Friday, April 30, 2004

Forward With The Euro AND The Pound

I felt this article important enough to post, as it clearly covers the continueing euro-pound debate, plus illuminating theories about it and other reform areas. Anyone wishing an in depth view of these debates is encouraged to read this.

James Robertson

Question 8. Does the euro's democratic deficit seriously matter?

Yes, it does. It affects the lives of Eurozone citizens. It could also have a negative influence on the future shape of political economy

Although political democracy has spread round much of the world in the 20th century, financial democracy has not accompanied it. Unless today's monetary and financial institutions are reformed, political democracy will come to seem increasingly irrelevant. That has probably started to happen already, at least in some of the more "highly developed" countries. The nature of the money system greatly influences the nature of wealth and power, and its distribution. As this understanding spreads, the effects of the money system as it operates today are increasingly seen as perverse - in terms of economic efficiency, social justice and environmental sustainability. Growing numbers of people in the socalled anti-globalisation movement are protesting that the existing system of money and finance:
· is unjust ;
· is regulated by rich and powerful people and nations in their own interests;
· damages the well-being of billions of people worldwide and deprives them of freedom to manage their lives;
· serves the interests of corporate power, backed by rich-country governments and international institutions like the International
Monetary Fund (IMF), World Bank and World Trade Organisation (WTO); and thus
· gives the lie to Western lip service to democratic values.

The need for global monetary and financial reform is increasingly being expressed, not only in negative protest but also in constructive proposals for change. ...Link

And a related article: THE GLOBAL DIMENSION - Robertson

The development of international institutions for dealing with world public revenue, public spending, and monetary management should be based similarly on sharing the value of common resources. In 1995 the Commission on Global Governance recognised the need for global taxation “to service the needs of the global neighbourhood”. It proposed making nations pay for use of global commons, including:
· ocean fishing, sea-bed mining, sea lanes, flight lanes, outer space, and the electro-magnetic spectrum; and for
· activities that pollute and damage the global environment, or cause hazards beyond national boundaries, such as emissions of CO2 and CFCs, oil spills, and dumping wastes at sea.

The Commission also recognised the urgent need for international
monetary reform in a globalised world economy. Since then there has been growing criticism of the present international monetary system based on the 'dollar hegemony' of the United States. Here are two examples from recent reports, one from Asia and one from Ireland.
1) "The dollar is a global monetary instrument that the United States, and only the United States, can produce. .... World trade is now a game in which the US produces dollars and the rest of the world produces things that dollars can buy.
2) The rest of the world pays a total annual subsidy (or 'tribute'!) to the US of at least $400bn a year for using the dollar as the main global currency. A Pentagon analyst has justified this as payment to the US for keeping world order. Others see it as a means by which the richest country in the world compels poorer ones to pay for its unsustainable consumption of global resources.

A genuine international currency, issued by a world monetary authority, is clearly needed as an alternative to the US dollar (and other 'reserve currencies' like the yen, the euro and the pound). Issuing it would give a source of revenue to the world community, just as national monetary reform would do for national communities. It would also help to prevent national governments manipulating the value of their currencies in order to distort the terms of international trade in their own favour.

Revenue from global taxes and global money creation would then provide stable sources of finance for global expenditures, including international peace-keeping programmes. Some of the revenue could also be distributed to all nations according to population size, reflecting the right of every person in the world to a global “citizen's income" based on fair shares of the value of global resources.

This approach:
· would encourage environmentally sustainable development worldwide;
· it would generate a much needed source of revenue for the United Nations; · it would provide substantial financial transfers to developing countries by right and without strings, as payments for the rich countries’ disproportionate use of world resources;
· it would help to liberate developing countries from dependence on grants and loans from institutions like the World Bank and the International Monetary Fund which the rich countries now dominate;
· it would help to solve the problem of Third World debt;
· it would recognise the shared status of all people as citizens of the
world; and
· by helping to reduce the spreading sense of injustice in a globalised
world, it would contribute to global security. ...Link

Trouble Brewing In Asia

Stephen Roach

Thursday, April 29, 2004

China Pulls Reins On Its Economy

China Pulls Reins On Its Economy
By James Cox

{Related story} China's Wen Tough On Economy
"If we change the system rashly, it will certainly bring unpredictable problems to the domestic economy, and at the same time could affect the financial stability of the region and even the world," the Chinese premier said.
{Related story} Who Pays For Big Bank's Risks
{Related story} I also highly advise reading Andy Xie's very important article: "Today's Inflation May Cause Tomorrow's Deflation"

China acted to brake its speeding economy Wednesday, while the Bush administration rejected calls to penalize Beijing for abusing workers' rights or pressure it to loosen currency controls that hurt U.S. manufacturers. (Related story: China economy zooms ahead, but growth might be too fast)

Chinese regulators issued new land-use guidelines to rein in booming industrial growth, the latest in a series of measures to cool an overheating economy. Earlier this week, Beijing:

• Raised reserve requirements for banks — for the third time in seven months — to slow lending.

• Capped the percentage of debt companies can use to fund cement, steel, aluminum and real estate projects.

• Signaled tighter credit policies are coming. Several Chinese commercial banks confirmed they have halted new loans in anticipation of rewritten rules.

Chinese leaders are concerned the country could face a banking collapse, surging unemployment and falling prices if the economy zooms ahead unchecked.

In an interview Wednesday with Reuters, Chinese Premier Wen Jiabao vowed "very forceful measures" to bring the economy under control. Chinese officials say their 2004 growth target is between 7% and 8%, a slowdown from the 9.7% annual rate China posted in the first quarter.

In Washington, Bush administration officials rejected an AFL-CIO request to investigate labor rights abuses in China. They also said they would use diplomacy rather than penalties to persuade China to loosen its currency peg.

U.S. Trade Representative Robert Zoellick said the administration has "serious concerns" about working conditions in China and the value of the Chinese yuan.

Manufacturers say Chinese goods are artificially cheap compared with rival U.S. products because Beijing ties the yuan to the dollar at a rate of 8.2 to 1. The U.S. ran a $124 billion trade deficit with China last year, the largest with any country.

Zoellick says the administration favors "leveraged engagement" to get Beijing to improve pay and rights for workers and adopt a more flexible currency policy. High-level talks with Beijing are getting results, including a ramped-up campaign to stamp out Chinese piracy of software and movies, he says.

The AFL-CIO, manufacturing groups and others calling for more pressure on China would push the U.S. toward "economic isolationism," Zoellick says.

Sen. John Kerry, D-Mass., President Bush's likely rival in November, accused the administration of refusing to "make any serious effort to use the legitimate rules that govern trade to level the playing field and prevent our businesses and workers from being taken to the cleaners."

Tuesday, April 27, 2004

Auerback - Fed - Economy - Debt

The important element of Marshall's post is the dynamics of national and global debt structures' interest maintainance costs on global demand - what is to be done?

Marshall Auerback

...So what is the underlying paradox at work here? As we have discussed previously, a gently declining dollar has actually provided a far greater cushion to the US bond market than a rapidly strengthening greenback. Asia’s leading central banks, in particular, have in effect acted as a buffer between private speculative capital (which continues to wash its collective hands of the dollar), and the Asian and American industrialists, which are deriving benefits from a slowly declining currency, but who would be the first casualties of a dollar collapse (given the deflationary impact of the latter through the sharply higher long rates it would ultimately produce). Both China and Japan are prodigious financiers of US consumption--the two largest foreign holders of US Treasury bonds--despite the weak returns they get from low US interest rates. China and Japan are willing to do this because they calculate that sustaining their own industrial output and employment is worth more than seeking stronger financial returns elsewhere.

Ironically, should the very recent spate of dollar strength continue, it might begin to unravel this “happy” state of affairs insofar as it removes the incentive for foreign central banks to continue to buy US dollar bonds (as well as overseas speculative capital, which has begun to re-accumulate long term US securities over the past 6 months), as the need for dollar support operations diminish. We use the word “happy” guardedly, since it is clear that even if the dollar resumes its decline, the underlying problem of indebtedness remains, as does the inherent volatility in the bond market. The Fed, and its partners in crime in the Asian official sector, has pushed things so far out of control that they can't ever practically tighten. Consequently, the bond market will be left to swing wildly to accomplish this task for them. This is an environment when volatility protection should be at a premium, yet there is very little evidence this is so in either bonds or stocks.

By accommodating the Fed’s largesse, therefore, the Asian official sector has helped to sustain growing American financial and monetary profligacy, thereby accentuating underlying financial fragility in the US economy. Which brings us back to the Fed’s delicate balancing act: the US central bank must occasionally put grit on the dangerously slippery slope of dollar devaluation and continue to pretend that it can and will tighten to deal with incipient inflationary pressures when the time is right. In so doing, it hopes to retain the status quo of an economy kept afloat by enormous foreign lending so that consumers can keep buying more imports, thus increasing the bloated trade deficits.

