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The coming trade war and global depression
By Henry C K Liu
Many historians have suggested that the 1929 stock market crash was not the
cause of the Great Depression. If anything, the 1929 crash was the technical
reflection of the inevitable fate of an overblown bubble economy. Yet stock
market crashes can recover within a relatively short time with the help of
effective government monetary measures, as
demonstrated by the crashes of 1987 (23% drop, recovered in nine months), 1998
(36% drop, recovered in three months) and 2002 (37% drop, recovered in two
months).
There was no quick recovery after the 1929 crash. Structurally, what made the
Great Depression last for more than a decade from 1929 until the US entry into
World War II in 1941 were the 1930 Smoot-Hawley tariffs, which put world trade
into a tailspin from which it did not recover until the war began. While the US
economy finally recovered through war mobilization after the Japanese attack on
Pearl Harbor, Hawaii, on December 7, 1941, most of the world's market economies
sank deeper into war-torn distress and did not fully recover until the Korean
War boom in 1951.
Barely five years into the 21st century, with a globalized neo-liberal trade
regime firmly in place in a world where market economy has become the norm,
trade protectionism appears to be fast re-emerging and developing into a new
global trade war of complex dimensions. The irony is that this new trade war is
being launched not by the poor economies that have been receiving the short end
of the trade stick, but by the US, which has been winning more than it has been
losing on all counts from globalized neo-liberal trade, with the European Union
following suit in lockstep. Japan, of course, has never let up on protectionism
and never taken competition policy seriously. The rich nations need to
recognize that their efforts to squeeze every last drop of advantage out of
already unfair trade will only plunge the world into deep depression. History
has shown that while the poor suffer more in economic depressions, the rich,
even as they are financially cushioned by their wealth, are hurt by political
repercussions in the form of either war or revolution, or both.
Cold War and moral imperative
During the Cold War, there was no international free trade. The economies of
the two contending ideology blocs were completely disconnected. Within each
bloc, economies interacted through foreign aid and memorandum trade from their
respective superpowers. The competition was not for profit but for the hearts
and minds of the people in the two opposing blocs, as well as those in the
non-aligned nations in the Third World. The competition between the two
superpowers was to give rather than to take from their separate fraternal
economies.
The population of the superpowers worked hard to help the poorer people within
their separate blocs, and convergence toward equality was the policy aim even
if not always the practice. The Cold War era of foreign aid and memorandum
trade had a better record of poverty reduction in both camps than post-Cold War
globalized neo-liberal trade dominated by one single superpower. The aim was
not only to raise income and increase wealth, but also to close income and
wealth disparity between and within economies. Today, income and wealth
disparity is rationalized as a necessity for capital formation. The New York
Times reports that from 1980 to 2002, the total income earned by the top 0.1%
of earners in the United States more than doubled, while the share earned by
everyone else in the top 10% rose far less and the share of the bottom 90%
declined.
For all its ill effects, the Cold War achieved two formidable ends: it
prevented nuclear war and it introduced development as a moral imperative into
superpower geopolitical competition with rising economic equality within each
bloc. In the years since the end of the Cold War, nuclear terrorism has emerged
as a serious threat and domestic development is preempted by global trade, even
in the rich economies, while income and wealth disparity has widened
everywhere.
Since the end of the Cold War some 15 years ago, world economic growth has
shifted to rely exclusively on globalized neo-liberal trade engineered and led
by the US as the sole remaining superpower, financed with the US dollar as the
main reserve currency for trade and anchored by the huge US consumer market
made possible by the high wages of US workers. This growth has been sustained
by knocking down national tariffs everywhere around the world through
supranational institutions such as the World Trade Organization (WTO), and
financed by a deregulated foreign-exchange market working in concert with a
global central-banking regime independent of local political pressure, lorded
over by the supranational Bank of International Settlement (BIS) and the
International Monetary Fund (IMF).
Redefining humanist morality, the United States asserts that world trade is a
moral imperative and as such trade promotes democracy, political freedom and
respect for human rights in trade participating nations. Unfortunately, income
and wealth equality is not among the benefits promoted by trade. Even if the
validity of this twisted ideological assertion is not questioned, it clearly
contradicts the US practice of trade embargo against countries Washington deems
undemocratic, lacking in political freedom and deficient in respect for human
rights. If trade promotes such desirable conditions, the practice of linking
trade to freedom is tantamount to denying medicine to the sick.
US President George W Bush defends his free-trade agenda in moralistic terms.
"Open trade is not just an economic opportunity, it is a moral imperative," he
declared in a May 7, 2001, speech. "Trade creates jobs for the unemployed. When
we negotiate for open markets, we're providing new hope for the world's poor.
And when we promote open trade, we are promoting political freedom." Such
claims remain highly controversial when tested by actual data.
Phyllis Schlafly, a syndicated conservative columnist, responded three weeks
later in an article "Free trade is an economic issue, not a moral one". In it,
she noted that while conservatives should be happy finally to have a president
who added a moral dimension to his actions, "the Bible does not instruct us on
free trade and it's not one of the Ten Commandments. Jesus did not tell us to
follow Him along the road to free trade ... Nor is there anything in the US
constitution that requires us to support free trade and to abhor protectionism.
In fact, protectionism was the economic system believed in and practiced by the
framers of our constitution. Protective tariffs were the principal source of
revenue for our federal government from its beginning in 1789 until the passage
of the 16th Amendment, which created the federal income tax, in 1913. Were all
those public officials during those hundred-plus years remiss in not adhering
to a "moral obligation" of free trade?" Hardly, argued Schlafly, whose views
are noteworthy because US politics is currently enmeshed in a struggle between
strict-constructionist paleo-conservatives and moral-imperialist
neo-conservatives. Despite the ascendance of neo-imperialism in US foreign
policy, protectionism remains strong in US political culture, particularly
among conservatives and in the labor movement.
