Socialist Economic Bulletin and international readers
Readers of SEB may have noted that we are now putting in very slightly more explanation regarding relatively well known British political figures and facts. The reason for this is that SEB has picked up an international readership. Among the countries where we have found readers are the United States, Poland, France, India, Spain, Jamaica, Australia, Colombia, the Netherlands, Belgium, New Zealand, Austria, China, Israel, Canada, the United Arab Emirates, Portugal, Brazil, Germany, and Singapore. While SEB will remain centred on dealing with the British economy it aids its international readers to have slightly more explanation regarding some of the persons and facts being discussed. If British readers feel slightly they are sometimes getting information that is obvious we hope they will understand.
The dilemma of the dollar and the coming international summit meetings
Socialist Economic Bulletin has analysed the mechanism of the present international financial crisis in several posts. Its core is the long term overvaluation of the dollar. This overvaluation is demonstrated in the $700 billion a year US balance of payments deficit, which shows the uncompetitive position of the US economy at current exchange rates.
But such overvaluation of the dollar also means overvaluation of assets held in dollars in comparison to their real international market values. Eventually economic forces will bring dollar assets down towards their real values, but as they fall in price this destroys the balance sheet of institutions holding them - in turn creating a severe liquidity crisis. This, reduced to essentials, is the mechanism of the present global financial crisis.
Given that the decline in the price of overvalued dollar assets is inevitable, the relatively non-painful way for this adjustment to have taken place would have been a prolonged and gradual decline of the exchange rate of the dollar over many years. But this was strongly resisted by the US - it would have meant increased political discontent in the US as inflation would have risen and living standards would have been lower, and it would have put put economic pressure on the US to cut military expenditure and overseas operations such as the Iraq war. As the net debt position of the US increased large foreign holders of US assets also become concerned about a decline in the value of these holdings due to dollar devaluation.
For these reasons the decrease in the price of dollar assets took place not gradually, and over a prolonged period, but in the intense financial crisis that has gripped the world for the last months.
In the long term the uncompetitive character of the US economy means that there is no alternative to a reduction of the price of dollar assets down towards their real, much lower, values either via dollar devaluation or falls in their nominal values or both. And this will mean the US accepting a reduced role in the world both economically and militarily.
It is greatly to be hoped that the US accepts this decline gracefully, rather than running the risk of plunging the world into a new depression through futile attempts to avoid the inevitable.
There is no point, for example, in other countries lending large sums of money to the US, to prop up the dollar, when in the long run the only outcome of the attempt to avoid the inevitable will be that such countries suffer large losses as either the dollar devalues or the price of dollar assets they hold declines.
In the short term, however, an increase in the exchange rate of the dollar temporarily helps slow the decline in US asset prices, and therefore also slows down the fundamental mechanism of the financial crisis. To show the processes operating the graph below, therefore, shows the exchange rate of the dollar over the last six years. The most recent peak in long term movement of the dollar's exchange rate was on 27 February 2002.
As may be seen, for six and half years the dollar fell with only short term fluctuations. The decline between its peak on 27 February 2002 and its low point in this period, on 22 September 2008, was 23.7 per cent. To indicate the significance of the latter date, the nationalisation of US mortgage insurers Fanny Mae and Freddie Mac occurred on 7 September, the collapse of Lehman Brothers on 14 September, and the nationalisation of US insurer AIG on 16 September. By this point, therefore, the decline of US balance sheets was leading to widespread collapse of financial institutions and explicit panic on financial markets.
From 23 September onwards the dollar reversed course and began to rose rapidly - as may be seen in the graph. By the end of trading on 17 October the dollar had risen by 7.6 per cent from its low. This temporarily stabilised dollar assets in terms of real international prices.
The mechanisms by which the dollar moved sharply upwards will not be known with certainty in detail until figures for US financial flows are published but the most striking feature of this period was massive purchases of short term US Treasury Bonds - which drove up their price so sharply that the interest rate paid on them fell to record levels (if the price of a bond rises the rate of interest it yields falls). Taking closing prices on 17 October, the interest rate on 1 month US Treasury bonds fell to 0.06 per cent, that is virtually zero, and the rate on a 3 month bond fell to 0.79 per cent - that is under 1 per cent. The rate on 10 year US Treasury Bonds remained low at 3.92 per cent.
