THE
WAGES OF NEO-LIBERALISM PART 1:Core
contradictions By Henry C K Liu
The US trade deficit with China ballooned
in 2005 to US$202 billion, more than one-quarter
of the total deficit. Rising trade imbalance
between the US and China in recent years has given
rise to intense pressure from the United States on
China to revalue the fixed exchange rate of its
currency, which had been pegged at 8.28 yuan to a
dollar within a narrow band of 0.03% for a decade,
from 1995-2005.
On July 21, 2005, after
repeated pronouncements that no revaluation was
necessary or even being considered, China
announced a surprise 2% appreciation of the
currency, putting it at 8.11 yuan to the US
dollar. It also announced that the yuan would
henceforth be pegged with the same narrow range to
a basket of foreign currencies that includes the
dollar, the euro, the yen and others likely to
reflect China's trade relationships with the
rest
of the world. The components and weight of
different currencies within the basket is not
disclosed to the market. China appears to be
following Singapore's managed-float model, keeping
both weights and effective bands confidential to
allow maximum flexibility within a narrow range
tied to a reference peg to the dollar. Many saw it
as an obvious political move to appease US
pressure.
Yet US pressure on China to
revalue the yuan further continues, as the trade
deficit with China for January 2006 registered
$17.9 billion, a 10% increase from the previous
month. Total worldwide US trade deficit for the
month was $68.5 billion despite a rise in US
exports of aircraft and soybeans. This pressure
from the US is motivated by the misguided
conventional assumption that a lower exchange rate
of the dollar will reduce the US trade deficit,
despite clear historical data showing that past
revaluations of the Japanese yen and the German
mark had not reduced US trade deficits with these
major trade partners in the long run.
All
such revaluations did was to lower the domestic
cost in local-currency terms more than raise the
dollar price of Japanese and German exports. The
net effect was deflation in Japan and Germany,
with inflation in the US while the US trade
deficit continued.
The dollar takes the
form of a US Federal Reserve note, a monetary
instrument issued by a central bank. The yuan
takes the form of Chinese People's Currency
(renminbi, or RMB) issued by the People's Bank of
China (PBoC), another central bank. Both are fiat
currencies issued by central banks in that they
are money with no intrinsic value, not backed by
gold or other species of value. Both currencies
are not issued directly by their respective
governments, but by their respective central
banks. This means that the full faith and credit
of the nation is not directly behind either of
these currencies.
A holder of these fiat
currencies cannot go to their government to claim
a piece of the national wealth. The values of
either of these currencies are determined by their
purchasing powers in the respective economies as
affected by the monetary policies of their
respective issuers, ie, the respective central
banks. The holder of a dollar is entitled to
exchange it at the Fed for another dollar, no
more, no less. The dollar's purchasing power
within the US is affected by the Fed's monetary
policy as such policy affects the inflation or
deflation rates in the US economy. The same is
true for the yuan. Thus the exchange rate of the
two currencies reflects the domestic purchasing
power differential caused by the monetary polices
of their respective central banks, which are in
principle politically independent.
The
trade imbalance between the US and China is not
caused by the exchange rate of the two currencies.
It is caused mainly by a disparity in the factors
of production, such as wages and rent as expressed
in prices in the two trading economies. The
Chinese trade imbalance with the US is primarily
caused by Chinese wages and rent being too low
compared with equivalent productivity in US wages
and rent. The dysfunctionality in the exchange
rate between the yuan and the dollar is the
result, not the cause, of the trade imbalance. To
correct this trade imbalance, Chinese wages and
rent need to rise, not the Chinese currency. Wages
and rent in the two trading economies need to
converge toward parity, rather than the currencies
to diverge from any particular exchange rate that
has been in operation for a decade.
The
yuan at 8.12 to $1 is already valued at twice the
purchasing-power-parity gap of 4 between it and
the dollar within their respective economies. Wage
disparity between China and the US ranges from 20
to 50 times in various sectors, and an exchange
rate that reflected such a wide disparity would
border on the ridiculous.
A stable
exchange rate is not only beneficial to trade, it
is also fundamentally critical to global financial
stability. Every financial crisis since the 1971
collapse of the Bretton Woods fixed-exchange-rate
regime has been caused by exchange-rate
instability. Exchange-rate policies cannot be
substitutes for structural economic adjustments
necessary for mutually beneficial trade between
two economies. Nor can exchange-rate policies be
substitutes for sound domestic monetary or
economic policy.
When two economies at
uneven stages of development trade, a trade
surplus in favor of the less-developed economy is
natural and just, until the less developed economy
catches up with the more developed one, otherwise
it would be imperialistic exploitation, not trade.
Market forces on exchange rates are
derived from the relative strength of trading
economies. Foreign-exchange markets express the
net summary judgments of market participants on
the economic health of trading economies as they
are affected by government fiscal and central bank
monetary policies. Markets use exchange-rate
fluctuation to carry the message of aggregate
judgments to the monetary and fiscal authorities
of the trading economies. These authorities,
usually the central bank and the Treasury, cannot
ignore such market sentiments without a cost.
For economies where the currencies are
freely convertible, the cost can be massive
attacks on their currencies by speculators, such
as hedge funds, that would quickly drain the
government's foreign-exchange reserves and cause a
collapse in the economy's debt market. For
economies that practice exchange and capital
control, the penalty would be a drain in foreign
reserves and a reduction in trade in the case of a
deficit. In the case of a trade surplus, the
penalty would be a drain of domestic currency
capital into growing foreign-exchange reserves.
In the current global central-banking
regime, fiat currencies are issued mostly directly
by central banks or by banks authorized by the
central bank to issue currency, such as in former
British colonies like Hong Kong. Central banks are
supposed to be politically independent in their
key role of maintaining the stability and the
value of a nation's fiat money, unaffected by
constant and relentless political pressure for
easy money.