Bush also said China, which reached a trade agreement with the United States at
the close of the administration of his predecessor Bill Clinton, and became a
member of the WTO in late 2001, would benefit from political changes as a
result of liberalized trade policies. This pronouncement gives clear evidence
to those in China who see foreign trade as part of an anti-China "peaceful
evolution" strategy first envisaged by John Forster Dulles, US secretary of
state under president Dwight Eisenhower in the 1950s. It is a strategy of
inducing through peaceful trade the Chinese Communist Party (CCP) to reform
itself out of power and to eliminate the dictatorship of the proletariat in
favor of bourgeois liberalization. Almost four decades later, Deng Xiaoping
criticized CCP chairman Hu Yaobang and premier Zhao Ziyang for having failed to
contain bourgeois liberalization in their implementation of China's
modernization policy. Deng warned in November 1989, five months after the
Tiananmen incident: "The Western imperialist countries are staging a third
world war without guns. They want to bring about the peaceful evolution of
socialist countries towards capitalism." Deng's handling of the Tiananmen
incident prevented China from going the catastrophic route of the USSR, which
dissolved in 1991.
Hostility in the name of 'freedom'
Yet it is clear that political freedom is often the first casualty of a
garrison-state mentality and such mentality inevitably results from hostile
economic and security policy toward any country the US deems as not free.
Whenever the US pronounces a nation to be not free, that nation will become
less free as a result of US policy. This has been repeatedly evident in China
and elsewhere in the Third World. Whenever US policy toward China turns
hostile, as it currently appears to be heading, political and press freedoms
inevitably face stricter curbs. For trade mutually and truly to benefit the
trading economies, three conditions are necessary: 1) the de-linking of trade
from ideological/political objectives, 2) maintenance of equality in the terms
of trade and 3) recognition that global full employment at rising, living wages
is the prerequisite for true comparative advantage in global trade.
The developing rupture between the sole superpower and its traditionally
deferential allies lies in mounting trade conflicts. The United States has
benefited from an international financial architecture that gives the US
economy a structural monetary advantage over those of the EU and Japan, not to
mention the rest of the world. Trade issues range from government-subsidy
disputes between Airbus and Boeing to those regarding bananas, sugar, beef,
oranges and steel, as well as disputes over fair competition associated with
mergers and acquisition and financial services. If either government is found
to be in breach of WTO rules when these disputes wind through long processes of
judgment, the other will be authorized to retaliate. The US could put tariffs
on other European goods if the WTO rules against Airbus and vice versa. So if
both governments are found in breach, both could retaliate, leading to a cycle
of offensive protectionism. When the US was ruled to have unfairly supported
its steel industry, tariffs were slapped by the EU on Florida oranges to make a
political point in a politically important state in US politics.
Trade competition between the EU and the US is spilling over into security
areas, allowing economic interests to conflict with ideological sympathy. Both
of these production engines, saddled with serious overcapacity, are desperately
seeking new markets, which inevitably leads them to Asia in general and China
in particular, with its phenomenal growth rate and its 1.2 billion eager
consumers bulging with rapidly rising disposable income. The growth of the
Chinese economy will lift all other economies in Asia, including Australia,
which has only recently begun to understand that its future cannot be separated
from its geographic location and that its prosperity is interdependent with
those of other Asia-Pacific economies. Australian iron ore and beef and dairy
products are destined for China, not the British Isles. The EU is eager to lift
its 15-year-old arms embargo on China, much to the displeasure of the US.
Israel, with its close relations with the US, faces a similar dilemma on
military sales to China.
Even the US defense establishment has largely come around to the view that the
US arms industry must export, even to China, to remain on top. It was reported
recently that US Defense Secretary Donald Rumsfeld tried to sell to Thailand
F-16 warplanes capable of firing advanced medium-range air-to-air missiles two
days after he lashed out in Singapore at China for upgrading its own military
when no neighboring nations are threatening it (see
Rumsfeld pitches in for F-16s, June 9).
The sales pitch was in competition with Russian-made Sukhoi Su-30s and Swedish
JAS-39s. The open competition in arms export had been spelled out for the US
Congress years earlier by Donald Hicks, a leading Pentagon technologist in the
administration of president Ronald Reagan. "Globalization is not a policy
option, but a fact to which policymakers must adapt," he said. "The emerging
reality is that all nations' militaries are sharing essentially the same global
commercial-defense industrial base." The boots and uniforms worn by US soldiers
in Afghanistan and Iraq were made in China.
The widening wealth gap
The WTO is the only global international organization dealing with the rules of
trade among its 148 member nations. At its heart are the WTO agreements, known
as the multilateral trading system, negotiated and signed by the majority of
the world's trading nations and ratified in their parliaments. The stated goal
is to help producers of goods and services, exporters and importers conduct
their business, with the dubious assumption that trade automatically brings
equal benefits to all participants. The welfare of the people is viewed only as
a collateral aim based on the doctrinal fantasy that "balanced" trade
inevitably brings prosperity equally to all, a claim that has been contradicted
by facts produced by the very terms of trade promoted by the WTO itself.
Two decades of neo-liberal globalized trade have widened income and wealth
disparity within and between nations. Free trade has turned out not to be the
win-win game promised by neo-liberals. It is very much a win-lose game, with
heads, the rich economies win, and tails, the poor economies lose. Domestic
development has been marginalized as a hapless victim of foreign trade,
dependent on trade surplus for capital. Foreign trade and foreign investment
have become the prerequisite engines for domestic development. This trade model
condemns those economies with trade deficits to perpetual underdevelopment.
