, due in the
spring of
2009. “The question is how and when to broach the subject in order to
do more
good than harm,” he hedged.
To disprove the validity of the
accusation that China is
manipulating the exchange rate of its currency, all China has to do is
to
release records showing that its government did not intervene directly,
albeit
the effective exchange rate of the yuan for Chinese exporters is
periodically
affected by government non-monetary measures. But the US
is not really interested in proving its accusation of China
as a currency manipulator. It only wants appease the US manufacturing
sector
and the labor unions by empty posturing while pressuring China to
cooperate in
other areas of economic relations under threats of protectionist
backlash.
The currency issue dates back decades
in US-China relations.
By Reagan’s second term that began on January 20, 1985, it became
undeniable
that US policy of a strong dollar, while it benefited the US economy as
a
whole, was doing much damage to the manufacturing sector of the US
economy and
threatening the Republicans with the loss of political support from key
industrial states in permanent recession, not to mention the labor
unions,
which the Republican Party was trying to woo with a theme of Cold War
anti-communist
patriotism as elite East-coast liberal Republicanism gave way to macho
redneck
Republicanism of the Southwest. The exchange value of the dollar then
became a
red herring in US
geopolitical discourse to divert attention from cross-border wage
disparity,
the true cause of trade imbalance.
The US
has long claimed that China
was artificially depressing the value of its currency to a falling
dollar to
boost exports to the detriment of US
business. Since such claims are factually and theoretically of no
merit, both
the Clinton and Bush administrations always stopped short of formally
declaring
China a currency manipulator because the economic facts showed that the
US
economy was benefiting as a whole more than it was losing in its
manufacturing
sector. More over, the US
was in denial of the fact that it was the dollar that was falling as a
result
of US
policy,
therefore the yuan being pegged to the dollar was robbing the dollar of
any
benefit of depreciation.
Hank Paulson, Geithner’s predecessor,
to appease US domestic
special interests, repeatedly criticized Beijing
for holding down its currency but resisted pressure from anti-China
hawks in Congress
to formally name China
as a manipulator because he knew the US
was the real currency manipulator but the manipulation was neutralized
by the
yuan-dollar peg.. Existing US
legislation requires only that the administration starts negotiations
with any
country designated as having manipulated its currency, so the Strategic
Economic Dialogue was the convenient solution.
To appease US
demand, China
abandoned a fixed yuan-dollar peg in 2005 for a managed float against a
basket of currencies within a band and at a crawl rate (BBC). Since
then the renminbi (RMB) has appreciated by
about 20% against the dollar. When the yuan was pegged to the dollar,
it lost
value relative to other currencies when the dollar falls, as it did
between
February 2002 and 2005. Thus the US
was the main manipulator of the Chinese currency during that time with China
only as a derivative of the real manipulator.
In November, 2008, in response to
adverse impacts on the
Chinese export sector from the global financial crisis, the Chinese
authorities
let the currency depreciate modestly by market forces, prompting
speculation
about a shift in foreign exchange policy. Since then, the renminbi has
traded
in a narrow band against the dollar, leading some economists to argue
that a de
facto peg has been restored. Between 2005 and 2008, despite the gradual
appreciation in the renminbi, China has continued to record large
current
account surpluses with the US, leading many economists to conclude that
the
trade imbalance between the US and China was not caused primarily by
exchange
rates. (Please see
my February 15, 2007 AToL article: The US as leading currency manipulator)
Geithner’s confirmation hearing
testimony solicited an
immediate response in China.
In an article published in the Chinese media, Zhang Jianhua, head of
the
research bureau of the People’s Bank of China, the central bank, said
that
“wrong economic policies and improper market monitoring [in the US]
are the primary reasons for the current financial crisis”. He added:
“Any
attempts to shift the responsibility to other countries reflect an
inability to
develop the right attitude for seeking solutions.”