This lopsided arrangement will end when those foreign creditors--major trading partners like Japan, China and Europe, or overseas portfolio capital--decide to stop the lending or simply reduce it substantially. To forestall this eventuality, the Federal Reserve has to continue to control inflationary expectations, as Governor Bernanke disarmingly conceded. It is part of an elaborate confidence trick on a country sinking into financial dependency--dangerously indebted to rival nations that are holding its debt, collecting the interest on Treasury bonds and private bank loans, or repatriating the profits from companies that used to be American- owned. A very wealthy nation can tolerate this negative toll for many years, but not forever. Unless the historic meaning of debt has been repealed, no nation – even one with a reserve currency – can borrow endlessly from others without sooner or later forfeiting control of its destiny, and also losing the economic foundations of its general prosperity. Messrs Greenspan and Bernanke can slow the process (to the country’s longer term detriment), but they cannot forestall the ultimate outcome. Gritting icy roads provides but a temporary respite, not a permanent solution against crashes. ...Link

Monday, April 26, 2004

Debtor Nation

Not that I agree with all or what Greider has proposed in this article, as I do not, I still feel it is worth the read as it covers so many areas that are valid. At the end he does have the currency issue correct, as I feel this is the priority issue to solve all the world's problems. He also makes the link of WWII war financing to a possible present reality - an important issue. I suggest reading the entire article with a grain of salt. My point is, we need major international financial architecture reform - Greider, at least, is headed in this direction.
James Robertson monetary system proposal - a look at another possible direction - debt-free money issue
Crisis At Mitsubishi Motors - DaimlerChrysler

Debtor Nation

The backstory for this election year lacks the urgency of war or of defeating George W. Bush but focuses on a most fateful question: When will this hemorrhaging debtor nation be compelled to pull back from profligate consumption and resign its role as "buyer of last resort" for the global economy? The smart money assumes such a momentous reckoning probably won't occur in time to disrupt Bush's re-election campaign, but it may well become the dominating crisis in the next presidential term, whoever is elected. At that point, the United States will lose its aura of unilateral superiority, and globalization will be forced to undergo wrenching change. The American economy, in other words, is in much deeper trouble than most people realize.

The facts are not secret. Despite ebbs and surges, the gap between US exports and imports has been steadily widening across three decades. The trade deficits of the early 1970s (due mainly to soaring oil prices) were trivial in size, but Americans were shocked in 1978 when the deficit hit $30 billion (TV sets and some cars were now made in Japan). During the 1980s, the trade deficit expanded enormously, as Washington's strong- dollar policy crippled US manufacturers and companies moved jobs and production offshore in swelling volume. After a recession and dollar devaluation, the gap shrank briefly, but soon began expanding again.

For several decades, in fact, the federal government has tolerated and even encouraged the dispersal of American production overseas--first to secure allies during the cold war, later to advance the fortunes of US multinationals. No other major economy in the world accepts perennial trade deficits; some maintain huge surpluses. But American leaders and policy-makers are uniquely dedicated to a faith in "free market" globalization, and they have regularly promised Americans that despite the disruptions, this policy guarantees their long-term prosperity. Present facts make these long-held convictions look like gross illusion. By 1998, the trade deficit was back to a new high and expanding ferociously, despite supposed improvements in US competitiveness. Last year it set another new record: $489 billion.

Yet no one running for President has found the nerve to discuss these facts in a straightforward manner. Nor do the candidates have anything to say about how the country might avoid a potential calamity. A few wise heads in finance, like billionaire investor Warren Buffett, have sounded the alarm--Buffett refers to the United States as "Squanderville" and is shifting billions offshore into foreign currencies for safety. Meanwhile, political leaders remain silent.

The US economy, in essence, is being kept afloat by enormous foreign lending so that consumers can keep buying more imports, thus increasing the bloated trade deficits. This lopsided arrangement will end when those foreign creditors--major trading partners like Japan, China and Europe--decide to stop the lending or simply reduce it substantially.

That reckoning could arrive as a sudden thunderclap of financial crisis--spiking interest rates, swooning stock market and crashing home prices. More likely it will be less dramatic but equally painful. As foreign capital moves elsewhere and easy credit disappears for consumers, many Americans will experience a major decline in their living standards--a gradual grinding-down process that could continue for years. If the US government reacts passively and allows "market forces" to make these adjustments, the consequences will be especially severe for the less affluent--families already stretched by stagnating wages and too much borrowing.

Normally, I wouldn't use an economic chart to make my point, but the one you see on page 11 tells the story of America's predicament more effectively than words. Prepared by University of Wisconsin economist Menzie Chinn (and illustrated by Stephen Kling/Avenging Angels), with dollar values adjusted to remove the distortions of price inflation, it's a visual display of the US economy's performance in the global trading system during the past three decades. Year by year, it traces the line of US imports versus the line of US exports. The red ink in between represents America's trade deficits.

The red ink, as you can see, is exploding. The thick red blob in the upper right-hand corner represents our present condition--the record trade deficits of recent years. Starting six or seven years ago, these two lines diverged dramatically: The volume of imports soared, while export growth leveled off. Historically, when a mature economy suffers perennial trade deficits, it is usually understood as a sign of weakness, especially if the deficits keep getting larger.

The red ink can also be read as a rough approximation of America's indebtedness to the rest of the world. Last year the US economy (business and households as well as the federal government) was compelled to borrow $540 billion from overseas creditors. Since the United States first became a debtor nation fifteen years ago, it has accumulated nearly $3 trillion in debt obligations abroad. At the current pace, the foreign debt load will double again in the next six or seven years. You can see why we have depicted the debt as a serpent, rising to strike. The serpent, I suggest, is biting the debtor nation that has fed it. Actually, it ate our lunch.

Leading authorities typically explain what is happening by observing correctly that Americans are collectively "overconsuming"--that is, living beyond their means--but experts assume that "market forces" will eventually correct the situation. Once the global economy regains robust growth, it is said, other nations will buy more US exports. Or, once the dollar has depreciated in value sufficiently, Americans will buy fewer imports. Some even claim the indebtedness is America's good fortune--a sign of strength that other nations are so eager to finance US consumption.

I think the authorities are wrong. When I look at the chart, I see the United States sinking into financial dependency--dangerously indebted to rival nations that are holding our debt paper, collecting the interest on Treasury bonds and private bank loans, or repatriating the profits from companies that used to be American- owned. A very wealthy nation can tolerate this negative toll for many years, but not forever. Unless the historic meaning of debt has been repealed, no nation can borrow endlessly from others without sooner or later forfeiting control of its destiny, and also losing the economic foundations of its general prosperity.

The world at large will be better off, in my view, when Washington is compelled to accept a less dominating role and global political power is dispersed more multilaterally. But the transition itself could be an unsettling, even dangerous time, since the declining economic power also happens to be the pre-eminent military power. In any case, an American reckoning would also have economic consequences for the rest of the world. If the United States were to tap out, the global system would lose its best customer. American consumers have propped up global trade with their open-ended purchases. Now the rest of the world is propping up American consumers, lending them the money to buy still more.

The endgame might be triggered by any number of events--including the financial exhaustion of America's overextended consumers--but the most likely venue is the global trade in capital, not the trade in goods and services. In theory, wealthy countries are expected to ship investment capital to poorer countries to build factories and infrastructure. But at present, most of the world's capital is flowing in reverse: The net inflow of foreign capital to the United States represents a staggering 75 percent of the net outflows from the rest of the world, according to economist Jane D'Arista of the Financial Markets Center. Even more abnormal is that nearly one-fourth of this lending comes from emerging-market nations, led by China, whose trade surplus with America has surpassed Japan's.

Both China and Japan are prodigious financiers of US consumption--the two largest foreign holders of US Treasury bonds--despite the weak returns they get from low US interest rates. China and Japan are willing to do this because they calculate that sustaining their own industrial output and employment is worth more than seeking stronger financial returns elsewhere.

All sides recognize a self-interest in keeping the game going--avoiding a global meltdown that might ruin everyone. But the anticipated benefits from this cooperation are very different: The US consumes in the present, through indebtedness that it must repay from future production; the others accumulate financial wealth now and expand their industrial capabilities to produce in the future.

The Bush Administration must convince its major trading partners, especially China and Japan, to stay at the table and keep lending huge sums even as it encourages the dollar's decline in the hope of boosting US exports, discouraging imports from Asia and Europe and thus shrinking America's trade gap (with little success so far).

The poker game ends when one major player or another decides it has gotten the last dollar off the table and it's time to go home. Creditor nations naturally have the upper hand, like any banker who can call the loan when he sees the borrower is hopelessly mired. But the decision to exit might be dictated by necessity more than bad faith. China, for instance, is booming, with a banking system riddled with bad loans to its domestic enterprises. If a banking crisis developed, Beijing might have no choice but to sell off its US bonds and use the capital at home to stabilize its financial system or to assuage political unrest among its unemployed masses. Tokyo has for some years anticipated an eventual American reckoning but hoped to keep the United States from doing anything rash until the Asian sphere was strong enough to prosper on its own, without depending so heavily on American consumers.