Because of dollar hegemony, all foreign investment goes only to the export
sector where US dollars can be earned. Even the economies with trade surpluses
cannot use their dollar trade earnings for domestic development, as they are
forced to hold huge dollar reserves to support the exchange rate of their
currencies.
In the fifth WTO ministerial conference held in Cancun, Mexico, in September
2003, the richer countries rejected the demands of poorer nations for radical
reform of agricultural subsidies that have decimated Third World agriculture.
Failure to get the Doha Round back on track after the collapse of Cancun runs
the danger of a global resurgence of protectionism, with the US leading the
way. Larry Elliott reported on October 13, 2003, in The Guardian on the failed
2003 Cancun ministerial meeting: "The language of globalization is all about
democracy, free trade and sharing the benefits of technological advance. The
reality is about rule by elites, mercantilism and selfishness." Elliot noted
that the process is full of paradoxes: why is it that in a world where human
capital is supposed to be the new wealth of nations, labor is treated with such
contempt?
Sam Mpasu, Malawi's commerce and industry minister, asked at Cancun for his
comments about the benefits of trade liberalization, replied dryly: "We have
opened our economy. That's why we are flat on our back." Mpasu's comments
summarized the wide chasm that divides the perspectives of those who write the
rules of globalization and those who are powerless to resist them.
Exports of manufactures by low-wage developing countries have increased rapidly
over the past three decades due in part to falling tariffs and declining
transport costs that enable outsourcing based on wage arbitrage. It grew from
25% in 1965 to nearly 75% over three decades, while agriculture's share of
developing-country exports has fallen from 50% to less than 10%. Many
developing countries have gained relatively little from increased manufactures
trade, with most of the profit going to foreign capital. Market access for
their most competitive manufactured export, such as textiles and apparel,
remains highly restricted, and recent trade disputes threaten further
restrictions. Still, the key cause of unemployment in all developing economies
is the trade-related collapse of agriculture, exacerbated by the massive
government subsidies provided to farmers in rich economies. Many poor economies
are predominantly agriculturally based and a collapse of agriculture means a
general collapse of the whole economy.
The Doha Development Agenda negotiations, sponsored by the WTO, collapsed in
Cancun over the question of government support for agriculture in rich
economies and its potential impacts on causing more poverty in developing
countries. Negotiations since Cancun have focused on the need to understand
better the linkages between trade policies, particularly those of the rich
economies, and poverty in the developing world. While poverty reduction is now
more widely accepted by establishment economists as a necessary central focus
for development efforts and has become the main mission of the World Bank and
other development institutions, very few effective measures have been
forthcoming.
The UN Millennium Development Goals (UNMDG) commit the international community
to halving world poverty by 2015, a decade from now. With current trends, that
goal is likely to be achievable only through the death of half of the poor by
starvation, disease and local conflicts. The UN Development Program warns that
3 million children will die in sub-Saharan Africa alone by 2015 if the world
continues on its current path of failing to meet the UNMDG agreed to in 2000.
Several key avenues to this goal supposedly lie in international trade, but the
record of poverty reduction has been exceedingly poor, if not outright
negative. The fundamental question whether trade can replace or even augment
socio-economic development remains unasked, let alone answered. Until such
issues are earnestly addressed, protectionism will re-emerge in the poor
countries. Under such conditions, if democracy expresses the will of the
people, democracy will demand protectionism more than government by elite.
While tariffs in the past decade have been coming down like leaves in autumn,
flexible exchange rates have become a form of virtual countervailing tariff. In
the current globalized neo-liberal trade regime operating in a deregulated
global foreign-exchange market, the exchanged value of a currency is regularly
used to balance trade through government intervention in currency-market
fluctuations against the world's main reserve currency - the US dollar, as the
head of the international monetary snake.
Purchasing power parity (PPP) measures the disconnection between exchange rates
and local prices. PPP contrasts with the interest rate parity (IRP) theory,
which assumes that the actions of investors, whose transactions are recorded on
the capital account, induce changes in the exchange rate. For a dollar investor
to earn the same interest rate in a foreign economy with a PPP of four times,
such as the purchasing power parity between the US dollar and the Chinese yuan,
local wages would have to be at least four times (75%) lower than US wages. PPP
theory is based on an extension and variation of the "law of one price" as
applied to the aggregate economy.
The law of one price says that identical goods should sell for the same price
in two separate markets when there are no transportation costs and no
differential taxes applied in the two markets. But the law of one price does
not apply to the price of labor. Price arbitrage is the opposite of wage
arbitrage in that producers seek to make their goods in the lowest wage
locations and to sell their goods in the highest price markets. This is the
incentive for outsourcing, which never seeks to sell products locally at prices
that reflect PPP differentials. What is not generally noticed is that price
deflation in an economy increases its PPP, in that the same local currency buys
more. But the cross-border one-price phenomenon applies only to certain
products, such as oil, thus for a PPP of four times, a rise in oil prices will
cost the Chinese economy four times the equivalent in other goods, or wages,
than in the US. The larger the purchasing power parity between a local currency
and the dollar, the more severe is the tyranny of dollar hegemony on forcing
down wage differentials.