In short the rise of the dollar coincided with massive buying of short term US government bonds. It would be highly unsurprising if it were discovered that very large purchases of US Treasury Bonds by foreign banks and central banks took place in this period in order to attempt to slow down the long term decline of the dollar and take the immediate heat out of the financial crisis.
In short, two rescue packages were taking place. An open, explicit, one in most countries to save banks. And a hidden one to reverse, in the short term, the slide of the dollar. The two together slowed the slide into the financial abyss.
But this leaves the fundamental problem of the dollar unresolved. To make the US economy competitive the dollar must devalue. Even the nearly 24 per cent devaluation of the dollar up to 22 September 2008 had not brought the US balance of payments into anything resembling balance. As the dollar was overvalued US asset prices themselves remained overvalued.
The rise in the exchange rate of the dollar in the last month will have made this underlying situation worse and, therefore, left the world exposed to future precipitate collapses as dollar assets decline towards their real values. In short, the overvaluation of the dollar leaves the world open to precisely the type of crisis that has gripped it in the last month.
The process that should take place in that situation, and which would form a realistic agenda of the coming summits of world heads of state and government called by George W Bush and others, would be to organise a steady and progressive devaluation of the dollar, thereby accepting the inevitable but allowing this to occur, as far as possible, in an orderly and controlled, as opposed to a catastrophic, way. But that would be for the US to sit down and negotiate the terms of its own decline - precisely what it has refused to do for the last 20 years. But if the US refuses to accept that decline it builds into the foundations of the present economic system the potential of crises whose power has been amply demonstrated in the last month.
The coming international summits are therefore likely to be tense affairs.
But such overvaluation of the dollar also means overvaluation of assets held in dollars in comparison to their real international market values. Eventually economic forces will bring dollar assets down towards their real values, but as they fall in price this destroys the balance sheet of institutions holding them - in turn creating a severe liquidity crisis. This, reduced to essentials, is the mechanism of the present global financial crisis.
Given that the decline in the price of overvalued dollar assets is inevitable, the relatively non-painful way for this adjustment to have taken place would have been a prolonged and gradual decline of the exchange rate of the dollar over many years. But this was strongly resisted by the US - it would have meant increased political discontent in the US as inflation would have risen and living standards would have been lower, and it would have put put economic pressure on the US to cut military expenditure and overseas operations such as the Iraq war. As the net debt position of the US increased large foreign holders of US assets also become concerned about a decline in the value of these holdings due to dollar devaluation.
For these reasons the decrease in the price of dollar assets took place not gradually, and over a prolonged period, but in the intense financial crisis that has gripped the world for the last months.
In the long term the uncompetitive character of the US economy means that there is no alternative to a reduction of the price of dollar assets down towards their real, much lower, values either via dollar devaluation or falls in their nominal values or both. And this will mean the US accepting a reduced role in the world both economically and militarily.
It is greatly to be hoped that the US accepts this decline gracefully, rather than running the risk of plunging the world into a new depression through futile attempts to avoid the inevitable.
There is no point, for example, in other countries lending large sums of money to the US, to prop up the dollar, when in the long run the only outcome of the attempt to avoid the inevitable will be that such countries suffer large losses as either the dollar devalues or the price of dollar assets they hold declines.
In the short term, however, an increase in the exchange rate of the dollar temporarily helps slow the decline in US asset prices, and therefore also slows down the fundamental mechanism of the financial crisis. To show the processes operating the graph below, therefore, shows the exchange rate of the dollar over the last six years. The most recent peak in long term movement of the dollar's exchange rate was on 27 February 2002.
As may be seen, for six and half years the dollar fell with only short term fluctuations. The decline between its peak on 27 February 2002 and its low point in this period, on 22 September 2008, was 23.7 per cent. To indicate the significance of the latter date, the nationalisation of US mortgage insurers Fanny Mae and Freddie Mac occurred on 7 September, the collapse of Lehman Brothers on 14 September, and the nationalisation of US insurer AIG on 16 September. By this point, therefore, the decline of US balance sheets was leading to widespread collapse of financial institutions and explicit panic on financial markets.
From 23 September onwards the dollar reversed course and began to rose rapidly - as may be seen in the graph. By the end of trading on 17 October the dollar had risen by 7.6 per cent from its low. This temporarily stabilised dollar assets in terms of real international prices.