The value of the fiat currency
of a sovereign nation is backed only by the
nation's economic health and by the issuing
government's acceptance of it for payment of
taxes. It enjoys monopoly status as legal tender
for settlement of all debts within the country's
borders. Most sovereign nations allow only their
own legal tenders to circulate within their
borders and require that foreign currencies be
first converted into local legal tenders before
being used in domestic markets. For cross-border
transactions, a foreign-exchange market is
necessary to inter-convert legal tenders of
trading nations at economically equitable rates.
When the foreign-exchange value of the
fiat currency of a country moves beyond what the
government or the foreign-exchange market deems
appropriate, the correction needs to come from a
readjustment of the structure of its economy, not
from artificial manipulation of the exchange rate
of its currency. Regardless of whether the
exchange rate is fixed by government or by market
forces, the volatility in the gap between the
economic value of a fiat currency and its exchange
rate is the main cause of financial instability.
Such instability has caused recurring financial
crises around the world in past decades since the
collapse in 1971 of the Bretton Woods regime of
fixed exchange rates based on a gold-backed
dollar.
The philosophical underpinning of
a central-banking regime is the assumption that a
stable value for a fiat currency is necessary for
the long-term health of the economy. In a
globalized market economy, the domestic purchasing
power of a fiat currency in large measure affects
its exchange rate, not the other way around. Yet
most central banks, including the US Federal
Reserve, categorically defer exchange-rate policy
to the Treasury or ministry of finance, because it
is an issue of national economic security.
Further, the raison d'etre for a
central-banking regime is equally rooted in a
contradicting assumption that monetary elasticity
is necessary to respond to the changing financial
needs of the economy to prevent cyclical bank
crises and recessions or depressions.
Thus
a central bank's first key function of preserving
the domestic purchasing power of fiat money
conflicts with its second key function of
providing monetary elasticity to a slowing
economy. A central bank must restrain commercial
banks from creating money through excessive
lending made possible by a partial reserve
regulatory regime, while at the same time it must
act as a lender of last resort in an approaching
financial crisis or panic.
The function of
a lender of last resort is to provide needed
liquidity to a market in distress from already
excessive debt. Without central-bank liquidity
reserves, a distressed market may freeze in a
circular domino effect of even creditworthy
debtors being temporarily unable to meet their
obligations because some less creditworthy debtors
are unable to pay their debts to them. Such
recurring banking crises had been regular in the
US prior to the establishment of the Federal
Reserve in 1913 and in recent decades in many
other countries with dollar debts for which their
central banks were unable to provide monetary
elasticity in dollars because only the Fed can
print dollars.
According to the quantity
theory of money, monetary elasticity, when
regularly invoked as convenient preventives
against cyclical slowdowns in the economy, leads
to a rise in "moral hazard", which is the
encouragement to borrowers to take unwarranted
financial risks with the knowledge that such risks
would be protected by central-bank bailouts.
Monetary elasticity is much easier to inject than
to retract because deflation is more painful than
inflation for debtors. Elasticity loss is
eventually caused by fatigue, in the same way that
rubber bands can get stretched or snapped.
The Fed under its former chairman Alan
Greenspan repeatedly went on record to assert its
belief in the heresy that "highly aggressive
monetary ease was doubtless also a significant
contributor to stability". Greenspan said in 2004
in hindsight after the bubble burst in 2000:
"Instead of trying to contain a putative bubble by
drastic actions with largely unpredictable
consequences, we chose, as we noted in our
mid-1999 congressional testimony, to focus on
policies to mitigate the fallout when it occurs
and, hopefully, ease the transition to the next
expansion."
By "the next expansion",
Greenspan meant the next bubble, which manifested
itself in housing after 2000. The "mitigating"
response was a massive injection of liquidity into
the US banking system.
There is a
structural reason that the housing bubble has
replaced the high-tech bubble. The US trade
deficit finances the US capital account surplus
which provides low-cost mortgages for the US
housing market. Houses cannot be imported from
low-wage countries like manufactured goods,
although many of the contents in houses, such as
furniture, hardware, windows, kitchen equipment,
bath fixtures and heating and air-conditioning
equipment, are manufactured overseas. Construction
jobs cannot be outsourced overseas to take
advantage of cross-border wage arbitrage, although
many low-skill construction jobs are filled by
illegal immigrants. But a housing bubble is not
different from any other types of debt bubbles. It
will burst if income fails to grow with asset
value to sustain debt-service payments.
Thus central banks are saddled with
conceptual contradictions in assuming the dual
role of a vigilant supervisor of the rules of
prudence in the financial market while at the same
time acting as a permissive cheerleader for the
infraction of the same rules in the name of
innovative economic expansion. Moreover,
central-bank criteria for bailouts of distressed
private firms are tied to their potential systemic
impact. Such criteria are inherently undemocratic
in that the large debtors unfailingly get
preferred treatment merely because of their size.
Hence the birth of a rule of finance that every
borrower knows: if you owe the bank $10,000, you
are beholden to the bank; but if you owe the bank
$10 billion, the bank is beholden to you. It is
known as the "too big to fail" syndrome.
What is even more pathetic is that in the
US, the Federal Reserve is legally owned by its
member banks, not the government, or the people,
although some 98% of the profit made by the Fed
goes to the US Treasury by law. Board members of
the Fed are nominated by the member banks and
appointed by the US president, and as a group they
predominantly represent the special interests of
the banking sector.
In China, the passage
of the Central Bank Law in 1995 granted the
People's Bank of China central-bank status,
shifting it away from its previous role of a
national bank. The difference between a national
bank and a central bank is that a national bank
serves the banking needs of the economy while a
central bank seeks to maintain the stable value of
the currency and at the same time to provide
monetary elasticity to prevent banking crises, and
to adopt an interest-rate policy that ensures
profitability to the banking sector with the idea
that the banking sector, the heart of the economy,
must be protected at all cost for the good of the
economy.