The origins and effects of dollar hegemony
Ever since 1971, when US president Richard Nixon, under pressure from
persistent fiscal and trade deficits that drained US gold reserves, took the
dollar off the gold standard (at US$35 per ounce), the dollar has been a fiat
currency of a country of little fiscal or monetary discipline. The Bretton
Woods Conference at the end of World War II established the dollar, a solid
currency backed by gold, as a benchmark currency for financing international
trade, with all other currencies pegged to it at fixed rates that changed only
infrequently. The fixed-exchange-rate regime was designed to keep trading
nations honest and prevent them from running perpetual trade deficits. It was
not expected to dictate the living standards of trading economies, which were
measured by many other factors besides exchange rates. Bretton Woods was
conceived when conventional wisdom in international economics did not consider
cross-border flow of funds necessary or desirable for financing world trade,
precisely for this reason. Since 1971, the dollar has changed from a
gold-backed currency to a global reserve monetary instrument that the US, and
only the US, can produce by fiat. At the same time, the US has continued to
incur both current-account and fiscal deficits.
That was the beginning of dollar hegemony. With deregulation of
foreign-exchange and financial markets, many currencies began to free-float
against the dollar, not in response to market forces but to maintain export
competitiveness. Government interventions in foreign-exchange markets became a
regular last-resort option for many trading economies for preserving their
export competitiveness and for resisting the effect of dollar hegemony on
domestic living standards.
World trade under dollar hegemony is a game in which the US produces paper
dollars and the rest of the world produces real things that paper dollars can
buy. The world's interlinked economies no longer trade to capture comparative
advantage; they compete in exports to capture needed dollars to service
dollar-denominated foreign debts and to accumulate dollar reserves to sustain
the exchange value of their domestic currencies in foreign-exchange markets. To
prevent speculative and manipulative attacks on their currencies in deregulated
markets, the world's central banks must acquire and hold dollar reserves in
corresponding amounts to market pressure on their currencies in circulation.
The higher the market pressure to devalue a particular currency, the more
dollar reserves its central bank must hold. This creates a built-in support for
a strong dollar that in turn forces all central banks to acquire and hold more
dollar reserves, making it stronger. This anomalous phenomenon is known as
dollar hegemony, which is created by the geopolitically constructed peculiarity
that critical commodities, most notably oil, are denominated in dollars.
Everyone accepts dollars because dollars can buy oil. The denomination of oil
in dollars and the recycling of petro-dollars is the price the US has extracted
from oil-producing countries for US tolerance of the oil-exporting cartel since
1973.
By definition, dollar reserves must be invested in dollar-denominated assets,
creating a capital-accounts surplus for the US economy. A strong-dollar policy
is in the US national interest because it keeps US inflation low through
low-cost imports and it makes US assets denominated in dollars expensive for
foreign investors. This arrangement, which Federal Reserve Board chairman Alan
Greenspan proudly calls US financial hegemony in congressional testimony, has
kept the US economy booming in the face of recurrent financial crises in the
rest of the world. It has distorted globalization into a "race to the bottom"
process of exploiting the lowest labor costs and the highest environmental
abuse worldwide to produce items and produce for export to US markets in a
quest for the almighty dollar, which has not been backed by gold since 1971,
nor by economic fundamentals for more than a decade. The adverse effects of
this type of globalization on the developing economies are obvious. It robs
them of the meager fruits of their exports and keeps their domestic economies
starved for capital, as all surplus dollars must be reinvested in US treasuries
to prevent the collapse of their own domestic currencies.
The adverse effect of this type of globalization on the US economy is also
becoming clear. In order to act as consumer of last resort for the whole world,
the US economy has been pushed into a debt bubble that thrives on conspicuous
consumption and fraudulent accounting. The unsustainable and irrational rise of
US equity and real-estate prices, unsupported by revenue or profit, has meant a
de facto devaluation of the dollar. Ironically, the recent fall in US equity
prices from their 2004 peak and the anticipated fall in real-estate prices
reflect a trend to an even stronger dollar, as the same amount of dollars can
buy more deflated shares and properties. The rise in the purchasing power of
the dollar inside the United States impacts its purchasing-power disparity with
other currencies unevenly, causing sharp price instability in the economies
with freely exchangeable currencies and fixed exchange rates, such as Hong Kong
and until recently Argentina. For the US, a falling exchange rate of the dollar
actually causes asset prices to rise. Thus with a debt bubble in the US
economy, a strong dollar is not in the US national interest. Debt has turned US
policy on the dollar on its head.
The setting of exchange values of currencies is practiced not only by sovereign
governments on their own currencies as a sovereign right. The US, exploiting
dollar hegemony, usurps the privilege of dictating the exchange value of all
foreign currencies to support its own economic nationalism in the name of
global free trade. And the US position on exchange rates has not been
consistent. When the dollar was rising, as it did in the 1980s, the US, to
protect its export trade, hailed the stabilizing wisdom of fixed exchange
rates. When the dollar falls as it has been in recent years, the US, to deflect
blame for its trade deficit, attacks fixed exchange rates as currency
manipulation, as it now targets China's currency, which has been pegged to the
dollar for more than a decade. How can a nation manipulate the exchange value
of its currency when it is pegged to the dollar at the same rate over long
periods? Any manipulation came from the dollar, not the yuan.
Economic nationalism
The recent rise of the euro against the dollar, the first appreciation wave
since its introduction on January 1, 2002, is the result of an EU version of
the 1985 Plaza Accord on the Japanese yen, albeit without a formal accord. The
strategic purpose is more than merely moderating the US trade deficit. The
record shows that even with a 30% drop of the dollar against the euro, the US
trade deficit continued to climb. The strategic purpose of driving up the euro
is to reduce it to the status of the yen, as a subordinated currency to dollar
hegemony. The real effect of the Plaza Accord was to shift the cost of support
for the dollar-denominated US trade deficit, and the socio-economic pain
associated with that support, from the United States to Japan. What is
happening to the euro now is far from being the beginning of the demise of the
dollar. Rather, it is the beginning of the reduction of the euro into a
subservient currency to the dollar to support the US debt bubble.