The mechanisms by which the dollar moved sharply upwards will not be known with certainty in detail until figures for US financial flows are published but the most striking feature of this period was massive purchases of short term US Treasury Bonds - which drove up their price so sharply that the interest rate paid on them fell to record levels (if the price of a bond rises the rate of interest it yields falls). Taking closing prices on 17 October, the interest rate on 1 month US Treasury bonds fell to 0.06 per cent, that is virtually zero, and the rate on a 3 month bond fell to 0.79 per cent - that is under 1 per cent. The rate on 10 year US Treasury Bonds remained low at 3.92 per cent.
In short the rise of the dollar coincided with massive buying of short term US government bonds. It would be highly unsurprising if it were discovered that very large purchases of US Treasury Bonds by foreign banks and central banks took place in this period in order to attempt to slow down the long term decline of the dollar and take the immediate heat out of the financial crisis.
In short, two rescue packages were taking place. An open, explicit, one in most countries to save banks. And a hidden one to reverse, in the short term, the slide of the dollar. The two together slowed the slide into the financial abyss.
But this leaves the fundamental problem of the dollar unresolved. To make the US economy competitive the dollar must devalue. Even the nearly 24 per cent devaluation of the dollar up to 22 September 2008 had not brought the US balance of payments into anything resembling balance. As the dollar was overvalued US asset prices themselves remained overvalued.
The rise in the exchange rate of the dollar in the last month will have made this underlying situation worse and, therefore, left the world exposed to future precipitate collapses as dollar assets decline towards their real values. In short, the overvaluation of the dollar leaves the world open to precisely the type of crisis that has gripped it in the last month.
The process that should take place in that situation, and which would form a realistic agenda of the coming summits of world heads of state and government called by George W Bush and others, would be to organise a steady and progressive devaluation of the dollar, thereby accepting the inevitable but allowing this to occur, as far as possible, in an orderly and controlled, as opposed to a catastrophic, way. But that would be for the US to sit down and negotiate the terms of its own decline - precisely what it has refused to do for the last 20 years. But if the US refuses to accept that decline it builds into the foundations of the present economic system the potential of crises whose power has been amply demonstrated in the last month.
The coming international summits are therefore likely to be tense affairs.
Recession or depression?
It is entirely superfluous to argue here that Britain, the US and Europe are heading into a recession - every media outlet proclaims it. But the issue is whether this is going to be an economic recession (a cyclical downturn of moderate length followed by a recovery taking the economy to a higher level - as seen most recently in 1973, 1979, and 1991) or whether there is going to be a depression (an economic downturn which is not followed by recovery taking the economy to a higher level in a medium time frame - of the type seen most severely in the world economy after 1929, or, on a lesser scale, in Latin America in the 1980s).
Although the beginning of the financial crash is genuinely on a 1929 scale nevertheless the overall balance of probabilities is that this will be a very nasty recession and not a depression. The reason is that in 1929 the world economy had been severely weakened by World War I. The percentage of investment in GDP in most countries, and above all in the world's most dynamic economy of the time, the US, had never recovered to pre-war levels. The financial crash of 1929 kicked in the door of a structure that was already rotting.
The world economy today is in a different state. The Asian economies are genuinely dynamic. Therefore recession followed by recovery is the most likely scenario.
There is, however, an important risk. The outcome of this financial crisis will see a major reduction of the weight of the US in the world economy and therefore in world politics. It is possible that the US, in an attempt to stave this off, will engage in irrational actions that can prevent world economic recovery.
After 1929 the decisive role in making it impossible to recover from the financial crash was the US Smoot-Hawley Tariff Act - which very sharply raised tariff rates. This sundered the world economy into a series of competing economic and/or political empires protected by tariff barriers - US, British, German, French etc. The combination of the 1929 crash and the Smoot-Hawley Act led to a 66 per cent fall in US imports and 61 per cent fall in US exports. Unable to operate on a world scale, economies remained trapped behind these barriers with the world locked in depression. Only World War II overcame this fragmentation of the world economy and created a new framework in which growth could take place.
It is unlikely, although possible, that in this recession the decisive issue in the US will be tariffs - but to date even the most protectionist current proposals are mild compared to the catastrophic consequences of Smoot-Hawley. But in the financial sphere actions by the US that could shatter the unity of the world economy, and produce depression, are not inconceivable.
The real content of financial globalisation in the last twenty years has not only been greatly increased financial and capital flows between countries but a large net inflow into the US.
The United States' $700 billion a year balance of payments deficit requires an inflow of almost $2 billion a day into the US to offset it. This build up of huge international holdings of US debt is one of the main features of the present international economic situation.