In the twilight zone of Chinese
bank reform, no outsider knows how the process of
nomination and appointment of the board members of
the PBoC works. It is safe to say that the PBoC
still follows the policy directives of the Chinese
government, which in turn follows the policy
directive of the Chinese Communist Party. To the
extent that CCP policy drifts toward market
fundamentalism with Chinese characteristics, PBoC
will invariably also drifts toward representing
the special interests of the banking sector and
their big business clients at the expense of the
interests of the proletariat and peasant masses,
or Chinese banks cannot profitably compete in the
world market. Such is the class contradiction of a
"socialist market economy", no matter how the term
is defined with doctrinal sophistry.
By
the definition of the Bank of International
Settlement (BIS), the super-national central bank
for all national central banks, such an
undemocratic special-interest posture is viewed as
desirable "political independence" in a capitalist
democratic society. Unlike the Fed, which has an
arms-length relationship with the US Treasury, the
PBoC manages the state treasury as its fiscal
agent. In addition to regulating the inter-bank
lending market, the PBoC also regulates the
inter-bank bond market, the foreign-exchange
market and the gold market in China.
Political independence is not a policy
subject Chinese central bankers can discuss with
ease as long as China still views itself as a
socialist nation. They prefer more benign
euphemism in the jargon of bank reform such as
"conforming to international standards". There are
signs that after almost three decades of headlong
reform toward what Chinese officials call a
socialist market economy, the adverse consequences
are beginning to show.
Recent Chinese
policy has shifted back in populist directions to
provide affirmative financial assistance to the
poor and the undeveloped rural and interior
regions and to reverse blatant income disparity
and economic imbalances. It can be anticipated
that this policy shift will raise questions in the
capitalist West about the political independence
of the PBoC. Western neo-liberals will be
predictably critical of the PBoC for directing
money to where the country needs it most, rather
then to that part of the economy where bank profit
would be highest.
The birth of the
Bretton Woods regime After World War II, as
the United States emerged as the only country the
industrial sector of which had been left not only
undamaged but actually strengthened by war, the US
dollar by default became the uncontested world
reserve currency for international trade.
As early as April 1942, the so-called
White Plan, named after Harry Dexter White, US
Treasury under secretary and a student of
free-trade advocate and Harvard professor Frank W
Taussig, proposed a United Nations Stabilization
Fund and a Bank for Reconstruction and Development
of the United and Associated Nations. The
advantages of stable exchange rates that the
automatic classical gold standard had provided
while it lasted, from 1876 to 1914, had proved to
be not so automatic after World War I. The
classical gold standard was causing deflation
around the world that translated into a worldwide
depression, while mercantilism, the quest by
nations for gold through exporting, was causing
protectionist reaction in all countries.
The idea of the need for international
cooperation in trade and for a new "gold exchange
standard" that would make wider use of gold by
supplementing it with an anchor currency that
would be readily convertible into gold had been
developed at a 1920 international conference in
Genoa, Italy, but the participating governments
failed to reach agreement because not all were
ready to accept British sterling hegemony. This
idea was incorporated two and a half decades later
into the Bretton Woods regime with a gold-backed
US dollar replacing the British pound. The
challenge was to devise an operative international
finance architecture out of fiat currencies
anchored to a gold-backed dollar to accommodate
postwar international trade.
On August 14,
1941, some fours months before the Japanese attack
on Pearl Harbor, the United States, not yet at
war, issued jointly with a Britain - already at
war with Germany - the Atlantic Charter, which set
out a postwar world vision as an unspoken
condition for a pending US alliance with Britain.
Among other provisions, the Atlantic Charter
emphasized British commitment to postwar
international cooperation, including support for
US efforts to form a United Nations based on the
principle of self-determination for former
colonies. Six months later, in February 1942,
barely two months after the Pearl Harbor attack,
under the Lend-Lease Agreement, Britain agreed to
a postwar multilateral payments system in exchange
for US commitment to help Britain financially
during and after the war.
Four months
after the declaration of the Atlantic Charter, on
Sunday, December 14, 1941, one week after the
Pearl Harbor attack, while the US was mobilizing
for all-out war, treasury secretary Henry
Morgenthau was busy figuring out how to finance
the war. He asked White to prepare a
monetary-stabilization plan that would include all
the Allies, while Britain was also busy with its
own plan. One crucial difference between the US
plan by White and the British plan by John Maynard
Keynes was that the Stabilization Fund (SF)
proposed by the US was to be based on a mixed bag
of national currencies, while the Clearing Union
(CU) proposed by Britain was to operate with a new
international currency to be known as the bancor.
The CU also had less strict rules than did the SF
for its use by countries with balance-of-payments
deficits.
The US was concerned about its
own potential financial liability about the rights
of creditor countries with balance-of-payments
surpluses, which at that time meant only the
United States. The US team voiced serious
reservations about the British/Keynes plan, which
had liberal liquidity provisions and ready access
to liquidity for countries with temporary trade
deficits. Britain anticipated huge wartime
deficits as revenue from many parts of the British
Empire was suddenly interrupted.
In
addition, the White plan contemplated the
forbiddance of exchange-rate intervention, an
important feature for the United States, whereas
the Keynes plan did not put much emphasis on
limits on exchange-rate intervention and even
advocated the use of capital controls for the
weaker economies, of which Britain expected to
become one in the course of the war. Britain
imposed exchange control soon after the war began
and kept it for four decades until the new
Conservative government abolished exchange control
in 1979.