Six and a half years since the launch of the European Monetary Union, the
eurozone is trapped in an environment in which monetary policy of sound money
has in effect become destructive and supply-side fiscal policy unsustainable.
National economies are beginning to refuse to bear the pain needed for
adjustment to globalization or the EU's ambitious enlargement. The European
nations are beginning to resist the US strategy to make the euro economy a
captive supporter of a rising or falling dollar as such movements fit the
shifting needs of US economic nationalism.
It is the modern-day monetary equivalent of the brilliant Roman strategy of
making a dissident Jew a Christian god to preempt Judaism's rising cultural
domination over Roman civilization. Roman law, the foundation of the Roman
Empire, gained in sophistication from being influenced by, if not directly
derived from, Jewish Talmudic law, particularly on the concept of equity - an
eye for an eye. The Jews had devised a legal system based on the dignity of the
individual and equality before the law four centuries before Christ. There was
no written Roman law until two centuries before Christ. The Roman law of obligatio
was not conducive to finance as it held that all indebtedness was personal,
without institutional status. A creditor could not sell a note of indebtedness
to another party and a debtor did not have to pay anyone except the original
creditor. Talmudic law, on the other hand, recognized impersonal credit, and a
debt had to be paid to whoever presented the demand note. This was a key
development of modern finance. With the Talmud, the Jews under the Diaspora had
an international law that spanned three continents and many cultures.
The Romans were faced with a dilemma. Secular Jewish ideas and values were
permeating Roman society, but Judaism was an exclusive religion that the Romans
were not permitted to join. The Romans could not assimilate the Jews as they
did the Greeks. Early Christianity also kept its exclusionary trait until Paul,
who opened Christianity to all. Historian Edward Gibbon (1737-94) noted that
Rome recognized the Jews as a nation who as such were entitled to religious
peculiarities. The Christians, on the other hand, were a sect and, being
without a nation, subverted other nations. The Roman Jews were active in
government and, when not resisting Rome against social injustice, fought side
by side with Roman legionnaires to preserve the empire. Roman Jews were good
Roman citizens. By contrast, the early Christians were social dropouts, refused
responsibility in government and civic affairs and were conscientious objectors
and pacifists in a militant culture. Gibbon noted that Rome felt that the crime
of a Christian was not in what he did, but in being who he was.
Christianity gained control of Roman culture and society long before
Constantine, who in AD 324 sanctioned it with political legitimacy and power
after recognizing its power in helping to win wars against pagans, as pope
Urban II in 1095 used the Crusade to prolong papal temporal power. When early
Christianity, a secular Jewish dissident sect, began to move up from the lower
strata of Roman society and began to find converts in the upper echelons, the
Roman polity adopted Christianity, the least objectionable of all Jewish sects,
as a state religion. Gibbon estimated that Christians killed more of their own
members over religious disputes in the three centuries after coming to secular
power than did the Romans in three previous centuries. Persecution of the Jews
began in Christianized Rome. The disdain held by early Christianity for
centralized government gave rise to monasticism and contributed to the fall of
the Roman Empire.
By allowing a trade surplus denominated in dollars to be accumulated by
non-dollar economies such as the yen, euro, or now the Chinese yuan, the cost
of supporting the appropriate value of the US dollar to sustain perpetual
economic growth in the dollar economy is then shifted to these non-dollar
economies, which manifest themselves in perpetual relative low wages and weak
domestic consumption. For the already high-wage EU and Japan, the penalty is
the reduction of social-welfare benefits and job security traditional to these
economies. China, now the world's second-largest creditor nation, it is reduced
to having to ask the US, the world's largest debtor nation, for capital
denominated in dollars the US can print at will to finance its export trade to
a US running recurring trade deficits.
Market impotence against trade imbalance
The IMF, which has been ferocious in imposing draconian fiscal and monetary
"conditionalities" on all debtor nations everywhere in the decade after the
Cold War, is nowhere to be seen on the scene in the world's most fragrantly
irresponsible debtor nation. This is because the US can print dollars at will
and with immunity. The dollar is a fiat currency not backed by gold, not backed
by US productivity, not backed by US export prowess, but backed by US military
power. The US military budget request for Fiscal Year 2005 is $420.7 billion.
For Fiscal Year 2004, it was $399.1 billion; for 2003, $396.1 billion; for
2002, $343.2 billion; and for 2001, $310 billion. In the first term of George W
Bush's presidency, the US spent $1.5 trillion on its military. That is more
than the entire gross domestic product of China in 2004. The US trade deficit
is about 6% of its GDP, while it military budget is about 4%. In other words,
the trading partners of the US are paying for one and a half times the cost of
a military that can some day be used against any one of them for any number of
reasons, including trade disputes. The anti-dollar crowd has nothing to
celebrate about the recurring US trade deficit.
It is pathetic that Rumsfeld tries to persuade the world that China's military
budget, which is less that one-tenth of that of the United States, is a threat
to Asia, even when he is forced to acknowledge that Chinese military
modernization is mostly focused on defending its coastal territories, not on
force projection for distant conflicts, as is US military doctrine. While
Rumsfeld urges more political freedom in China, his militant posture toward
China is directly counterproductive toward that goal. Ironically, Rumsfeld
chose to make his case about political freedom in Singapore, the bastion of
Confucian authoritarianism.