The Geithner statement at his
confirmation came in response
to written questions from Democratic Senator (New
York)
Charles Schumer who once co-wrote a bill to impose punitive tariffs on China
if it did not revalue its currency; and Democratic Senator Debbie
Stabenow (Michigan)
who wrote a similar bill co-sponsored by then Democratic Senator Obama (Illinois).
The statement appeared calculated to send a number of messages at once:
to fulfill
campaign promises to US
labor and to anti-China trade hawks in Congress, warning Beijing
not to devalue its currency even as its export sector was collapsing
from the
global financial crisis and highlighting the need for an eventual
process of
global economic rebalancing. The statement also set the stage for tough
talks
with Beijing, and puts
pressure on
the IMF which had been expected to shy away from any formal finding
that
Chinese policy was in breach of its international commitments.
Geithner’s confirmation statement, if
translated into
policy, could increase trade tensions at a time of global recession and
fast-rising unemployment in both countries. However, the White House
can be
expected to pre-empt binding legislation by convincing US legislators
that the Treasury
secretary shares their concerns but he intends to find solution to the
problem
through negotiation with his Chinese counterpart. At any rate, there is
mounting consensus that China
needs to reorient its economic policy to reduce over-reliance on
foreign trade
and to develop its own domestic market. With China’s
policy shift, US trade sanctions on whatever pretext would have less
effect on China,
particularly if trade is being reduced by the reality of economic
downturn in
the US
anyway.
Even before the current crisis, growth of US-China trade has been
slowing as China
shifts it trade to markets in other regions.
Most economists agree that
exchange-rate policy cannot be
substitute for structural economic adjustments necessary for mutually
beneficial trade between two economies. Nor can exchange-rate policy be
substitute for sound domestic monetary or economic policies. When two
economies
are at uneven stages of development trade, a trade surplus in favor of
the less
developed economy is natural and just, until the less developed economy
catches
up with the more developed one. Otherwise it would be imperialistic
exploitation, not trade.
In a conference on China’s
Exchange Rate Policy at
the Petersen Institute in Washington DC held on October 19, 2007, three
months after the global credit crunch broke out, attending by Wu
Xiaoling, Deputy Governor of the People’s Bank of China, the central
bank, and
by Larry Summers, former Clinton
Treasury Secretary and now Obama’s Director of National Economic
Council, who
concluded that the real concern should be with China’s large global
surplus
rather than with the negligible effect of the RMB on US workers. It
would be better
to follow a multilateral, rather than a bilateral US-led approach with China to correcting
global payments imbalances. Summers did not see the RMB exchange rate
as the
primary source of US current
account deficit. Any attempt to blame RMB exchange rate for the
concerns of US
middle class workers is based on flawed economic judgment.
Summers’ Position on the
Falling Dollar
In an article in the October 28, 2007 edition of
the Financial Times entitled: How to Handle the Falling
Dollar,
Summers wrote:
The
vast majority of the US
current account deficit is now being funded by central banks
accumulating
reserves as they seek to avoid appreciation of their home currencies.
While the
US dollar is usually viewed as a floating rate currency, substantial
and
critical parts of the world economy operate with currencies pegged to
dollar
parities or at least managed with them in mind.
This
suggests the need for
rethinking traditional approaches to dollar policy at a time when the
global
economy is more vulnerable than it has been since 1998.
The Clinton
administration approach of asserting the desirability of a strong
dollar based
on strong fundamentals while allowing its value to be set on foreign
exchange
markets was highly successful in its time and has largely been followed
by the
Bush Treasury. But it is insufficient in the current world, where the
dollar’s
trade-weighted exchange rate is to an important extent managed abroad.
Some
means of engagement must be found with those who have yoked their
currencies
and so their financial policies to that of the US.
The US
has responded in an ad hoc way by carrying on a “strategic dialogue”
with China,
by far the largest economy with an exchange rate linked to the dollar,
backed
by congressional threats to address exchange rate issues using the
tools of
trade policy and references to communiqués from the Group of
Seven leading
industrial nations. In reality, the dialogue is anything but strategic.