The pre-1979 controls on direct
investment restricted sterling-financed foreign
investment except where it had a positive effect
on the balance of payments. With respect to
portfolio investment, the controls stipulated that
purchase by United Kingdom residents of foreign
exchange to invest overseas could be made only
from the sale of existing foreign securities or
from foreign-currency borrowing. A third element
of the controls restricted the holding by UK
residents of foreign-currency deposits as well as
sterling lending to overseas residents.
The 1944-45 international conference at
Bretton Woods, New Hampshire, was attended by
representatives of 44 governments who agreed on "a
framework for economic cooperation partly designed
to avoid a repetition of the disastrous economic
policies that had contributed to the Great
Depression of the 1930s" and which led to a
further eclipse of a British Empire already
weakened by World War I.
British
resistance, with US support, to a geopolitical
challenge to its crumbling empire from rising
powers such as Japan and Germany in the 1930s
eventually led to World War II, which was a
geopolitical contest between competing powers that
morphed into an ideological contest between
democracy and fascism, an image created by
Anglo-US propaganda as a high-principle pretext to
marshal domestic political support for war.
While constantly vowing in private that
Britain did not go to war merely to give the
empire away, prime minister Winston Churchill
cleverly referred in public to the Allies as "the
democracies", to appease historical US
anti-colonial ideology. Churchill neutralized the
isolationist elite in the United States by
appealing to the anti-communist right in US
politics with conservative rhetoric in his
spirited speeches. Taking advantage of a common
language, Churchill's ringing speeches sounded
inspiring to the US public just as Adolf Hitler's
firebrand speeches inspired the Austrians.
Churchill's protective posture toward
fascist Spain illustrates his ambivalence toward
fascism. On June 19, 1945, at the San Francisco
Conference, the United Nations, a reincarnation of
the Allied Powers, voted unanimously to exclude
Francisco Franco's fascist Spain. Then, at the
Potsdam Conference later that summer, Soviet
leader Josef Stalin proposed a worldwide total
boycott of fascist Spain, and that the Allies
break diplomatic relations with Madrid and aid the
"democratic opposition" within Spain.
US
president Harry Truman was in favor, which was the
only time he and Stalin ever agreed on anything,
but Churchill opposed the idea, pointing out that
Britain had strong trade links with Spain that a
postwar Britain could not afford to break and that
"interference in the internal affairs of other
states was contrary to the United Nations
Charter". Churchill was counting on the Spanish
fascists to keep the communists from gaining back
Spain, lost in the Civil War through Third Reich
help to Franco.
The Soviet Union, while
wanting to appear to be associated with plans
being fashioned at Bretton Woods out of a desire
to be perceived as a participating world power,
showed little enthusiasm for monetary cooperation
with US capitalism. Soviet economists were not
interested in capitalist world trade and they
lacked sufficient theoretical sophistication to
understand the subtleties between the contested
proposals in capitalist economies. The USSR agreed
to send a technical observer delegation to the
Bretton Woods conference without the commissar of
finance.
Britain, concerned with
preserving its special economic relationship with
members of the Commonwealth, reorganized from a
collapsed empire, also said it would not send
cabinet-level officials to the conference. Both
Britain and the Soviet Union asserted that
participation in the conference in no way
foreclosed their option to reject eventual
membership in the proposed International Monetary
Fund.
The Bretton Woods conference,
predominantly a US-run show, produced an
international financial regime that set the value
of the US dollar at one-35th of an ounce of gold,
with all other currencies of other participating
nations set at fixed exchange rates to the dollar
that were not expected to fluctuate beyond a
narrow range of 1% from unruly market forces.
Foreign-exchange control between borders was
strictly enforced. Official exchange rates were
determined by economic fundamentals and were
expected to change only fundamentally, but not
temporarily because of speculative forces, because
trade was supposed to increase wealth for all
trading nations proportionately and was not
expected to alter their relative wealth.
Cross-border flows of funds were not
considered by then-prevalent trade-economics
theories as either necessary for trade or
desirable for domestic development. All members of
the United Nations were eligible to join, provided
they were committed both to eliminating controls
over foreign-exchange transactions and to
establishing fixed exchange rates, to be altered
only with the consent of the Fund.
Trade,
though not unimportant, was considered to have
only a supplementary function in a nation's
economy, the main economic functions being in
domestic economic development. A weak domestic
economy could not possibly be expected to solve
its problems through trade alone. National
economic development was the goal of every nation,
with trade being conducted only for auxiliary
purposes. This was just common sense, for no
nation would tolerate or could afford a sustained
trade deficit. Trade among nations either had to
be balanced or trade would soon stop until
temporary trade deficits were eliminated. If every
national economy were to seek growth only through
exports, the aggregate effect for the world
economy would be negative.
While World War
II was a global conflict between the Allies and
the Axis powers, a parallel undercurrent financial
war was waged between the two leading allies.
British historian Robert Skidelsky in his
three-volume biography of John Maynard Keynes
writes of the relationship between Keynes, who
represented Britain, and White, who represented
the US at Bretton Woods, as a "battle between the
two ... one of the grand political duels of the
Second World War, though it was largely buried in
financial minutiae".
He sees the
differences as the result of US malevolence:
"Harry Dexter White of the US Treasury wanted to
cripple Britain in order to clear the ground for a
postwar American-Soviet alliance." Later, in the
Joseph McCarthy era, White was accused unfairly of
having been a communist, on flimsy circumstantial
evidence, notwithstanding that in the 1920s, every
thinking individual on the US cultural scene was
to some degree sympathetic to communism. Critics
on the right in the United States at the time saw
Bretton Woods as an attempt to "set up a
super-national Brains Trust which is to think for
the world and plan for the world, and to tell the
governments of the world what to do", wrote
Skidelsky.
After the Dunkirk evacuation,
when the badly mauled British military retrieved
its expeditionary force of 300,000 by the skin of
their teeth with the use of civilian small boats,
the British had to make a choice: either to lose
the military war to Germany as France did, or to
lose the financial war to the United States.