Normally, according to free-trade theory, trade can only stay unbalanced
temporarily before equilibrium is re-established or free trade would simply
stop. When bilateral trade is temporarily unbalanced, it is generally because
one trade partner has become temporarily uncompetitive, inefficient or
unproductive. The partner with the trade deficit receives more goods and
services from the partner with the trade surplus than it can offer in return
and thus pays the difference with its currency that someday can buy foods
produced by the deficit trade partner to re-established balance of payments.
This temporary trade imbalance can be due to a number of socio-economic
factors, such as terms of trade, wage levels, return on investment, regulatory
regimes, shortages in labor or material or energy, trade-supporting
infrastructure adequacy, purchasing power disparity, etc. A trading partner
that runs a recurring trade deficit earns the reputation of being what banks
call a habitual borrower, ie, a bad credit risk, one that habitually lives
beyond its means. If the trade deficit is paid with its currency, a downward
pressure results in the exchange rate. A flexible exchange rate seeks to remove
or moderate a temporary trade imbalance while the productivity disparities
between trading partners are being addressed fundamentally.
Dollar hegemony prevents US trade imbalance from returning to equilibrium
through market forces. It allows a US trade deficit to persist based on
monetary prowess. This translates over time into a falling exchange rate for
the dollar even as dollar hegemony keeps the fall at a slow pace. But a
below-par exchange rate over a long period can run the risk of turning the
temporary imbalance in productivity into a permanent one. A continuously
weakening currency condemns the issuing economy into a downward economic
spiral. This has happened to the United States in the past decade. To make
matters worse, with globalization of deregulated markets, the recurring US
trade deficit is accompanied by an escalating loss of jobs in sectors sensitive
to cross-border wage arbitrage, with the job-loss escalation climbing up the
skill ladder. Discriminatory US immigration policies also prevent the retention
of low-paying jobs within the US and exacerbate the illegal-immigration
problem.
Regional wage arbitrage within the US in past decades kept its economy lean and
productive internationally. Labor-intensive US industries relocated to the
low-wage south of the country through regional wage arbitrage, and despite
temporary adjustment pains from the loss of textile mills, the northern
economies managed to upgrade their productivity, technology level, financial
sophistication and output quality. The economies in the southern US also
managed to upgrade these factors of production and in time managed to narrow
the wage disparity within the national economy. This happened because the jobs
stayed within the nation. With globalization, it is another story. Jobs are
leaving the United States mercilessly. According to free-trade theory, the US
trade deficit is supposed to cause the dollar to fall temporarily against the
currencies of its trading partners, causing export competitiveness to
rebalance, thereby removing or reducing the US trade deficit. Jobs that have
been lost temporarily are then supposed to return to the US.
But the persistent US trade deficit defies trade theory because of dollar
hegemony. The broad trade-weighted dollar index stays in an upward trend,
despite selective appreciation of some strong currencies, as highly indebted
emerging market economies attempt to extricate themselves from
dollar-denominated debt through the devaluation of their currencies. While the
aim is to subsidize exports, this ironically makes dollar debts more expensive
in local-currency terms. The moderating impact on US price inflation also
amplifies the upward trend of the trade-weighted dollar index despite
persistent US expansion of monetary aggregates, also known as monetary easing
or money printing.
Adjusting for this debt-driven increase in the exchange value of dollars, the
import volume into the US can be estimated in relationship to expanding
monetary aggregates. The annual growth of the volume of goods shipped to the
United States has remained around 15% for most of the 1990s, more than five
times the average annual GDP growth. The US enjoyed a booming economy when the
dollar was gaining ground, and this occurred at a time when interest rates in
the US were higher than those in its creditor nations. This led to the odd
effect that raising interest rates actually prolonged the boom in the US rather
than threatened it, because it caused massive inflows of liquidity into the US
financial system, lowered import-price inflation, increased apparent
productivity and prompted further spending by American consumers enriched by
the wealth effect despite a slowing of wage increases. Returns on dollar assets
stayed high in foreign-currency terms.
This was precisely what Greenspan did in the 1990s in the name of preemptive
measures against inflation. Dollar hegemony enabled the US to print money to
fight inflation, causing a debt bubble of asset appreciation. These data
substantiated the view of the US as Rome in a New Roman Empire with an unending
stream of imports as the free tribute from conquered lands. This was what
Greenspan meant by US "financial hegemony".
The Fed Funds Rate (FFR)target has been lifted eight times in steps of 25 basis
points from 1% in mid-2004 to 3% on May 3, 2005. If the same pattern of
"measured pace" continues, the FFR target would be at 4.25% by the end of 2005.
Despite Fed rhetoric, the lifting of dollar interest rates has more to do with
preventing foreign central banks from selling dollar-denominated assets, such
as US Treasuries, than with fighting inflation. In a debt-driven economy, high
interest rates are themselves inflationary. Raising interest rates to fight
inflation could become the monetary dog chasing its own interest-rate tail,
with rising rates adding to rising inflation, which then requires more
interest-rate hikes. Still, interest-rate policy is a double edged sword: it
keeps funds from leaving the debt bubble, but it can also puncture the debt
bubble by making the servicing of debt prohibitively expensive.
To prevent this last adverse effect, the Fed adds to the money supply, creating
an unnatural condition of abundant liquidity with rising short-term interest
rates, resulting in a narrowing of interest spread between short-term and
long-term debts, a leading indication for inevitable recession down the road.
The problem of adding to the money supply is what John Maynard Keynes called
the liquidity trap, that is, an absolute preference for liquidity even at
near-zero interest-rate levels. Keynes argued that either a liquidity trap or
interest-insensitive investment draft could render monetary expansion
ineffective in a recession. It is what is popularly called pushing on a credit
string, where ample money cannot find creditworthy willing borrowers. Much of
the new low-cost money tends to go to refinancing existing debt taken out at
previously higher interest rates. Rising short-term interest rates,
particularly at a measured pace, would not remove the liquidity trap while
long-term rates stay flat because of excess liquidity.