What might be done to avoid the worst? The necessary first step is for American politicians to cast aside the propagandistic claims advanced by multinational business and finance and endorsed by policy elites and orthodox economists. For decades, globalization advocates insisted, for example, that the solution to America's trade deficits was more "free trade." Each new trade agreement has been heralded as a market-opening breakthrough that would boost US exports and thus move toward balanced trade. That is not what happened--not after NAFTA (1993) and the WTO (1994), nor after China normalization (2000). In each case, the trade deficits grew dramatically. (Yes, it's true that since the early 1970s US export volume has grown by more than five times, but import volume has grown by eight times.) Economists have also claimed that ending deficit spending by the federal government would eliminate the trade gap. Yet when the federal government's budget did finally come into balance in 1999, the trade deficits were exploding. This discredited explanation is nonetheless being recycled, now that huge federal deficits have been spectacularly revived by the Bush Administration.

The humbling reality is this: Across three decades, only one economic event has been guaranteed to produce balanced US trade: a recession. When the economy is contracting, people naturally buy less of everything, including imports. Look at the chart: On the four occasions when the line of exports briefly converged with the line of imports, the country was in recession. Each time economic growth was restored, the trade deficits resumed. A more ominous contradiction occurred during the 2001 recession: The trade gap was so enormous it persisted throughout. This suggests that American dependency on foreign producers has advanced to a dangerous new level.

The failure of conventional explanations for trade deficits leads, logically, to an unorthodox conclusion: The source of the deficits (and growing indebtedness) must be embedded in the trading system itself, independent of shifts in macroeconomic conditions, and so it is there we must also look for solutions. The national ambitions and competitive energies of globalization, at least as currently practiced, persist in developing new productive capacity--more factories--faster than they generate rising incomes and adequate demand to absorb the surplus of goods. This leads inevitably to falling prices and stiffer pressures for cost reductions. The convenient remedy--somebody, somewhere has to shut down factories--has typically begun by closing America's and moving its high-wage production offshore for cheaper labor.

American production usually goes first because the US government does not resist and US multinationals gain from the transaction, even if the US labor force does not. Indeed, the multinationals are major actors in generating America's trade deficits, since they "export" and "import" within the firms themselves--shipping components and materials back and forth between their overseas subsidiaries and US-based plants. Trade is commonly described as between nations, but fully half of US foreign trade, excluding oil, is composed of these intra-firm transactions. This reality explains the interconnection between trade deficits and job losses: When an American company moves production to Mexico or China, it still counts the output as its own, but its labor costs are reduced drastically while its foreign-manufactured products becomes imports, adding to the trade deficit and accumulating foreign debt. For years, advocates have dismissed worries about deficits in manufactured goods by pointing to the smaller but growing surplus in services. As more service jobs are offshored, however, that surplus is shrinking rapidly too, declining from $90 billion to $60 billion over the past seven years.

Of course, other advanced economies face the same global pressures and engage in the same sort of dispersal when required, but their governments (and societies) do not yield so willingly. Through industrial policy and numerous informal barriers, America's European rivals have managed to avoid both trade deficits and the thirty-year stagnation of wages that US industrial workers have suffered. Only in America do the experts believe these consequences have no meaning for overall prosperity. Only in America has the government put the interests of multinationals ahead of citizens.

A decisive President, one who grasped the gravity of the situation, would start by bringing up a taboo subject--tariffs--and inform the world that the United States is prepared to impose a temporary general tariff of 10 or 15 percent on all US imports. Every multinational would have to rethink its industrial strategy, because some of its production might be stranded in the wrong country. Import-dependent retailers like Wal-Mart would be seriously disrupted, too.

The idea of tariffs is so alien to conventional wisdom it probably sounds illegal. Actually, a nondiscriminatory general tariff is permitted under the original GATT agreement for a nation to correct grave financial imbalances--exactly the problem America is facing. Richard Nixon stunned the world in 1971 when he abruptly announced a 10 percent import surcharge, devalued the dollar and unilaterally discarded the Bretton Woods monetary system. America needs a bit of Nixonian nerve.

With a general tariff, the practice of wage arbitrage--shifting high-wage jobs to low-wage nations, then selling the goods to the US market--would no longer be a free ride. If the US market were less wide-open, globalization could continue, but countries and companies would need to disperse production on different assumptions. They might finally confront the central dilemma of inadequate global demand versus the permanent overabundance of supply.

The fundamental solution is to raise wages everywhere in the world, with perhaps fewer millionaires but a more generalized prosperity, especially in developing nations. In short, the global system needs more workers with the incomes to buy what they make. Globalization would have to proceed at a more moderate pace, with less rip-and-run disruption, financial crisis and social disorder. It is most unlikely, I have to add, that America's governing elites will come around to such drastic measures in time to avert an end-of-era reckoning.

If a full-blown crisis does occur, the macroeconomic challenge would be unlike anything the United States has faced in more than half a century. While this would be a time of wrenching, painful change, the new adverse circumstances might also inspire a great shift toward a new, more progressive politics. Given our rapidly deteriorating condition, it is not too soon to begin considering how the nation might dig out, lest popular confusion and bitterness generate reactionary politics instead.

The first imperative--an unavoidable necessity--would be to suppress consumption through credit-restraining measures, fiscal caution or tax reform, and to stimulate greater domestic savings, yet somehow to keep the economy growing. If this great adjustment is left to market forces alone, the predictable consequences will be to punish the innocent--struggling households and small businesses--first.

Thus, the second imperative would be to confront inequality aggressively, through progressive taxation and other measures. An interlude of mild austerity will seem more tolerable if people know the sacrifices are genuinely shared by all.

The principle of equity also matches the economics. With consumption suppressed, far greater investment spending will be needed to sustain the economy--an ambitious agenda of public and private investments. After decades of obsession with global competition, the country's wealth and ingenuity will be refocused inward--rebuilding and expanding the public infrastructure and common assets all citizens need and use (education, healthcare, transportation, energy, the environment). But the investment also would be aimed at long-term redevelopment of the economy, force-feeding new industrial sectors. Not coincidentally, this will generate millions of new jobs not subject to export.

The jump-shift strategy I am describing would be the economic equivalent of wartime, without the bombing and killing. Indeed, the closest precedent is World War II, an extraordinary era of economic development that virtually shut down many forms of domestic consumption (cars and housing) while the government's spending on war production launched major new industries (electronics, petrochemicals, modern aircraft and many others). Essentially, accelerated investment and forced savings replaced consumer spending as the leading fuel for economic growth. After the war, pent-up desires and needs became the economic demand that drove the long postwar era of prosperity.

War mobilizations encourage national cohesion, but the need for solidarity can also create a political consensus to enact greater social and economic guarantees to citizens. In that sense, World War II was a seedbed for postwar reform and lasting social change: The GI Bill, which universalized access to higher education, broadened home ownership and the initial political agitations for what became the civil rights movement. In Britain, wartime solidarity produced bipartisan agreement to enact national health insurance. If the United States must accept a period of shared sacrifice, the experience can similarly create commitments to enact fundamental measures involving health, education and other social needs once the financial cloud has lifted.

An important difference from the World War II example, however, is that the reconstruction could not be financed primarily through deficit spending, given that the country is already burdened by growing indebtedness and the objective would be to reverse that trend. Financing would come, most obviously, from the revival of steeply progressive taxation. But private capital can also be pushed to invest in neglected domestic priorities. For example:

§ An "invest or else" wealth tax, quite modest in size, would give the largest wealth-holders and financial institutions this choice: Either pay the wealth tax or invest an equivalent amount in a priority list of long-term public improvements, from high-speed rail to renewable energy systems, these projects to be pursued as both private ventures and public programs. Alternatively, one's "wealth tax due" could be invested in ten-year, low-yield, inflation-proof government bonds that provide cheaper financing for softer projects like revitalizing education, from early infancy to midlife job-skills training.

§ Progressive taxation could be restored through a graduated consumption tax, replacing the deformed federal income tax. The tax rate on consumption would rise steeply by income class, but generous deductions for necessary household living expenses would effectively exempt most families on the bottom half of the income ladder. They might still be taxed on their consumption through value-added taxes collected at points of sale, much like Europe's. Either system could discreetly encourage more responsible choices by favoring less wasteful and damaging products, while lucrative tax-avoidance schemes and pointless subsidies would disappear for both corporations and wealthy individuals. Suggesting a consumption tax is risky, I concede, because unless political forces are realigned by crisis, the right wing would turn it into a regressive flat tax--injuring those who have already been injured.