Churchill chose losing to the US, based on the
time-honored strategic theory of keeping distant
allies to oppose nearby enemies.
Churchill
was out-and-out pro-US, with his American mother
and close connection to the US moneyed elite. This
policy was not unanimously supported by all in
Britain, the Duke of Windsor being a prominent
example. But Churchill's choice turned out to be
the only sensible option, with Canada dominated by
the US and Singapore, Malaysia, British Borneo,
India and Australia threatened by a hostile Japan,
an ally of Germany.
Moving US General
Douglas MacArthur from embarrassing defeat by the
Japanese in the Philippines to Australia cemented
British-US interests in Asia and saved the United
States from an unthinkable disgrace of having a
top general surrender to what was commonly
considered by US sentiment as an inferior race.
Since 1941, Britain had been holding up a
stiff-upper-lip facade, pretending to remain a
world power in its de facto role of a US client
state, a mere water boy on a powerful team. It did
get some benefits from the Cold War, which was in
no small way engineered by Churchill, exploiting
the insecurity and paranoia of Truman to keep a
crippled Britain a minor player in the power game
of global geopolitics.
Bretton Woods
called for a Bank for Reconstruction (now known as
the World Bank) to finance investment in the
postwar era, and an International Stabilization
Fund to repair the flaws in the inter-war gold
standard. This was to make explicit and to enforce
the rules of behavior expected of trading nations,
to manage exchange rates, to assist in resolving
temporary balance-of-payments problems (the key
operative word is "temporary", ie, not
persistent), to encourage tariff reduction and
free trade, and to control destabilizing movements
of "hot money" across national borders, as in
Mexico in 1995 and in Asia in 1997.
Keynes
saw payments imbalance as a problem for both
surplus and deficit countries, both of which
needed to be encouraged to change their domestic
policies, not rely on changing exchange rates to
paper over unsustainable imbalances. White,
representing the US, which anticipated huge trade
surpluses, saw a balance-of-payments deficit as
the problem that the countries running the deficit
need to correct by changing their domestic
policies.
John Maynard Keynes, father of
Keynesianism, which became the theoretical fuel
for US president Franklin Roosevelt's New Deal,
and by 1941 an adviser to the British Treasury,
came to Washington that July, some six months
before the Pearl Harbor attack, to discuss with US
officials the conditions for US wartime financial
aid to Britain. The State Department gave him a
draft agreement for defense aid that would include
a provision for postwar arrangements in which
there would be no discrimination by the United
States or the United Kingdom against imports from
any other country. This provision upset Keynes,
because it meant abolishing the British imperial
preference system that had been negotiated in
Ottawa with the members of the Commonwealth in
1932.
Keynes, who had been working and
writing on monetary and exchange-rate problems
since World War I and who had come to prominence
after that war with his criticisms of the
reparations provisions of the Treaty of
Versailles, was inclined, however, to look with
favor on the benefits of stabilizing exchange
rates. Keynes believed that it was possible and
desirable to have a high degree of exchange-rate
stability without the rigidity of classical gold
standard.
Thus US and UK officials had a
common starting point. Keynes, however, worried
that the US might return to the pre-New Deal
deflationary policies of the 1930s, and so favored
a plan that would give the UK freedom to pursue
domestic full-employment policies without having
to be concerned about the impact on the resultant
UK balance of payments.
The policy
struggle between Keynes and White was geopolitical
in a world of finance capitalism where national
wealth determined national power more than the
reverse, as in the age of imperialistic
mercantilism. The subtle economics difference
between the two plans represented a huge gulf
geopolitically. The Keynes plan fit the need of a
financially drained British Empire upon which the
sun was about to set while the White plan fit the
needs of a financially well-heeled US about to
inherit the Earth.
British imperial
conservatives believe that the US during World War
II provided aid to Britain on measly terms
guaranteed to destroy Britain as a super power.
Skidelsky writes of financial war as the
"intensity and often bitterness of the struggle
between Britain and America for postwar position
which went on under the facade of the Grand
Alliance. When the European war started, Britain,
not Germany, was seen by most American leaders as
America's chief rival." He writes of how
"Churchill fought to preserve Britain and its
Empire against Nazi Germany. Keynes fought to
preserve Britain as a Great Power against the
United States. The war against Germany was won;
but, in helping to win it, Britain lost both
Empire and greatness."
He writes of how it
was a tragedy that Hitler's being "in charge of a
great nation ... threw Britain into the arms of
America as a suppliant, and therefore subordinate:
a subordination masked by the illusion of a
'special relationship'". Skidelsky saw that the
British government's "underlying belief that the
New World had to be yoked ... to the Old" led to
"the deference Britain paid to America's wishes
... and its failure to exploit crucial elements in
its bargaining position - like fighting a more
limited war, or even making a separate peace with
Germany."
Declassified documents on
wartime Allied summits provide substantial
evidence to support Skidelsky's observations.
Until his untimely death, Roosevelt was on a
collision course with Churchill on the "good"
war's objective vis-a-vis British colonialism. It
was not until Truman replaced Roosevelt as
president that US policy accepted British
insistence on the preservation of the British
Empire as a war aim, in the name of
anti-global-communism. This policy change greatly
limited US options in developing a viable postwar
foreign policy toward new emerging nations of the
Third World, and this limitation eventually led to
the Vietnam War by indiscriminately equating Third
War nationalism with communism.
The idea
that the United States should help Britain fight
to defeat a tyranny, not to preserve an empire,
was an embarrassing self-deception. The US only
declared war on Germany after Japan attacked Pearl
Harbor, Hawaii. German tyranny had by then been
going on for a number of years.