Like so
much of American international policy in recent years, it seems to
confuse the
firm statement of legitimate desire with the serious conduct of
diplomacy.
Think
of the questions Chinese
policymakers must ask themselves. What is the highest US
priority – global financial stability or market access for
well-connected US
firms? Can the US
take yes for an answer or is it a certainty that a new president will
insist in
18 months on a new set of economic diplomacy accomplishments with China?
In which areas, if any, is the US
prepared to adjust its policies in response to global interests? Given
that the
Chinese authorities have presided over nearly double-digit annual
growth for a
generation, do US officials who make assertions about what is in China’s
interest have the experience and knowledge of China
that should cause their views to be taken seriously? Why is China
being singled out? How could China
– even if it wished to – act in ways that the US
prefers without appearing to yield to international pressure?
Maintaining
global financial
stability and the role of the dollar requires a more strategic approach
– a
task that, given the political calendar, is likely to fall to the next US
administration.
Unfortunately, the new Obama
administration so far in its
early weeks has yet to show any sign of a new strategic approach. All
the
pronouncements from the Obama team have the tone of emergency
firefighting,
only after which would the restructuring of the economy begin. But so
far no
one has any detail idea of what the Obama team will do and how it plans
to
accomplish its ambitious agenda. Obama’s call for bipartisan
cooperation was
answered by a house divided even within his own party. Even the vetting
for
nominations for key cabinet positions faced repeated setbacks,
indicating that
the Obama White House is up against a steep learning curve in a crisis
situation that cannot afford long learning periods. Obama’s foreign
policy
machinery has yet to start its strategic engine while the
administration,
consumed by having to deal with its own economic house on fire, is
merely
rushing to quench hot spots in Afghanistan,
Pakistan,
the Middle East, Iran,
and to explain confused signals on China.
US Foreign Policy Floudering
It is not surprising that US
foreign policy is floundering. US geopolitical leadership is based
primarily on
US economic prowess that translates into military power. As the US
model of neoliberal market fundamentalism faces imminent collapse from
its own
internal contradiction and abuses, the US
appears to be deprived of the advice of Teddy Roosevelt: Speak
softly, and carry a big stick; you will go far. The US
big stick is shrinking along with the falling exchange rate of the
dollar
reflected by massive fiscal deficits and a sharply deflated economy
while US
rhetoric is becoming louder. Obama declares he plans to cut US
annual fiscal deficit by half by the end of his first term. His 2009
budget
request totals $3.66 trillion, including $442 billion for financial
rescue
(12%), $524 billion for defense (17% - not including expected
supplemental war
funding) and $196 billion for interest on the national debt (5.4%). Projected tax revenue for 2009 is $2.29
trillion, yielding a deficit of $1.3 trillion. Add to the mandatory and
discretionary mix the $2.1 trillion-and-counting that has been
committed to
rescue the banks and credit markets, the auto industry, the housing
market and
financially strained consumers and businesses. With a potential fall in
tax
revenue, the deficit could balloon to $4 trillion.
How is the US
going to expect China
to appreciate the renminbi as Washington
dictates while the US
market is shrinking even at current exchange rates? China’s
export sector is in free fall and the Chinese central bank cannot
possibly
allow the yen to appreciate against the dollar under such
circumstances. The
dollar fell from 0.7388 euro on July
1, 2007 to 0.6276 euro on July 16, 2008 and rose to 0.7904 euro on February 18, 2009 as the
economies of the euro zone fell
into crisis. The dollar rose from 123.466 yen on July 10, 2007 to 99.2911 yen on March 30, 2008, fell to
88.7730 yen on January 24,
2009 and rose to 92.1410
yen on February 18, 2009.
The rise in the yen has caused much pain on the Japanese economy.