§ A Fannie Mae for environmental progress, for small businesses, for inner-city rehabilitation and for other capital-starved realms of the economy would insure greater access to capital and credit, just as Fannie Mae's financing does for home ownership. Other quasi-governmental institutions might provide partial tax preferences for experimental ventures embracing equitable commitments to workers, like the living wage, or important new priorities, like ecological sustainability and worker ownership.

§ A less grandiose military posture toward the rest of the world would save scarce capital. Why exactly does the United States maintain its vast forward empire of military outposts? The $500 billion military budget, citizens may observe, does not protect America from the $500 billion trade deficit.

§ Trade deficits (or surpluses) could be held to moderate levels for all nations by a band of tolerances that, when violated, would authorize nations to take protective measures. Global leaders would need to focus on institutional reforms like labor rights and ecological accords and on inventing a new international financial institution that could end destructive currency wars and other instabilities.

All these ideas, I know, sound quite improbable at this moment. Certainly, the establishment would brush them aside. But do not dismiss the possibility that dramatic change and epic political reforms lie ahead. When self-important people and powerful institutions are governed by illusion, history has a way of biting back. ...Link

Friday, April 23, 2004

Tax Havens: Releasing the Hidden Billions for Poverty Eradication

Tax Havens: Releasing the Hidden Billions for Poverty Eradication
by Oxfam

Tax havens and offshore financial centres (OFCs) have seldom figured as prominently in media coverage of economic affairs as they do today. Interest has focussed on the concerns of northern governments and the interests of powerful transnational corporations (TNCs). The main actors in the debate are revenue authorities, corporate lawyers, tax accountants and financial journalists. By contrast, the world's poorest countries are conspicuous by their absence. This is unfortunate because offshore tax havens represent an increasingly important obstacle to poverty reduction. They are depriving governments in developing countries of the revenues they need to sustain investment in basic services and the economic infrastructure upon which broad-based economic growth depends. This paper argues that off-shore centres are part of the global poverty problem - and that the interests of the poor must be brought onto the reform agenda.

It is impossible to calculate the financial losses to developing countries associated with offshore activity. Secrecy, electronic commerce and the growing mobility of capital have left all governments facing problems in revenue collection. The borderline between tax evasion and tax avoidance is becoming increasingly blurred. But at a conservative estimate, tax havens have contributed to revenue losses for developing countries of at least US$50 billion a year. To put this figure in context, it is roughly equivalent to annual aid flows to developing countries. We stress that the estimate is a conservative one. It is derived from the effects of tax competition and the non-payment of tax on flight capital. It does not take into account outright tax evasion, corporate practices such as transfer pricing, or the use of havens to under-report profit.

Revenue losses associated with tax havens and offshore centres cannot be considered in isolation. They interact with problems of unsustainable debt, deteriorating terms of trade, and declining aid. But there is no doubt the implied human development costs of tax havens are large. The US$50 billion loss is equivalent to six times the estimated annual costs of achieving universal primary education, and almost three times the cost of universal primary health coverage. Of course, ending the diversion of resources from governments into corporate profit margins and offshore bank accounts provides no guarantee that the funds released will be used for poverty reduction purposes. This will depend on governments developing effective poverty reduction strategies. But allowing current practices to continue will undermine the successful implementation of such strategies.

The extent of offshore financial activity is not widely appreciated. The globalisation of capital markets has massively increased the scope for offshore activity. It is estimated that the equivalent of one-third of total global GDP is now held in financial havens. Much of this money is undisclosed and untaxed - and the rest is under-taxed. Governments everywhere have become increasingly concerned at the implications. In Britain, the government's efforts to prevent the use of tax havens to under-report profit (and hence tax liability), has brought it into conflict with powerful transnational companies. At least one major corporation has responded by threatening to relocate their investments from Britain. Such problems have lead to a proliferation of initiatives designed to tackle various aspects of the problem. The OECD is leading an initiative to crackdown on harmful tax competition, UN agencies are trying to curb money laundering, and the Financial Stability Forum (FSF) is examining the impact of the offshore system on global financial stability.

These initiatives are useful up to a point, but they primarily reflect the concerns of northern governments. Ironically, these governments are in a far stronger position than their counterparts in developing countries. If revenue authorities in Britain and Germany feel threatened by offshore activity, how much more severe are the problems facing countries with weak systems of tax administration? And if governments in rich countries see tax havens as a threat to their capacity to finance basic services, how much more serious are the threats facing poor countries? After all, these are countries in which 1.2 billion people have no access to a health facility, in which 125 million primary school age children are not in school, and in which one out of every five people live below the poverty line.

Lack of attention to poverty is only one part of the problem with current initiatives. Another is their lack of balance. Some developing country havens justifiably see the actions of northern governments as being unbalanced and partial. Financial havens are part of a much wider problem that extends beyond the 'offshore' activity of small island states to ‘onshore’ activity in major economies such as the City of London and New York. Yet OECD efforts to address harmful tax competition have involved a crackdown on small state financial havens, while a far more light-handed approach has been applied to member countries engaging in harmful tax practices.

Tax havens may seem far removed from the problem of poverty, but they are intimately connected. There are three major ways in which offshore centres undermine the interests of poor countries.

- Tax competition and tax escape. Tax havens and harmful tax practices provide big business and wealthy individuals with opportunities to escape their tax obligations. This limits the capacity of countries to raise revenue through taxation, both on their own residents and on foreign-owned capital. This can seriously undermine the ability of governments in poor countries to make the vital investments in social services and economic infrastructure upon which human welfare and sustainable economic development depends. It also gives those TNCs that are prepared to make use of international tax avoidance opportunities an unfair competitive advantage over domestic competitors and small and medium size enterprises. Tax competition, and the implied threat of relocation, has forced developing countries to progressively lower corporate tax rates on foreign investors. Ten years ago, these rates were typically in the range of 30-35 per cent - broadly equivalent to the prevailing rate in most OECD countries. Today, few developing countries apply corporate tax rates in excess of 20 per cent. Efficiency considerations account for only a small part of this shift (as witnessed by the widening gap between OECD and developing country rates), suggesting that tax competition has been a central consideration. If developing countries were applying OECD corporate tax rates their revenues would be at least US$50 billion higher. If used effectively, funds siphoned through tax loopholes into offshore financial centres could be used to finance vital investments in health and education. None of this is to argue for a return to high tax regimes that deter investment activity. Foreign direct investment has the potential to generate real benefits for development. But without reasonable levels of tax collection, governments cannot maintain the social and economic infrastructure needed to sustain equitable growth.

- Money laundering. The offshore world provides a safe haven for the proceeds of political corruption, illicit arms dealing, illegal diamond trafficking, and the global drugs trade. While some havens, such as the Channel Islands and the Cayman Islands, have introduced anti-money laundering legislation, the problem remains widespread. Havens facilitate the plunder of public funds by corrupt elites in poor countries, which can represent a major barrier to economic and social development. It has been estimated that around US$55 billion was looted from Nigerian public funds during the Abacha dictatorship. To put the figure in perspective, the country is today blighted by an external debt burden of US$31 billion. Northern governments justifiably press southern governments to adopt more accountable and transparent budget systems, but then create incentives for corruption by failing to deal effectively with tax havens and other tax loopholes.

- Financial instability. The offshore system has contributed to the rising incidence of financial crises that have destroyed livelihoods in poor countries. Tax havens and OFCs are now thought to be central to the operation of global financial markets. Currency instability and rapid surges and reversals of capital flows around the world became defining features of the global financial system during the 1990s. The financial crisis that ravaged east Asia in the late 1990s was at least partly a result of these volatile global markets. Following the Asian crisis, the Indonesian economy underwent a severe contraction and the number of people living in poverty doubled to 40 million. In Thailand, the health budget was cut by almost one-third. Nearly three years on from the outbreak of the crisis, the economies of Thailand and Indonesia continue to struggle under the huge public debt burden that it created.

The aim of this paper is to draw attention to the implications of tax havens for poor countries and poor people. For meaningful change to happen, the international community needs to adopt a more comprehensive and inclusive approach to the issue of financial havens and harmful tax competition. The paper does not seek to make detailed policy proposals, but rather puts forward a set of guiding principles and six key policy options that should receive serious consideration by the international community.

Oxfam believes that an international framework for dealing with the effects of financial havens and harmful tax competition should include: a poverty perspective; a genuinely inclusive approach fully involving developing countries in discussions; a multilateral approach to what are global problems; and strategies to help small, poor and vulnerable economies to diversify from a reliance on harmful tax practices and to comply with standards to prevent money laundering. The following policy options could be considered by the international community to help poor countries stem tax evasion and reduce the negative impact of tax havens:

- A multilateral approach on common standards to define the tax base to minimise avoidance opportunities for both TNCs and international investors.

- A multilateral agreement to allow states to tax multinationals on a global unitary basis, with appropriate mechanisms to allocate tax revenues internationally.

- A global tax authority could be set up with the prime objective of ensuring that national tax systems do not have negative global implications.