The debt bubble in the US is clearly having problems, as evident in the bond
market. With just 14 deals worth $2.9 billion, May 2005 was the slowest month
for high-yield bond issuance since October 2002. The late-April downgrades of
the debt of General Motors and Ford Motor to junk status roiled the bond
markets. The number of high-yield, or junk-bond, deals fell 55% in the
March-to-May 2005 period compared with the same three months in 2004. They were
also down 45% from the December-through-February period. In dollar value,
junk-bond deals totaled $17.6 billion in the March-to-May 2005 period, compared
with $39.5 billion during the same three months in 2004 and $36 billion from
December 2004 through February 2005. There were 407 deals of investment-grade
bond underwriting during the March-to-May 2005 period, compared with 522 in the
same period 2004 - a decline of 22%. In dollar volume, some $153.9 billion of
high-grade bonds were underwritten from March to May 2005, compared with $165.5
billion in the same period in 2004 - a 7% decline.
Oil at $50 a barrel, along with astronomical asset-price appreciation,
particularly in real estate, is giving the debt bubble additional borrowed
time. But this game cannot go on forever and the end will likely be triggered
by a new trade war's effect on reduced trade volume. The price of a reduced US
trade deficit is the bursting of the US debt bubble, which could plunge the
world economy into a new depression. Given such options, the United States has
no choice but to ride the trade-deficit train for as long as the traffic will
bear, which may not be too long, particularly if protectionism begins to gather
force.
The transition to offshore outsourced production has been the source of the
productivity boom of the "New Economy" in the US in the past decade. The
productivity increase not attributable to the importing of other nations'
productivity is much less impressive. While published government figures of the
productivity index show a rise of nearly 70% since 1974, the actual rise is
between zero and 10% in many sectors if the effect of imports is removed from
the equation. The lower productivity values are consistent with the real-life
experience of members of the blue-collar working class and the white-collar
middle class who have been spending the equity cash-outs from the appreciated
market value of their homes. World trade has become a network of cross-border
arbitrage on differentials in labor availability, wages, interest rates,
exchange rates, prices, saving rates, productive capacities, liquidity
conditions and debt levels. In some of these areas, the US is becoming an
underdeveloped economy.
The Bush administration continues to assure the US public that the state of the
economy is sound while in reality the country has been losing entire sectors of
its economy, such as manufacturing and information technology, to foreign
producers, while at the same time selling off part of the nation to finance its
rising and unending trade deficit. Usually, when unjustified confidence crosses
over to fantasized hubris on the part of policymakers, disaster is not far
ahead.
The Clinton legacy
To be fair, the problems of the US economy started before the
administration of George W Bush. The Clinton administration's annual economic
report for 2000 claimed that the longest economic expansion in US history could
continue "indefinitely" as long as "we stick to sound policy", according to
chairman Martin Baily of the Council of Economic Advisers (CEA) as reported in
the Wall Street Journal. A New York Times report differed somewhat by quoting
Baily as saying: "stick to fiscal policy." Putting the two newspaper reports
together, one got the sense that the Clinton administration thought its fiscal
policy was the sound policy needed to put an end to the business cycle.
Economics high priests in government, unlike the rest of us mortals who are
unfortunate enough to have to float in the daily turbulence of the market, can
afford to focus aloofly on long-term trends and their structural congruence to
macro-economic theories. Yet outside of macro-economics, "long-term" is
increasingly being redefined in the real world. In the technology and
communication sectors, "long-term" evokes periods lasting less than five years.
For hedge funds and quant shops, long-term can mean a matter of weeks.
Two factors were identified by the Clinton CEA Year 2000 economic report as
contributing to the "good" news - technology-driven productivity and
neo-liberal trade globalization. Even with somewhat slower productivity and
spending growth, the CEA believed the economy could continue to expand
perpetually. As for the huge and growing trade deficit, the CEA expected global
recovery to boost demand for US exports, not withstanding the fact that most US
exports are increasingly composed of imported parts.
Yet the United States has long officially pursued a strong-dollar policy that
weakens world demand for US exports. The high expectation on e-commerce was a
big part of optimism, which had yet to be substantiated by data. In 2000, the
CEA expected the business to business (B2B) portion of e-commerce to rise to
$1.3 trillion by 2003 from $43 billion in 1998. Goldman Sachs claimed in 1999
that B2B e-commerce would reach $1.5 trillion by 2004, twice the size of the
combined 1998 revenues of the US auto industry and the US telecom sector.
Others were more cautious. Jupiter Research projected that companies around the
globe would increase their spending on B2B e-marketplaces from US$2.6 billion
in 2000 to only $137.2 billion by 2005 and spending in North America alone
would grow from $2.1 billion to only $80.9 billion. North American companies
accounted for 81% of the total spending in 1998, but by 2005, that figure was
expected to drop to 60% of the total. The fact of the matter is that Asia and
Europe are now faster growth markets for communication and technology.