Summers, whose credibility was
irrevocably tarnished
internationally by his inept handling of the 1997 Asian financial
crisis, gave
another admonishing speech in Japan
on February 26, 1999,
warning Japan
not to depend on a weak yen to boost its economy, using worn-out
slogans such
as: “the exchange rate cannot be a substitute for policy.”
It was an amazing posture after
Rubin/Summers turned down a
Japanese/EU joint proposal for a 3-currency stabilization regime at the
1999 G7
meeting in Bonn in
continuation of
the effort to reform the international financial architecture for the 21st
century. Japan
proposed the creation of an Asian Monetary Fund at the G7-IMF meetings
in Hong Kong during September 20-25, 1997. Washington
vetoed that proposal which called on the Asian Development Bank to
support
Asian currencies that came under speculative attack with a special $100
billion
fund to be provided by Japan.
The United States
took a hands-off attitude at this early stage of the Asian Crisis. The
Washington Post noted on August
12, 1997 that the “United
States [was] conspicuous by its
absence” during
the organization of the Thai bailout. MOF officials noted that the Thai
support
meeting had created an “Asian Consensus” and to some extent legitimized
Japan’s
role as a regional leader at the expense of the United
States.
When financial contagion hit Korea
in December from Thailand,
where the problem started on July 2, the 1997 Asian financial crisis
showed
itself as not a local problem but global one. The New York Times
reported that
the US decision to rescue Korea was reached by Treasury Secretary
Robert Rubin
in the last minute before a Korean default on its sovereign debt
because of the
surprise discovery that Brazilian banks were holding a lot of Korean
bonds and
total return swaps (TRS) contracts used to capture “carry trade” profit
from
interest rate differential between pegged currencies. A Korean default
would
quickly spread to South America with more
direct impact
on the US
economy than previously realized. US multinational banks, the US
Treasury and
the Fed colluded on the classification of non-performing loans in Korea
for regulatory purposes to safeguard the exposure of US
bank. But the local banks in Korea
enjoyed no such flexibility.
(See: The Dangers of Derivatives http://www.atimes.com/global-econ/DE23Dj01.html)
Having been humbled by his own dismal
record of first
diagnosing the Asian crisis as merely transient and local, and
subsequently
mistaking IMF off-the-shelve “conditionalities” as the only cure, and
finally
non-intervention of free financial markets as a inviolable guiding
principle
for Asia, Summers a decade later proposes for the current financial
crisis the
Krugman reflation cure. He declares vaguely: “What I think is crucial
is the
recognition that the goal of price stability includes the
responsibility to
avoid deflation.”
In 1999, having declared only a month
earlier that while
free markets are not perfect, all other forms intervention alternatives
are
worse, Summers went to Japan and again asked the Japanese to fix their
economy
with interventionist monetary policies. Yukihiko Ikeda, a senior member
of the
ruling Liberal Democratic Party, reportedly told the press: “Mr.
Summers says,
do this, do that. But we will continue
with steps already in the works.” Japanese officials were generally of
the
opinion that reflationary policies would further weaken the yen, due to
pressure on the value of the yen from increased money supply. It might lead to further competitive currency
devaluations in other parts of Asia. Officials at the Bank of Japan, the central
bank, thought Summers was offering snake oil cures in the notion of
fighting
deflation with easing the money supply. Stephen Roach of Morgan Stanley
points
out in an interview on CNBC On February
23, 2009 that Japan’s
bubble burst in the 1990s affected only its capital sector which
constituted
only 17% of GDP, while the US
bubble burst in 2007 is infecting the consumer sector which is 72% of
GDP. The US
is facing a crisis four times bigger than what Japan
faced in the 1990s.