- Support for the proposal for an International Convention to facilitate the recovery and repatriation of funds illegally appropriated from national treasuries of poor countries.

- Standards on payment of taxation in host countries should join environmental and labour standards as part of the corporate responsibility agenda. Standards requiring TNCs to refrain from harmful tax avoidance and evasion should be factored into official and voluntary codes of conduct for TNCs and for the tax planning industry.

- A multilateral agreement to share information on tax administration to help countries, especially poorer ones, to stem tax evasion. ...Link

Wednesday, April 21, 2004

BonoboLand - Inflation Stable - Productivity?

BonoboLand - Inflation Stable?

"Meyer also raises the connundrum of all connundrums: the great productivity puzzle. Good to see it is still puzzling everyone the way it is puzzling me. If this continues maybe it will get to rival the 70's Solow paradox. In fact come to think of it maybe we could now rephrase this: productivity improvements are making themselves evident everywhere.........except in the numbers of computers actually being purchased."

Don't forget about the sizable outsourcing/insourcing re-import of productivity - manufacturing and IT. This can only continue to worsen in the OECD nations with China, India, and much of S.E.Asia sitting so low in the currency game. None of these latter nations are creating internal consumer demand markets nearly fast or large enough, or much at all, to alleviate the problems of real missing global demand. They are depending on being re-export nations of global oversupply, yet creating rising price commodity demands for said re-export, and at the same time exporting deflationary and productivity forces to the OECD's - whose balance sheets can only continue to worsen.

Global corporate productivity is also increasing through the recent successes of their comptrollers/treasurers through their trading room activities. Global labor oversupply is also increasing, mainly through India and China, plus others such as Russia, E.Europe, Africa, L.America, etc. - allowing further productivity gains. We have a massive oversupply, lack of demand world continueing to contribute to real global market productivity at the increased expense of real aggregate global credit productivity.

In other words, we march ever closer and further into a real global debt deflationary spiral - without real needed structural reform. Micro-economics will no longer cure the world's massive macro-economic problems of over-supply and under-demand. Only true balance of payments and currency reform solutions are viable - Davidson. Micro solutions is just spinning your wheels on ice in an inferno of hell. ...Link

BonoboLand - Renminbi Float

BonoboLand - Renminbi Float
by Edward Hugh

Here it is, the news you've all been waiting for: China is planning to introduce flexibility into its exchange rate system, allowing the renminbi to fluctuate in a wider range against a basket of foreign currencies. The FT has been talking to Guo Shuqing, administrator of China's foreign exchange reserves.

"China is .....gradually lifting capital controls, partly to relieve upward pressure on the renminbi and partly to pursue a goal of having a 'basically' convertible currency and open capital account in five or six years, said Mr Guo. However, he cautioned, that 'we can never reach a point where the capital account is totally free."

Dissonance & Euphoria

Max Fraad Wolff

Max Fraad Wolff is a Doctoral Candidate in Economics at the University of Massachusetts, Amherst.

Bullishness is back, in force and vogue. Soaring earnings and economic rebound are the pillars of a glittering recovery McMansion. There is no disputing that the Fortune 500 had a great run in 2003-especially compared to the terrible years of 2001 and 2002. Their 540% increase in profits on 7% revenue gain is both exhilarating and bracing. The causes of macro glee are far harder to understand and follow. While the March BLS employment report was positive, it was far more a PR and short term trading event than an economic sea change. After all, the ranks and rate of unemployment failed to move as 1 month's good data don't undo three lean years. The present bout of euphoria rests on a very selective focus and more than a little bit of dissonance driven acquisitiveness in the markets.

One has to walk a macro and global economy high wire, refusing to look down, left or right. If you carefully follow this self imposed myopia you too can feel happily assured. If - by chance or training - you look around, timber!

Markets have stubbornly refused to price in or trade any of the recent news out of Iraq. No attention is paid to global attitudes- specifically the Pew Global Attitudes Survey. The alarming situation in Saudi Arabia bears only passing mention. The personal debt explosion is ignored. The trade deficit is ignored. Budget deficits are ignored - even as the IMF offers a second warning of threat to the global economy posed by massive DC red ink projection and numbers. The importance of housing and its exposure to upward rate pressure are off the talking points list. Election year risks don't exist-even as polls predict a close, bitter race. Energy prices are no big deal. Persistent economic weakness, growing rage over outsourcing and weak job prospects are not worthy of mention. However we all know the above really do matter.

About those great corporate numbers…

Duke and University of Washington researchers recently released survey numbers drawn from 401 financial executives. The results suggest that better than half would delay value enhancing activity to beat analyst expectation. Almost 80% would decrease research, advertising and maintenance spending to beat the numbers. These are the numbers that convince everyone that things have changed and the good times are set to role. In 2003 the Fortune 500 booked profits of about $446 billion. This is compared to 2002 negative profits of $70 billion. It is a whopping $2 billion more than the profit booked in 2000-less if adjusted for the decline in the dollar or inflation.

How did we regain-or nearly regain-2000 profits? It would appear that trillions in additional housing debt, hundreds of billions in additional personal debt, trillions in trade and budget deficits, multi-decade low interest rates and a declining dollar did the trick. Wow! This great return to profit was done with no real increase in revenues. Fortune 500 revenue went from $7.2 trillion in 2000 to $7.5 trillion in 2003. Stunning 4% revenue growth may explain why federal, state and local governments are broke and 3 million jobs are missing from the economy. It would appear that firms prosper if they pay no taxes, lower wages, little toward pensions, nearly nothing to borrow and repatriate foreign earnings in a declining dollar environment. Recent CBO estimates suggest that more than half of our larger corporate brethren have paid approximately nothing to Uncle Sam of late. I told you not to look to around.

Macroeconomic Strength…

The present prosperity rests on the above robust and sustainable structural pillars. Let's take a look at those tariff protected steel girders. Median disposable household income fell-even adjusting for falling taxes-according to the most recent Census Bureau data. In 2003 we ran a $489 billions trade deficit in goods and services as our trade balances with China, Japan and the EU deteriorated. As people's income fell they added trillions in new obligations in the form of mortgage and personal debt. Spending continued to outstrip income growth as savings stayed at horrifyingly low rates in the range of 2%. I guess that is why major banks assure shaky investors that they will gain when rates rise as new deposits are drawn from America's legions of savers. You might pause to consider that consumption recently passed 70% of GDP. Do you think housing refinancing and heavy borrowing might be feeding the fire? Who knows, it sure isn't coming from savings or wages.

Credible estimates of debt now total about $24 trillion across the household, federal governmental and business sectors. That breaks down to roughly $7 trillions for Uncle Sam, $9.4 trillions in all consumer debt including housing and $7.4 trillions in business debt. If you assign a very low average carry cost of 5% it will cost $1.2 trillions to service obligations with no amortization. That is about 12% of GDP- more than twice bullish growth forecasts. Recent growth has involved intensification of the mortgaging of our economic future-not a drawing down of obligation. Perhaps this is part of the reason that we now must borrow between $1.5 and $2 billion per day from the rest of the world. The difference must be generated by “credit innovation” that stretches the gap between material and monetary value. I told you not to look around.

The looming prospect of rising interest rates should probably rate a major concern as housing comes under pressure and America staggers under heart attack levels of debt intake. REIT investors and carry traders are not the only ones with something to fear. Firms in the debt and or trading games- financials; those who sell into the inflating government sector- defense contractors and security businesses; those with pricing power in a cost cutting economy- pharmaceuticals, energy and insurance firms; soared in 2003. If the macro environment is set to shift, they will have to adjust or fall off the pinnacle of the profit lists. Of course, macroeconomic conditions are still not definitely forecasting rapid and sustained growth. Unless we double dip, common sense would suggest that the radiant blush may be projected onto the recovery rose by dissonant euphoria. ...Link
IMF World Economic Outlook

Monday, April 19, 2004

BonoboLand - An Interesting Argument and a Possible Correction

Just a comment I made to one of Edward Hugh's posts at BonoboLand about the ZIRP problem.

BonoboLand - An Interesting Argument and a Possible Correction

"I don't see us escaping from the 'black hole' type characteristics of a global ZIRP environment any time soon. The difficulty is that the big indebtedness problem is primarily an OECD phenomenon. But any collective tightening across the OECD - apart from adding to the deflationary pain - would also drive up interest rates in the developing world, which is precisely where you don't want to do, at all. In fact quite the contrary."

Edward, in my opinion, the only way to escape from the ZIRP problem is to rebuild real global demand, especially in the really damaged countries, E. Europe, Russia, Africa, and L. America. The global TFP and ILO figures, charts, and graphs I have posted in the past clearly show the massive global shrinkage of these economies over the last twenty years and especially the last ten. Even if you slog through all the World Bank, IMF, OECD, and BIS data you will find the same story - a major lack of global demand in the 3rd world.