Kristallnacht, "the Night of Broken Glass",
took place on November 9-10, 1938, a year before
Britain and France declared war on Germany on
September 3, 1939, and three years before the US
entered the war. During Kristallnacht more
than 7,500 Jewish shops were destroyed and 400
synagogues were burned to the ground all over
Germany.
Ninety-one Jews were killed and
an estimated 20,000 were sent to concentration
camps, which until that time had been mainly for
non-Jewish political prisoners. Prominent
Americans were actively against US involvement in
Europe and many were actively pro-Germany until
after the Pearl Harbor attack.
World War
II was a conflict of geopolitical interests among
great powers. The "struggle against tyranny" image
was an afterthought moral icing on the
geopolitical cake. The "good war" was especially
good for the US economy.
After World War
II, Britain was still saddled with many of the
costs of empire while losing most of the benefits.
Colonial natives soon converged on the British
Isles to take advantage of liberal social programs
originally designed for native Britons - free
health care and generous unemployment benefits.
Even wealthy Third World elites would send their
children to Britain for fancy orthodontic work and
their pregnant mistresses to give birth in London
hospitals, all for free, plus a British passport
for the newborn, not to mention generous welfare
payments for the unwed mother.
Aside from
the pride of being on the "winning" side, Britain
got pitifully few tangible benefits from the war.
London and other industrial cities had suffered
severe damage from Luftwaffe air raids and the
country had in reality been an occupied territory
by US forces after 1942.
The other
disadvantage was that unlike Japan and Germany,
Britain actually still had a performing democracy
at the end of the war, though hardly a working
one. This prevented the British communists from
any real prospect of coming to power and thus did
not rate serious US attention. Unlike Germany and
Japan, on which much US aid was driven by the US
fixation on anti-communism, Britain had an
anti-communist Labour government, the worst of all
possible combinations in terms of the postwar US
geopolitical agenda. While the US hated and feared
communists, it had even less respect for the
social democrats in the Labour Party.
The
US was set to teach European social democrats a
lesson, and the British Empire was taken over by
the United States in the name of
communist-containment, with the pretense that
British Labour was not trustworthy on the
ideological struggle. Then there was the brain
drain to the US, and the overvalued pound sterling
devastated British trade. For five decades after
World War II, British ingenuity expressed itself
in pop culture rather than in independent national
revival strategy.
Immigrants from the
Commonwealth did not catch on until years later
that they could get free rides on the welfare
programs in Britain originally designed to serve
only UK residents with money collected before the
war from distant parts of the empire. But the
programs put in place by the Labour government
stayed operative long after the administration of
prime minister Clement Atlee, until the
Conservative Margaret Thatcher came to power. Not
only Third World residents but US residents did
the same thing.
Fulbright exchange
students selected Britain mostly for its medical
benefits for all residents regardless of
citizenship. The returned US students taught their
friends how to vacation in the United Kingdom for
free dental work and childbirths. Socialism cannot
work unless all who draw from the system also pay
into the system. The residual effects of a
collapsed empire were used by Thatcher to prove
that social welfare did not work.
The
collapse of the Bretton Woods regime US
president Richard Nixon's 1971 declaration "we are
all Keynesians now" had the effect of rendering
modern Keynesians monetarists, ending four decades
of polarity in economics between Keynesianism and
monetarism. The reason modern Keynesianism cannot
avoid monetarism is the collapse of Bretton Woods
in 1971, which exacerbated the monetary
implications of fiscal policy. Any government
today trying to repeat US president John Kennedy's
1960 New Economy of tax cuts and fiscal spending
will face a market assault on its currency. That
is, any government except the US, because of
dollar hegemony.
Nixon's declaration
served to cover up the impact of his historic
abandonment of the Bretton Woods regime of gold
standard/fixed exchange rates on August 15, 1971,
a date that marked the end of US dominance of
world finance derived from the strength of its
monetary system, and put the US on a slippery
slope of currency manipulation through dollar
hegemony. To compensate for removing the dollar
from its gold throne, Nixon imposed ineffective
wage/price controls to arrest domestic inflation,
which was really an institutional measure rather
than a Keynesian one. The net result was that
while wages were kept from rising legitimately,
prices rose in the black or gray market that came
into existence because of price-induced shortages.
Paul Volcker, Nixon's Treasury under
secretary for monetary policy and international
affairs, at first reassured foreign central
bankers and finance ministers that the United
States was merely looking for a "breathing space"
to reconstruct an orderly monetary system. Later,
Volcker admitted that the breakdown of Bretton
Woods was a failure of US leadership and
self-discipline to rein in US financial excesses.
With the collapse of the Bretton Woods
regime, for the first time in the post-World War
II economic order, inflation became exportable
because of cross-border flows of funds, and the
way to fight inflation was to force down wages in
the exporting economies. A government willing to
dilute the value of its currency by inflation
could gain windfalls at the expense of its trading
partners by temporary currency-exchange-rate and
pricing advantages. With unregulated global
foreign-exchange markets in the 1990s, the US was
eventually able to maintain a strong dollar
without merit, through the residual historical
geopolitical arrangement of denominating oil
(black gold) in dollars.
With dollar
hegemony, this temporary advantage became
permanent for the United States. It was able to
devalue its currency domestically while keeping it
strong in relation to other currencies. The boom
in the US economy was being financed by deflation
in the economies of its trading partners.
At Bretton Woods, Harry Dexter White used
the gold-backed dollar to appropriate a century of
British financial hegemony and to use the
gold-backed US dollar as a disciplinary device to
punish dishonest fiat currencies of countries that
ran recurring deficits. It is ironic that by the
1990s, the dollar had become the dishonest fiat
currency used by globalized currency markets to
punish honest fiat currencies of countries that
had accumulated surpluses.