Yet a decade after the 1997 Asian
Financial Crisis, in 2007,
Summers declared that “the G7 process has lost its focus on exchange
rate
issues over the years as its member governments stopped trying to
manage their
rates.” The G7, which Summers describes as “an anachronism in the
current
international context” needs to be radically reinvented, starting with
enlarging its composition. Any new approach must be premised on “the
desirability of a strong, integrated global economy that benefits the
citizens
of all countries, not on the idea that economists or politicians can
calculate
“fair” exchange rates.” The right and potentially effective case for
adjustments in the current alignment of exchange rates relies “on their
unsustainability and the distortions they induce in macroeconomic
policies, not
on ideas of fairness to workers.”
Summers warned that “multilateralism
is better politics and
economics than unilateralism but it must not become an excuse for
inertia.” Any
new group should “analytically informed but everyone should know that
key
decisions will ultimately be taken by senior officials in the national
interest, not by international organizations. … History tells us that
poorly
managed finance foments instability and economic insecurity.”
Yet the US
has repeatedly mismanaged its finances for decades by exploiting the
hegemonic
character of the fiat dollar as a global reserve currency for
international
trade. US
unemployment rate is set by US
monetary policy, not by China.
US economic and trade policies have transferred wealth from US workers
to Wall
Street, not to China,
only via China.
China
Needs an Independent Economic Strategy
As for China, following the US model
of economic growth
through unregulated market fundamentalism will create the same income
disparity
and social inequality that US political culture concedes as natural and
US
ideology accepts as structural in a market economy, but such blatant
inequality
would cause widespread sociopolitical discontent and instability for a
socialist political culture that forms the ideological foundation of
modern
China.
Worse yet, the efficiency that
supporters of free market
fundamentalism claim as inherent in the market system turned out to be
a mirage
of a castle in the sky build by debt. It is a house of cards held
together by
systemic fraud. Wealth in market fundamentalism had not been created by
honest
work in recent decades, but by systemic manipulation of credit to turn
risks
into safety and debt into assets. From
the central bank down to the average home owner, every participant in
the
market economy was abusing the false effect of unearned wealth as the
miracle
of finance capitalism. Many are now realizing that the Federal Reserve
has been
the biggest Ponzi scheme operator, not Bernie Madoff.
The fantasy mirage of debt capitalism
has been brought back
to earth fundamentally by the current unprecedented financial crisis to
show
that the US
neoliberal model of miracle growth and debt prosperity via free markets
is
unsustainable. As predatory dollar hegemony turns international trade
into a
process of spreading dollar denominate debt around the world that ends
in
sudden bankruptcy, prolonged depression and widespread resultant
poverty rather
than for achieving sustainable growth and solid prosperity, populist
national
politics will force all governments to refocus on orderly domestic
development
away from over-reliance of foreign trade, making the issue of exchange
rate
less relevant.
China
is not the cause of the financial problems the US
had inflicted on itself and the globalized economy. In many ways, China
has
been a double victim of the misleading lure of the empty promise of
easy
prosperity promoted by the false prophets of US market fundamentalism,
by
holding down Chinese wages to compete in the export market and
unwittingly
shipping real wealth created by its workers for fiat currency that the
US can
print at will, money that cannot be used in China. Chinese trade
surplus is not
the reward of 19th century mercantilism because Chinese
export does
not earn gold, only superpower fiat currency of no intrinsic value.
On the other side, US consumers who
want to enjoy a good
life without working are like Pinocchio, the wooden puppet who yearns
to be a
real boy as promised by the good fairy. But he is sidetracked by a boy
named
Romeo—nicknamed Candlewick because he is so tall and skinny – just the
type of
boy Pinocchio wishes to become, who lures him to go to the Land of Play
where
everyone plays and eats candy all day long and never doing any work.
Pinocchio
goes along with Candlewick and they have a wonderful time in the Land
of Play—until one morning
Pinocchio
awakes with donkey ears. Belatedly, a mouse tells him that boys who do
nothing
but play and never work always grow into donkeys after the initial fun.
Allan
Greenspan is Candlewick of the US
economy and the Land of Play
is the house of cards that Greenspan built.
Next: Brzezinski’s G2 Grand Strategy
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