As long as the capital inflows were into the United States US governments were content with that situation. If, however, confronted with decline in the price of dollar assets, the net financial and capital flows became out of the US then there might be, in extremis, intervention to try to limit this - through capital controls, partial defaults/bankruptcies, or other measures.[1] In that case the resulting fragmentation of the world economy could produce a depression - other measures that could produce the same effect are also conceivable.
For these reasons, while sharp recession is the most likely outcome of the present economic situation, desperate attempts by the US to stave off the inevitability of its relative decline are the wild card that could threaten something worse. Strengthening co-ordination of the non-US economies, in particular the major economic centres of Asia and Europe, co-operating with Latin America and Africa, is necessary to counter-balance this risk.
Notes
[1] The city of New York was on the verge of bankruptcy in 1975. Several US states, led by California, are under severe financial pressure already before the recession has seriously begun.
Although the beginning of the financial crash is genuinely on a 1929 scale nevertheless the overall balance of probabilities is that this will be a very nasty recession and not a depression. The reason is that in 1929 the world economy had been severely weakened by World War I. The percentage of investment in GDP in most countries, and above all in the world's most dynamic economy of the time, the US, had never recovered to pre-war levels. The financial crash of 1929 kicked in the door of a structure that was already rotting.
The world economy today is in a different state. The Asian economies are genuinely dynamic. Therefore recession followed by recovery is the most likely scenario.
There is, however, an important risk. The outcome of this financial crisis will see a major reduction of the weight of the US in the world economy and therefore in world politics. It is possible that the US, in an attempt to stave this off, will engage in irrational actions that can prevent world economic recovery.
After 1929 the decisive role in making it impossible to recover from the financial crash was the US Smoot-Hawley Tariff Act - which very sharply raised tariff rates. This sundered the world economy into a series of competing economic and/or political empires protected by tariff barriers - US, British, German, French etc. The combination of the 1929 crash and the Smoot-Hawley Act led to a 66 per cent fall in US imports and 61 per cent fall in US exports. Unable to operate on a world scale, economies remained trapped behind these barriers with the world locked in depression. Only World War II overcame this fragmentation of the world economy and created a new framework in which growth could take place.
It is unlikely, although possible, that in this recession the decisive issue in the US will be tariffs - but to date even the most protectionist current proposals are mild compared to the catastrophic consequences of Smoot-Hawley. But in the financial sphere actions by the US that could shatter the unity of the world economy, and produce depression, are not inconceivable.
The real content of financial globalisation in the last twenty years has not only been greatly increased financial and capital flows between countries but a large net inflow into the US.
The United States' $700 billion a year balance of payments deficit requires an inflow of almost $2 billion a day into the US to offset it. This build up of huge international holdings of US debt is one of the main features of the present international economic situation.
As long as the capital inflows were into the United States US governments were content with that situation. If, however, confronted with decline in the price of dollar assets, the net financial and capital flows became out of the US then there might be, in extremis, intervention to try to limit this - through capital controls, partial defaults/bankruptcies, or other measures.[1] In that case the resulting fragmentation of the world economy could produce a depression - other measures that could produce the same effect are also conceivable.
For these reasons, while sharp recession is the most likely outcome of the present economic situation, desperate attempts by the US to stave off the inevitability of its relative decline are the wild card that could threaten something worse. Strengthening co-ordination of the non-US economies, in particular the major economic centres of Asia and Europe, co-operating with Latin America and Africa, is necessary to counter-balance this risk.
Notes
[1] The city of New York was on the verge of bankruptcy in 1975. Several US states, led by California, are under severe financial pressure already before the recession has seriously begun.
Jon Cruddas and other Labour MPs call for nationalisation in the construction industry
The Financial Times reports that Labour MPs Jon Cruddas, Frank Dobson, and Austen Mitchell have told it that nationalisation should be extended into the construction industry. The FT reported on 18 October: 'Gordon Brown has been urged by senior Labour MPs to nationalise parts of the housebuilding industry in the wake of this week's rescue of the big banks. Jon Cruddas, who recently declined the post of housing minister, pushed for state intervention in the housing industry, arguing there was a case for wholesale nationalisation. Backbenchers, former ministers and left-wing pressure groups have told the Financial Times that the time has come for the prime minister to seize housebuilders, a move that only a year ago would have been inconceivable.'