Milton Friedman
applauded the fall of the Bretton Woods regime in
1991, since he and other conservative monetarists
of the Chicago School saw floating exchange rates
as an excellent "laissez-faire" free-market
solution, notwithstanding that events have since
shown that currency markets, manipulated by hedge
funds that created recurring financial crises
around the globe, are anything but "free".
Friedman, father of modern monetarism, saw
the development of foreign-exchange markets as
forcing the US Federal Reserve to focus on the one
thing it allegedly could control: the domestic
money supply. Friedman was fixated on the truism
of the theory and not particularly concerned with
the practical effects on the economy from the
violent volatility in interest rates that a steady
money supply would generate.
Volcker, as
Fed chairman, influenced by a Friedman, who had
been buoyed by a general wave of conservatism into
guru status among ideologue monetarists, adopted
in 1980 a "new operating method" for the Fed as a
therapeutic thunderbolt on Wall Street, which
seemed to have lost faith in the Fed's political
will to control inflation.
The new
operating method, by concentrating on monetary
aggregates, ie, money supply, and letting it
dictate interest-rate swings within a range from
13-19%, to be authorized by the Federal Open
Market Committee (FOMC), was an exercise in
"creative uncertainty" to disrupt the financial
market's complacency about interest-rate stability
or gradualism, which was widely perceived as the
key Fed policy objective. There had been a
traditional expectation that even if the Fed were
to raise rates, it would do so at a gradual pace
to avoid causing the market to become volatile.
The expectation of interest-rate gradualism was
again justified by the Fed's most recent "measured
paced" approach to interest-rate hikes in the
final year of Greenspan's watch.
Volcker's
failed monetary experiment in 1980 forced the Fed
back on its old path: focusing on interest rates
and not money supply, and ironically to vow again
to focus on the long term. To avoid total economic
collapse, the Fed had no choice but to maintain
interest-rate gradualism over aggregate money
stability that came with the unbearable price of
interest-rate volatility.
For the long
term, money supply was the correct barometer,
while interest-rate policy was the appropriate
tool for the short term. Since interest-rate
volatility is unavoidable, the compromise is to
make the change in rates gradual to reduce the
volatility. But gradualism prolongs a short-term
solution into a long-term cure, thus neutralizing
the effectiveness of interest-rate policy as a
short-term tool. That is the real conundrum of
interest-rate policy, not the inverse yield curve
as Greenspan suggests.
The surviving
Bretton Woods twins Two related
super-national institutions were organized by the
US-sponsored Bretton Woods conference: the
International Monetary Fund (IMF) and the
International Bank for Reconstruction and
Development (IBRD), more commonly known as the
World Bank. Both institutions have been dominated
by the US since their inception, as the United
Nations has been. Together, these two
super-national agencies helped build the US global
financial empire through world trade conducted
under the auspices of the World Trade
Organization, the rules of which are set by the
strong, well-developed economies to the
disadvantage of the weak, developing economies.
The IMF world view is expressed by its
official statement of its function:
During that decade [1930s], as
economic activity in the major industrial
countries weakened, countries attempted to
defend their economies by increasing
restrictions on imports; but this just worsened
the downward spiral in world trade, output, and
employment. To conserve dwindling reserves of
gold and foreign exchange, some countries
curtailed their citizens' freedom to buy abroad,
some devalued their currencies, and some
introduced complicated restrictions on their
citizens' freedom to hold foreign exchange.
These fixes, however, also proved
self-defeating, and no country was able to
maintain its competitive edge for long. Such
"beggar-thy-neighbor" policies devastated the
international economy; world trade declined
sharply, as did employment and living standards
in many countries.
This of course is a
free-trade view favored by the dominant economies,
such as prewar Britain and the postwar US.
Among the official purposes of the IMF
are: to promote exchange stability, to maintain
orderly exchange arrangements among members, and
to avoid competitive exchange depreciation; to
assist in the establishment of a multilateral
system of payments in respect of current
transactions between members and in the
elimination of foreign exchange restrictions that
hamper the growth of world trade; to give
confidence to members by making the general
resources of the Fund temporarily available to
them under adequate safeguards, thus providing
them with opportunity to correct maladjustments in
their balance of payments without resorting to
measures destructive of national or international
prosperity.
Only 29 of the 43 conference
participants signed the IMF's Articles of
Agreement in 1945 because many governments saw
Bretton Woods as a US-British condominium, with
Britain ceding many of its prewar financial
hegemonic privileges to the US in exchange for
being allowed to stay in the game. Thus when the
US forced Japan and Germany to accept the Plaza
Accord of 1985 to revalue the yen and the mark
respectively, it amounted to forcing a
"competitive exchange depreciation" of the dollar,
in violation of IMF principle.
The
overvaluation of the dollar in the 1980s was the
result of Federal Reserve policy under Volcker,
not of policies of the central banks of Germany or
Japan. Similarly, pressure on China in recent
years to revalue the yuan amounted to a comparable
violation of the same IMF principles. The fall in
the purchasing power of the dollar was the result
of Fed policy under Alan Greenspan, and the
unwarranted strength of the dollar exchange rate
reflects the effects of dollar hegemony
constructed by Robert Rubin, US treasury secretary
under president Bill Clinton.
Unlike the
IMF, whose function was to promote international
trade with a currency-stabilizing fund, the
official function of the World Bank was to promote
long-term economic development, including
financing of infrastructure projects, such as
road-building and improving water supply. The
so-called Bretton Woods twins, the IMF and the
World Bank, because of critical noises made by
Joseph Stiglitz, a former World Bank chief
economist who had been forced out by US treasury
secretary Lawrence Summers, appeared to be at odds
in their policy focus. But this was mere sibling
rivalry.
In late 1995, in the face of
threats from the US Congress to cut US
contributions to the bank, the World Bank embarked
on a high-profile advertising campaign to
underline its importance to the economies of donor
countries. The World Bank announced that it
"doesn't just lend money; it helps developing
countries become tomorrow's markets". The US was
getting back from the World Bank more than what it
put in, so the argument went.