I say this problem can only be solved by the massive savings, balance of payments redirection, of major structural reform. It just seems to me as though no one has even considered the trillions of dollars there would be saved by rebalancing the currency system, which could be redirected to increasing real near bankrupt nations' demand, to reflate the world by demand created by improved balance sheets of the worst demand nations - again the nations mentioned above. We need the 3rd world to drag us kicking and screeming away from ZIRP - the OECD's don't have the capacity with the major deflationary drag of most of the entire 3rd world.

China, and the other E.Asian nations simply add to this deflationary drag by having their currencies pegged even lower than the rest of the 3rd world - this is no help. All nations' currencies are massively too far out of ppp + exchange rate equilibrium, at present, for our ZIRP problem to right itself - correctly, ie., without massive bubbles and crashes.

China using the reserve ratio tool to slow its economy is a case in point. Although they couldn't really use interest rate increases, because it would have exacerbated the problem by attracting unwanted funds, this ratio increase is the most dangerous tool to use, as it puts many balance sheets in dire circumstances and could quickly lead to internal financial trouble.

Finally, China, with the help of MNC's, creating excess global supply, on such massive scale, when the world is already suffering from a demand crisis is the most foolish development in economic history - short of wars. We have a global demand crisis, headed for a global debt deflationary spiral, of humongous magnitude - and the world can't yet see structural reform is necessary???

Where, oh where is Keynes? Davidson???

Edward, you know Davidson also mentioned a simpler quick solution to global imbalances - "the fixed exchange variant." This system simply works by all nations agreeing to write laws of currency re-balance over a number of years and then have the central banks of all nations act as market makers to maintain equilibrium within reasonable ppp + exchange rate balances. Quite simple, and works almost as good as exchange clearing if proper numbers are collected. Since the forties we have come a long way in collecting the data needed. I could even back this easy system - better than doing nothing, while Rome burns. ...Link

`29 Depression Era Comparisons
Pitfalls of Asian Central Banking

Thursday, April 15, 2004

Today's Inflation May Cause Tomorrow's Deflation

Asia Pacific: Today's Inflation May Cause Tomorrow's Deflation
Andy Xie (Hong Kong)

Today’s inflation is based on borrowed money that supports consumption in the US and investment in China via its impact on commodity prices. This situation cannot last because labor surplus kills inflation expectations. When the cycle turns down, demand can be expected to bottom lower than normal under a higher debt burden, while capacity would be higher than normal. This combination would lead to deflation.

The central banks may raise interest rates against cost-push induced inflation. This would be the right action for the wrong reason. Low interest rates have led to debt-induced bubbles that will worsen deflationary pressure later. The right reason for tightening monetary policy would be to contain asset bubbles in order to prevent future deflation.

What Is Causing Inflation?

Headline inflation data are picking up, raising fears that the global economy could enter a period of high inflation. This is an erroneous conclusion, in my view. The current inflation stems from rising commodity prices caused by property speculation, mainly in the United States and China, that spills over into consumption in the US and investment in China. The pass-through to consumers of higher raw material costs in production is much less than usual, due to the overall surplus situation. Because wages are not linked to inflation in the current environment, the inflation mostly redistributes income from households to producers and from downstream to upstream producers.

Many analysts point to loose Fed policy as the reason for inflationary pressure. The source is correct but the mechanism is quite different. Loose monetary policy normally causes inflation due to, as Milton Friedman put it best, too much money chasing too few goods. However, broadly speaking, this is not what is occurring. Because globalization and new technologies have greatly lifted global output potential, i.e., there is a big global output gap, monetary policy currently has much less impact on inflation expectations.

Instead, cheap money causes speculation in asset markets. In a global economy where potential supply is greater than demand, the equilibrium inflation rate should be low. Hence, nominal income growth should also be low even though real income growth would be high. Further, the income growth would shift disproportionately to low-cost producers. Hence, rich households face low income growth in today’s world. But as money becomes cheap, the rich households expect assets to appreciate, which would be logical if their income growth potential had not changed. This “money illusion” – cheap money with income potential unchanged – is causing rich households to speculate. This is what is occurring in many Western economies.

The Fed’s cheap money policy has made money available for China’s high growth economy. The combination has caused even greater property speculation in China. The expectation that Shanghai’s property prices would converge towards those of Hong Kong and Taiwan was the catalyst for China’s property bubble. The low US interest rate prompted Hong Kong and Taiwan speculators to jump on this ‘convergence’ trade. As Shanghai’s property prices have risen and the revenue to the government has enabled the city to grow rapidly, other cities have emulated the trend, causing a nationwide property bubble.

Why is this type of inflation different? Under normal circumstances, when a central bank prints too much money, everyone expects prices to rise and, hence, asks for a wage increase. The economy experiences a price-wage spiral, and the leverage in the economy’s debt-to-GDP ratio does not rise. The current type of inflation comes from the spillover of demand from property speculation funded by debt. The indirect nature means that debt rises much faster than GDP.

In the last three years, the ratio of net borrowing by the financial sector to GDP increase in the US was 3.6 compared with 1.8 in the 1990s, 2.3 in the 1980s, 1.5 in the 1970s, and 1.6 in the 1960s. In the past three years, every dollar increase in China’s GDP was accompanied by a US$2.50 increase in domestic credit compared to US$1.60 in the 1990s.

Smaller Impact of Commodity Prices on Inflation

Under normal circumstances, loose monetary policy causes commodity prices to rise in a wage-price spiral; commodity producers ask for more money because they expect production costs to rise. When looser monetary policy works through property speculation to increase demand, commodity prices rise because demand is greater than expected. It is much more difficult to pass through higher commodity costs in production to customers in such an environment.

Historical patterns would suggest 4% inflation in OECD economies at this point in the commodity cycle. But we are only observing about 1%. The same disconnect is happening in East Asia ex-Japan. If we use the early 1990s as a comparator, the inflation rate in the region should be 8-10% at this point in the cycle. But we are only observing about 3% based on the official data and 5% if we assume that China’s data understate inflation now.

Debt Deflation May Not Be Far Away

The global economy has experienced a positive capacity shock through globalization. The need to find an equilibrium should have caused a downward price level adjustment in the developed economies. Instead, monetary authorities, mainly the Fed, are using cheap money to fight this adjustment, causing a massive property bubble that creates superficial demand and stops prices from declining. However, as soon as the bubble bursts, the world will need a bigger downward adjustment because of the extra capacity formed during the bubble.

Most importantly, so much debt has been created that it may lead to debt deflation. Globalization would have caused benign deflation that benefits consumers and causes some industries to relocate to lower-cost locations. But fighting against this sort of deflation with bubbles and debts must lead to deflation. In my view, this is what happened in the 1920s after World War I.

When the global property bubble bursts, debt deflation could ensue. It is always possible that the Fed could create another bubble to postpone the inevitable. For example, direct purchase of US Treasuries to push the 10-year yield down to 2% could create another property bubble. However, the Fed may repent and Mr. Greenspan could retire. It may not be profitable to bet on the next bubble. ...Link

Wednesday, April 14, 2004

Auerback - Stop This Runaway Train

It's going to be interesting to see how the near future plays out. We have China with a pegged currency - to low I might add - inflation bubbles and possible busts just around the corner, and the countries concerned - unconcerned! I can just picture it - China - Pop - and everyone rushing to damage control. If China does not allow its currency to rise befor trouble really sets in, she is positioned for a massive hyper-inflation, just because of her massive export potential which can do nothing but accelerate during a future bubble pop and crash. If this happens, her currency should be massively re-valued, but in all likely-hood will be de-valued further - the insane non-common sense of the world's present state of fictitious capitalism. The world's market foolishness will most likely rule during the next crash if present conditions are any measure. China should start re-valueing immediately to avoid the severity of a possible future market shock - but will she?

The U.S. Fed seems to encourage China's profligate path by possibly worrying more about real global deflation being the more serious problem - it is - but the Fed is caught in quite a conundrum. It can't raise rates for fear of deflation, yet it needs to set a better example for China's policy makers to take the right currency course. It is in the entire world's best interest, as well as China's, to re-value its currency befor it's too late for all of us. Even if the Fed did raise rates it would more than likely exacerbate the problem with China's currency stance, as it would simply make it more profitable for her to buy more treasury bonds and bills to continue further defense of its peg on the cheap, so we're in quite a pickle. My advise would be for all the world's central bankers to strong-arm China into re-valueing its currency, or the rest of the world simply re-valueing it for them - this is too serious a situation to let fester any longer. We have a choice - either develop the courage to solve the problem or go down with the sinking ship. It's too bad the world has to be so cowardly, not to do the necessary re-alignment of currencies - and I mean the serious re-alignment of all the world's currencies.