According to the paper Jon Cruddas said: 'There's a danger that we look reactive. Now is the time to get ahead of the curve. All the indicators are going one way. We need to reintroduce a mixed economy in terms of supply. The question is the political will... What seemed off-piste a few months ago should now be centre stage in terms of policy options."
Frank Dobson told the FT he: 'backed the nationalisation of housebuilders to increase the level of social housing. Mr Dobson said this move would be an effective way to reduce the impact of recession. "I think he [Mr Brown] has got an appetite for this. He is attempting to minimise the impact on everyone else from banking lunacy and he'll be looking for anything practical. It is back to Keynes, spending money in a way that creates useful wealth."'
Also according to the FT: 'Austin Mitchell, MP for Great Grimsby, said the government should act swiftly to nationalise the builders and "put them to work" making council homes.'
This is an impoortant issue. In a recession there are two key tasks:
First, to stop the attack on the living standards of ordinary people and the attempt to transfer their resources to capital through higher unemployment, lower wages, social spending cuts, increased discrimination against the lowest paid workers, who are women and from ethnic minorities, and other measures.
Second, in a recession, due to the fact that the majority of investment decisions are still taken in the private sector of the economy, investment collapses by far more than consumption. The state must therefore intervene as far as possible into the economy with the aim of keeping up investment. Nationalisation of all or sections of the construction industry, and embarking on a large programme of house construction, would be an important way of doing this.
These proposals are therefore important and SEB will feature any policy developments in this field.
According to the paper Jon Cruddas said: 'There's a danger that we look reactive. Now is the time to get ahead of the curve. All the indicators are going one way. We need to reintroduce a mixed economy in terms of supply. The question is the political will... What seemed off-piste a few months ago should now be centre stage in terms of policy options."
Frank Dobson told the FT he: 'backed the nationalisation of housebuilders to increase the level of social housing. Mr Dobson said this move would be an effective way to reduce the impact of recession. "I think he [Mr Brown] has got an appetite for this. He is attempting to minimise the impact on everyone else from banking lunacy and he'll be looking for anything practical. It is back to Keynes, spending money in a way that creates useful wealth."'
Also according to the FT: 'Austin Mitchell, MP for Great Grimsby, said the government should act swiftly to nationalise the builders and "put them to work" making council homes.'
This is an impoortant issue. In a recession there are two key tasks:
First, to stop the attack on the living standards of ordinary people and the attempt to transfer their resources to capital through higher unemployment, lower wages, social spending cuts, increased discrimination against the lowest paid workers, who are women and from ethnic minorities, and other measures.
Second, in a recession, due to the fact that the majority of investment decisions are still taken in the private sector of the economy, investment collapses by far more than consumption. The state must therefore intervene as far as possible into the economy with the aim of keeping up investment. Nationalisation of all or sections of the construction industry, and embarking on a large programme of house construction, would be an important way of doing this.
These proposals are therefore important and SEB will feature any policy developments in this field.
Joseph Stiglitz on how Hank Paulson is ripping off the US taxpayer
Joseph Stiglitz, Nobel Prize winner in Economics, has a telling piece on the Guardian’s 'Comment is Free' site. It compares the rip off terms US Treasury Secretary Hank Paulson imposed on US taxpayers in offering $250 billion to US banks with those made by US billionaire investor Warren Buffet for this putting money into Goldman Sachs. Stiglitz writes:
‘the US taxpayer got a raw deal. There is no comparison with the terms that Warren Buffett secured when he provided capital to Goldman Sachs. Buffett got a warrant - the right to buy in the future at a price that was even below the depressed price at the time. Paulson got for the US a warrant to buy in the future - at whatever the prevailing price at the time... The Paulson plan responded to Congress's demand to have something like a warrant, but as a matter of form, not substance. Buffett got warrants equal to 100% of the value of what he put in. America's taxpayers got just 15%.’ Read the rest here.
‘the US taxpayer got a raw deal. There is no comparison with the terms that Warren Buffett secured when he provided capital to Goldman Sachs. Buffett got a warrant - the right to buy in the future at a price that was even below the depressed price at the time. Paulson got for the US a warrant to buy in the future - at whatever the prevailing price at the time... The Paulson plan responded to Congress's demand to have something like a warrant, but as a matter of form, not substance. Buffett got warrants equal to 100% of the value of what he put in. America's taxpayers got just 15%.’ Read the rest here.
Subscribe to:
Posts (Atom)