Social
welfare has transformed into corporate welfare,
with the World Bank clinging to the party line
that what is good for Northern industry is also
good for the poor of the South. The Summers'
infamous World Bank memo, in which he, as the
United States' chief economist, argued that the
export of pollution to poor countries represented
"immaculate" economic logic because Third World
lives were worth less, is a classic example of
warped neo-liberal mentality.
The amount
of money the World Bank is throwing in the
direction of the private sector and its new belief
that corporations can handle development on their
own, without government involvement, is manifested
in the bank's shift from project lending to
"policy" lending in the form of loans for removing
trade barriers, privatizing government-owned
companies and restructuring whole sectors of the
economy to allow the entry of transnational
corporations from the advanced economies.
Private-sector projects have weaker information
and disclosure policies, less accountability and
less stringent environmental policies than
public-sector projects.
For example, the
World Bank has been one of the most powerful
forces behind genetic erosion around the world for
the past 50 years. This devastation has resulted
from a wide range of activities in most of the
sectors at the bank - in particular, agriculture,
energy, forestry, infrastructure and industry. In
the 1950s, the bank's agricultural focus was on
cash crops (such as cacao, rubber and palm oil),
which started the decline of diversity in farming
systems and the crops themselves.
When the
Ford Motor Co fell into decline after founder
Henry Ford's death in 1947, it was "saved" by the
"Whiz Kids" who managed to turn the company back
toward profits by producing the worst cars in the
industry through the application of a systems
approach to management in which the quality and
safety of a product was only a tradeoff component
in the quest for profitability.
The Whiz
Kids were led by Robert S McNamara, who went on to
mislead US president Lyndon Johnson into the
Vietnam War quagmire as the secretary of defense
who promised to win an unwinnable war by
committing more and more troops and money, after
which he went on to become president of the World
Bank (1968-81) with equally disastrous impact on
the world's poor. McNamara's top-down anti-poverty
strategy accelerated a process of agricultural
modernization and integration into the global
market that increased inequality, exacerbated
poverty and had a devastating impact on
biodiversity and the environment.
Ambitious land-clearing and settlement
projects were another important component of the
World Bank's purported poverty-alleviation
strategy in the McNamara era. These often involved
the decimation of vast areas of prime biodiversity
habitats, particularly tropical rainforests. For
example, in the 1970s, the bank approved a series
of loans that cleared 526,000 hectares, or 6.5%,
of Malaysia's rainforests, mainly to install
mono-cultural plantations for the production of
palm oil. Such areas experienced dramatic losses
in biodiversity: in one fell swoop, diversity
plummeted from thousands of species per hectare to
a single lonely palm tree. All told, plantation
forestry systems cover some 15 million hectares
today, and they are still expanding.
These
kinds of escapades continued into the 1980s.
Brazil's infamous Polonoreste agricultural
development program, funded by the World Bank to
the tune of $443 million, singlehandedly increased
the deforestation of the Brazilian Amazon from
1.7% in 1978 to 16.1% in 1991. More than half the
loans financed the paving of a 1,500-kilometer
dirt track through the rainforests of Rondnia.
Most of the rest went into constructing feeder and
access roads, and the establishment of 39 rural
settlement centers to consolidate and attract
settlers who were to raise tree crops (mainly
cocoa and coffee) for export. Instead of the tens
of thousands of settlers anticipated, half a
million arrived in the space of five years.
Agricultural extension services and credit
never materialized and resettlement officials were
overwhelmed. To survive, the settlers tried,
largely unsuccessfully, to grow crops such as
rice, beans and corn (maize) in the poor soils,
which would become exhausted in a year or two.
Slash-and-burn went completely out of control, as
the settlers were constantly forced to move on.
The impact on the fragile rainforest environment
was of course devastating. By the mid-1980s, the
burning of Rondnia was identified by the US
National Aeronautics and Space Administration as
the single largest, most rapid human-caused change
on Earth visible from space.
Indonesia's
Transmigration program had an equally devastating
impact on both biological and cultural diversity.
Between 1976 and 1986 the World Bank lent $630
million to support the movement of millions of
Javanese people to outlying islands. In addition,
it provided $734 million for agricultural
development, which either did not materialize or
was used to provide rice that people tried, and
failed, to grow in totally inappropriate
environments, razing the environment in the
process. By the late 1980s, transmigration was
responsible for deforestation rates in the fragile
forests of the outer islands reaching a rate of
5,000 square kilometers a year.
The
results of the program were particularly
devastating in Irian Jaya, now called West Papua,
one of the world's great reservoirs of biological
and cultural diversity. Here, transmigration was
little more than an attempt to "Javanize" what the
authorities viewed as backward and disrespectful
ethnic groups. The original plan was to match the
1 million ethnic people, belonging to numerous
tribal groups speaking more than 200 languages,
with 1 million Javanese. This target was never
actually reached because the program proved so
disastrous, but transmigration did have its
desired effect in decimating Papua's social and
cultural fabric.
In the wake of the World
Bank's advertising campaign, the US Treasury
subsequently issued a report demonstrating that in
just two years (1993-95), the World Bank and other
multinational development banks had channeled
nearly $5 billion of contracts to US firms. One
major beneficiary was Cargill, the third-largest
food corporation in the world. Cargill's 1995-96
sales were a mind-boggling $56 billion, which is
roughly equivalent to the gross national product
of Pakistan, Venezuela or the Philippines. Company
earnings reached almost $1 billion and profits
were 34% higher than in the previous year.
Next: The US-China trade
imbalance
Henry C K Liu is
chairman of a New York-based private investment
group. His website is atHenryCKLiu.com
.
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