Now, many will argue that China can not hyper-inflate in its present deflationary stance. It is true that the majority of the country has a massive excess labor supply, and real lack of internal demand, contributing to holding it for the forseeable future in real deflation. I do not hold this view, as any economic history has shown, when a nation enters a true market collapse entirely new dynamic forces take over. These new forces of real inflation, mostly created by foolish emergency thinking, ie, under-valueing the currency by world markets when it should be re-valued - herein lies the problem. My guess is this will happen again if history is any guide. Markets act foolishly in dire emergencies - fear, extreme speculation, and capital flight guarantees this.

Now, others will argue that derivatives will hold the markets more in balance this time around. I do not believe this either, as market fears can overcome any insurance system ever devised by the simple mind of man - market history should be our true guide. Derivatives are only forward contracts in new clothes and fancy hats. Markets of fear will chew up any new ideas known to the minds of us all.

This is only a warning - I do not know whether China can survive the future in tact or not. It just doesn't look good to me - all around. I do know positively - we need true and full global currency reform - ASAP. ...And not that I agree with Auerback completely, as I do not, but he comes close to my thinking in many areas - have a look.

Nobody Can Stop This Runaway Train

....We cite these examples to illustrate that something is clearly giving way: pressure is building for the Fed to remove its overly accommodative monetary stance - despite the open recognition and admission by them that there is no easy way to back out of the credit morass they have created and nurtured over the past decade.

The risk, of course, is having read this report or seen references to it in the financial media, the leveraged speculating community may begin to try to hasten the arrival of some of these risks by betting the Fed has no easy way out, starting with a bet on a “spike in yields and volatility in the US Treasury market” which “could also trigger a widening of credit spreads”, as the IMF document suggests. If in fact aggressive professional investors do anticipate such repercussions, and begin to put on trades to benefit from them, they will have a good chance of initiating a self-fulfilling prophecy which would place the Fed in even more of a policy pickle. Such policy dilemmas, after all, can be the means to make a killing, as George Soros illustrated when he took on the Bank of England in 1992 in its sterling defence.

But they can also be the means to further huge financial disruptions, as any Asian policymaker around during the late 1990s can attest. Thus far in the US, credit expansion has proven so virile over the past two years that if the dynamics of the recent economic recovery become cumulative or self reinforcing, it may persist through a multi year expansion and the ultimate fallout could be much worse.

What are the driving factors here? For one thing, the recovery of house prices in the US since the days of “recession” in 2001 has metamorphosed into a fully-fledged real estate bubble. The re-establishment of a positive trend in equity prices has set into motion once again the full dynamics of rational destabilising speculation, except that, this time around, participants (as Leon Cooperman recently illustrated) no longer believe in the fantasies of new era never ending growth and profit miracles but are playing along cynically only because the Fed has orchestrated everyone else to do so.

Cynically gaming a self fulfilling prophesy is surely a difficult and dangerous exercise. As for the US balance-of-payments and current account with the rest of the world, in such an environment Goldman Sachs’ chief global economist Jim O’Neill has simulated a likely outcome with US external debt, now at a hefty 25 per cent of GDP, rising into the 40 per cent – 50 per cent range - a level that is characteristic of LDC debt delinquents.

But how can the current dynamic be halted? How, for example, does one stand in the way of a housing bubble mischaracterised by Franklin Raines, as a “piece of the American dream”, even though the explosive growth in mortgage finance has, as our colleague Doug Noland has vividly demonstrated, become a hugely destabilising part of the American financial landscape? In this case, the ultimate investor purchases an instrument which he believes to be government guaranteed; consequently, the entire private credit risk is believed to be socialised through GSE intermediation or insurance. For all of the tough talk now meted out by Treasury Secretary Snow, or various members of Congress, when the crunch comes, will the government truly withdraw this implicit guarantee?

In fact, it is almost nonsensical to speak of a “credit system” in the US any longer, since the use of the term “system” implies that there is some underlying rational structure, ultimately controlled by a responsible regulating entity, such as a central bank. As Doug Noland has illustrated time and again, this is a completely fictional construct: the whole US system today in effect works toward credit “dis-intermediation”, rendering some form of external constraint virtually impossible. Asset backed securities, convertible bonds, financial commercial paper, structured finance, the proprietary desks of the commercial banks, and the hedge funds all slice and dice credit out of any recognisable classical form that is still taught in Economics 101 textbooks: we see nothing more than acts of financial engineering, which eventually drive a wedge between the ultimate borrower and the ultimate lender so as to render the whole process unrecognisable.

Similarly, the use of derivatives, particularly those of the OTC variety, are of such complexity and opacity, that it is virtually impossible for the market to exert any kind of discipline, since most do not understand the nature of the credit or the complexity of the risk being held in the portfolio, thereby engendering mis-pricing in the risk premiums. By the same token, for regulators to understand and thereby deter a huge potential source of destabilising financial speculation (assuming, of course, that they want to deter, which is questionable in the case of the Fed), they need to have some understanding of the underlying instruments which are the source of so much financial destabilisation. But in most instances, the authorities seem reluctant or unable to tackle the problem (as the examples of Enron and Parmalat vividly illustrate) until disaster strikes. So it is absurd (for the Fed in particular) to laud the use of derivatives as (in the words of Mr Greenspan) “more calibrated than before to not only reward innovation but also to discipline the mistakes of private investment or public policy”, when neither the market participants, nor the regulators, can properly calibrate the risks involved.

For all of the warnings of the IMF, it is clear that in today’s environment, both the Fed, and the leveraged speculating community whose interests it persistently champions, may have more instruments to keep the credit spigot open than most of us realise. This is why the rise in commodity prices has been so telling: something is finally cracking in the system in spite of persistent denials of its relevance. Whether this is occurring because of the increased activities of leveraged hedge funds or a surge in genuine end-user demand is almost beside the point because both are two sides of the same coin: global liquidity run amok. China is a prime example of this two-sided coin, as this where some of the consequences of the US policy strategy are being felt owing in part to the dollar/RMB peg. The unsustainable boom in productive capacity creation there (and the corresponding parabolic rise in commodity prices) can be traced back to the Fed-induced borrowing and spending boom over here, and the rock-bottom financing rates for risky ventures enabled by the sharply positive yield curve, precisely the sort of issues touched on by the IMF report. But no amount of warning, however well intentioned, is going to stop this runaway train until the wreck inevitably occurs. ...Link

An Addition: Kurt Richeb├Ącher - Policy Traction

“Policy traction” is an expression that lately has come into fashion. In essence, it refers to the relationship between the size of the monetary and fiscal stimulus injected into an economy...and its effect upon economic growth and employment.

In the past three years, America has experienced an interest rate collapse, a record fiscal stimulus and the loosest monetary policy imaginable...all of which fueled money and credit creation at a scale that has no precedent in history. Has it really worked?

Well, in one way this policy of stimulus has had fabulous traction: It has engendered the greatest credit and debt bubble in history. Total outstanding debt, financial and non-financial, in the United States has ballooned by almost $6,500 billion since 2000, as against GDP growth of $1,238 billion. For each dollar added to GDP, there were about six dollars added to indebtedness. ...Link

In an earlier post I mentioned speculative increases being related to the massive expansion in the derivatives markets. Maybe the two above posts add some clarity to my positions. At least I hope so.

Monday, April 12, 2004

The World Turned Upside Down - Maybe?

The World Turned Upside Down

Chris Temple is editor of The National Investor newsletter and founder of The Foundation for American Renewal.

Much better news on the jobs front as well as another anticipated strong earnings season for Corporate America have helped Wall Street right itself somewhat following the nasty March swoon. This past week the market had to struggle with the escalation of violence in Iraq; thus, it did not manage to push ahead even further than it has recently. Nevertheless, most traders seem to view the Iraqi quagmire as more of a nuisance than anything substantive that will affect our economy over the longer term.

I won’t argue that point here. Rather, I do want to remind readers that—quite apart from Iraq—there have been other developments recently which the overwhelming majority of investors have not paid nearly enough attention to. Twice in just the last few weeks, in fact, developments occurred which have much deeper implications for the U.S. economy and markets. In fact, the eventual effect of these for Americans particularly will translate into a drastically different standing in the world economically than what we’ve all been long accustomed to. It can truly be said that, for us, the world will be turned upside down over the next several years.

None of us alive today has ever dealt with an economic and market environment that did not have at its core somehow one important anchor. And that, my friends, was that—though there were transient occasions since World War 2 when there were some interruptions—the world, in the end, has revolved around the United States of America.

In a military sense, it has been American might and muscle that, for the most part, have kept most of the world a safer place. Sure, there have been small flare-ups, wars and their attendant “police actions.” Yes, there are uncomfortably many of these kinds of things going on right now. Yet nobody can deny that America’s formidable military strength and resolve won the Cold War, have kept historically volatile Europe free of conflict, and have otherwise created an environment of relative stability.

America’s economy has for several decades been the world’s largest. U.S. consumers, though they have dangerously built their seeming prosperity on mountains of debt, have nevertheless contributed to economic activity elsewhere by consuming so much. It can truly be said that, especially in recent years, Americans have virtually carried the entire world on their backs.

Part and parcel of the world being “tilted” toward the U.S. has been the establishment of U.S. capital markets as the largest and most liquid in the world. People and even governments the world over have shoveled endless amounts of money into U.S. financial assets, giving an even greater aura to the United States as the great engine of wealth creation in the world.

As one sage once put it, though, “Whatever can’t last, won’t.” As the above scenario and America’s being the consumptive center of the universe has endured, major imbalances have been built up. For years, pundits of all stripes have speculated as to when the “tipping point” would come, where America could no longer accumulate such massive internal and external debts; and, further, when others in the world would smell trouble—or greater opportunity elsewhere—and begin to change their behavior towards America.

Early answers to these questions—and warnings to the wise—are starting to come in. A few weeks ago, Japanese officials surprised currency traders by suggesting that their long and heavy intervention in the currency markets designed to keep the yen from appreciating too drastically was coming to an end. Make no mistake, said the Bank of Japan; it will still intervene if and when necessary to arrest any sudden or overly sharp yen rallies versus the greenback. However, the signal was clear; an orderly appreciation of the yen was something the BOJ was now resigned to, if not welcoming. As we all know, the Japanese have been buying boatloads of Treasury securities and otherwise keeping the yen in check in order to best protect their interests.

All things being equal, that nation has been best served until now by keeping its citizens employed in the many export-oriented businesses that have fed the American consumer economy. In the recent past, though, signs have been increasing that Japan’s own consumer economy has been revived. Further, it has been doing increasing amounts of business with other nations in the Asian region; most notably, China. No longer as dependent on America’s consumers, Japan has begun the process of a “readjustment” of sorts away from an economic model that has worked well in recent years. Now, Japan must see to its own domestic growth, a reinvigoration of its own lending industry, and as sustainable an increase in domestic consumption as it can engineer. An important element of this will be to, in effect, do what the United States did for much of the 1990’s: have a stronger currency so as to make imports as inexpensive as possible.

As Japan’s resurgent economy increases its appetite for imported raw materials, it will need a strong currency to keep those commodities—all of which are priced in the U.S. dollar—from getting overly expensive in their yen. I predict that China won’t be far behind in following the same course as Japan. As that nation of well over a billion people has developed an even more incredible appetite now for imports, inflationary pressures have grown; so much so that some are suggesting China has become a “bubble,” whose rapid growth is unsustainable, at least in the near term. That may well be. However, what better way to take some of the inflationary pressure away than by “giving in” to the U.S. and finally allowing its currency to strengthen versus the U.S. dollar? The irony here—even more so than with Japan having already moved in this direction—is absolutely incredible.

For some time now, politicians of both parties have sought to cover their systematic dismantling of America’s domestic economy on behalf of corporations by blaming China (just as they used Japan as a scapegoat in the 1980’s.) “If only China would get rid of its unfair currency peg to the dollar and allow the yuan to rise,” they tell us, “we wouldn’t have such a trade imbalance. Exports would soar. We’d have an even playing field.” And so on. There’s an old saying that one should be careful of what one wishes for—because one just might get it! Soon, China will join Japan in allowing its currency to rise against the U.S. dollar. Particularly if this occurs before November, President Bush will claim a major victory in having finally succeeded in cajoling the Chinese into being more “fair” and in opening the door to greater U.S. competitiveness. Almost nobody will understand the true meaning of such a move, however. First, it will demonstrate China’s belief that the previously insatiable American consumer is finally about “full,” and that the best days of exporting gobs of cheap goods to America are over. Second, it will ratify China’s own growth story; one that is likely to play out over many years to come, but perhaps with some future geopolitical tension thrown into the mix as China flexes its bigger muscles. Finally, the Japan/China moves will translate into soaring costs for everything priced in U.S. dollars which will, of course, most acutely affect Americans.

That brings us to the second watershed event of recent days: OPEC’s refusal to cancel planned production cuts, thereby keeping upward pressure on oil prices. Here again, this signals a major change from a regimen that has pretty much been the norm for many years; that being America’s past ability to compel the oil cartel to follow our will. Following the 1970’s embargo, an implicit deal was struck between the U.S. and OPEC, with Saudi Arabia being the main representative of the latter. With the U.S. by far being the world’s largest importer and consumer of oil, OPEC has had to consider at times what its major customer could “bear” as far as prices were concerned. Simply put, the U.S. has on many occasions been able to browbeat the cartel into pushing prices down to make already (relatively) cheap oil in America even cheaper. The threat was that if Americans were asked to spend a rising percentage of their incomes for energy, the U.S. economy would stagnate or go into reverse; and future sales at any price would thus suffer. That was a point that President Bush argued forcefully in recent weeks; but a point which the OPEC cartel, led by Saudi Arabia, rejected. This has led to some of the most lame partisan wrangling of anything we’ve yet seen in the early days of this election season (yes, I know, it’s still early—and that things will get even more insulting by November.) Bush and presumed Democrat nominee John Kerry are jousting over what Bush might still do, or what Kerry would have done, in a juvenile discourse that completely ignores reality.

That reality, dear friends, is that the world has begun to turn upside down for America. We no longer dictate every element of the global economy and prices as we once did in order to maintain our own advantage (in this case, much cheaper costs for oil than in the rest of the world.) The real issue here is that, due in great part to exponential growth in China and elsewhere, demand for oil is so great that prices have to rise. That’s the free market, folks, that Bush and others—and even John Kerry--claims to support. With other buyers increasingly demanding their product and willing to pay its price, why in the world would OPEC continue to kowtow to America, when it’s no longer necessary? What OPEC essentially said to America a couple weeks ago was that, “We’re sorry you think our price is too high; but if you don’t want our oil at US$36 per barrel, we have plenty of customers in Japan and China (and, increasingly, India) who will buy it.”

The implications for America are clear: Continuing records for gasoline and other energy products, with their attendant drags on corporate profits and spending, not to mention their own inflationary pressures.

As evidenced by both the Japanese and OPEC developments in recent weeks, America will no longer be the author of its own destiny. The implications are enormous; yet the handwriting now on the wall is being ignored by almost everyone else. Only those who understand that, for America, the world we’ve known for more than half a century is irreversibly changing will be able to both protect themselves and profit in the years ahead. In addition, only those who apply these new facts of life in a positive, constructive way will be able to lead their friends, neighbors and nation in, hopefully, one day repairing the damage to America that has been done while our caretakers and leaders have fiddled (or, in some cases, willingly sold out their countrymen.)

Will you be one of them? ...Link
Another View - Roach
The Carry Trade
Greenspan - Cash and Carry

Wednesday, April 07, 2004

Derivatives Expose'


"How efficient (in the technical sense) are real-world markets? Corporate scandals, bubbles and assorted dubious data points (like the US Senators' consistently high investment performance) suggest that the answer is "not as much as we'd like to think". I'm a big fan of Adam Smith's heartless invisible hand, but I worry like hell when it starts looking stupid."

I just sent this related comment to another bonoboer, about structural reform.

"Beyond the economics, the difficult part of this is political." As you have written, this is by far the greatest hurdle. I also think educating enough economists to make it politically possible is also a great problem. I think the derivatives markets will start showing their ugly face shortly, and make knowledge evolution a considerable amount faster. Just as an example, if I were Wall-Mart right now, I'd have bought as many trillion dollars worth of forward contracts/derivatives contracts as I could afford out to five years at China's current prices, and renew every year there is no currency reform toward real rebalancing. I/Wall-Mart would be plenty safe as it will take a minimum of five years for real currency reform to cut into such forward contract advantages, since the financial markets can't safely handle any more than 20% per year currency reform - thus a five years minimum market gauranteed profit. This is only Wall-Mart, think of all the other ones really doing it, with all the other corporations. I believe the number is three major U.S. banks have been given the green light by China to start selling their own derivatives inside China. China is already operating in the derivatives market through its own SOB's and through its Hong Kong banks. Anne at Bonobo posted an article about corporate profits surpassing labor profits by a wide margin, only recently, for the first time in history. This is most likely attributed to increased derivatives insurance and speculative activities, ie, guranteed profits. One final thought, remember I stated none of the bancor type schemes should be undertaken without real and thorough structural reform, as to do so would only be self-defeated by the global $874 trillion derivatives realities - BIS factual numbers: BIS You can't beat the speculators when they're insured by this much actual turnover. Only true currency reform to sane balances will solve this problem. Derivatives become less necessary and less profitable the closer we arive at a future true equilibrium. In my opinion, this is our only hope.

"Are we becoming, as individuals, groups and species, better information processors, smarter?"

"Without a full understanding of the functioning of forward markets, all discussion of exchange rate policy must remain seriously deficient." Egon Sohmen

Need I/Egon say more about derivatives?

The Day The Fed Stood Still!