Reality proved disappointing. A 2004 UN Conference on Trade and Development
(UNCTAD) report said that in the United States, e-commerce between enterprises,
which in 2002 represented almost 93% of all e-commerce, accounted for 16.28% of
all commercial transactions between enterprises. While overall transactions
between enterprises (e-commerce and non e-commerce) fell in 2002, e-commerce
B2B grew at an annual rate of 6.1%. As for business-to-consumer (B2C)
e-commerce, UNCTAD reported that sales in the first quarter of 2004 amounted to
1.9% of total retail sales, a proportion nearly twice as large as that recorded
in 2001. The annual rate of growth of retail e-commerce in the US in the year
to the end of the first quarter of 2004 was 28.1%, while the growth of total
retail in the same period was only 8.8%. Dow Jones reported on May 20, 2005,
that first-quarter retail e-commerce sales in the US rose 23.8% compared with
the year-ago period to $19.8 billion from $16 billion, according to preliminary
numbers released by the Department of Commerce. E-commerce sales during the
first quarter rose 6.4% from the fourth quarter, when they were $18.6 billion.
Sales for all periods are on an adjusted basis, meaning the Commerce Department
adjusts them for seasonal variations and holiday and trading-day differences
but not for price changes.
E-commerce sales accounted for 2.2% of total retail sales in the first quarter
of 2005, when those sales were an estimated $916.9 billion, according to the
Commerce Department. Wal-Mart, the low-priced retailer that imports outsourced
goods from overseas, grew only 2%, indicating spending fatigue on the part of
low-income US consumers, while Target Stores, the upscale retailer that also
imports outsourced goods, continued to grow at 7%, indicating the effects of
rising income disparity.
The CEA 2000 report did not address the question of whether e-commerce was
merely a shift of commerce or a real growth. The possibility exists for the new
technology to generate negative growth. It happened to IBM - the increased
efficiency (lower unit cost of calculation power) of IBM big frames actually
reduced overall IBM sales, and most of the profit and growth in personal
computers went to Microsoft, the software company that grew on business that
IBM, a self-professed hardware manufacturer, did not consider worthy of keeping
for itself. The same thing happened to Intel, where in 1965 company co-founder
Gordon Moore observed an exponential growth in the number of transistors per
integrated circuit and predicted that this trend would continue the doubling of
transistors every couple of years. But what this so-called Moore's Law did not
predict was that this growth of computing power per dollar would cut into
company profitability. As the market price of computer power continues to fall,
the cost to producers to achieve Moore's Law has followed the opposite trend:
research and development, manufacturing, and test costs have increased steadily
with each new generation of chips. As the fixed cost of semiconductor
production continues to increase, manufacturers must sell larger and larger
quantities of chips to remain profitable. In recent years, analysts have
observed a decline in the number of "design starts" at advanced process nodes.
While these observations were made in the period after the year 2000 economic
downturn, the decline may be evidence that the long-term global market cannot
economically sustain Moore's Law. Is the Google bubble a replay of the AOL
fiasco?
Joseph Alois Schumepter's creative destruction theory, while revitalizing the
macro-economy with technological obsolescence in the long run, leaves real
corporate bodies in its path, not just obsolete theoretical concepts. Financial
intermediaries and stock exchanges face challenges from electronic
communication networks (ECNs), which may well turn the likes of the New York
Stock Exchange (NYSE) into sunset industries. ECNs are electronic marketplaces
that bring buy/sell orders together and match them in virtual space. Today,
ECNs handle roughly 25% of the volume in Nasdaq stocks. The NYSE and the
Archipelago Exchange (ArcaEx) announced on April 20 that they had entered a
definitive merger agreement that will lead to a combined entity, NYSE Group
Inc, becoming a publicly held company. If approved by regulators, NYSE members
and Archipelago shareholders, the merger will represent the largest-ever among
securities exchanges and combine the world's leading equities market with the
most successful totally open, fully electronic exchange. Through Archipelago,
the NYSE will compete for the first time in the trading of Nasdaq -listed
stocks; it will be able to indirectly capture listings business that otherwise
would not qualify to list on the NYSE. Archipelago lists stocks of companies
that do not meet the NYSE's listing standards.
On fiscal policy, US government spending, including social programs and
defense, declined as a share of the economy during the eight years of the
Clinton watch. This in no small way contributed to a polarization of both
income and wealth, with visible distortions in both the demand and supply sides
of the economy. This was the opposite of the Roosevelt administration's record
of increasing income and wealth equality by policy. The wealth effect tied to
bloated equity and real-estate markets could reverse suddenly and did in 2000,
bailed out only by the Bush tax cut and the deficit spending on the "war on
terrorism" after 2001. Private debt kept hitting all-time highs throughout the
1990s and was celebrated by neo-liberal economists as a positive factor.
Household spending was heavily based on expected rising future earnings or
paper profits, both of which might and did vanish on short notice. By election
time in November 1999, the Clinton economic miracle was fizzling. The business
cycle had not ended after all, and certainly not by self-aggrandizing
government policies. It merely got postponed for a more severe crash later. The
idea of ending the business cycle in a market economy was as much a fantasy as
the assertion by the current vice president, Richard Cheney, in a speech before
the Veterans of Foreign Wars in August 26, 2002, that "the Middle East expert
Professor Fouad Ajami predicts that after liberation, the streets in Basra and
Baghdad are sure to erupt in joy ..."
In their 1991 populist campaign for the White House, Bill Clinton and Al Gore
repeatedly pointed out the obscenity of the top 1% of Americans owning 40% of
the country's wealth. They also said that if you eliminated home ownership and
only counted businesses, factories and offices, then the top 1% owned 90% of
all commercial wealth. And the top 10%, they said, owned 99%. It was a
situation they pledged to change if elected. But once in office, president
Clinton and vice president Gore did nothing to redistribute wealth more equally
- despite the fact that their two terms in office spanned the economic joyride
of the 1990s that would eventually hurt the poor much more severely than the
rich. On the contrary, economic inequality only continued to grow under the
Democrats. Reagan spread the national debt equally among the people while
Clinton gave all the wealth to the rich.
Rising resistance to globalization
Geopolitically, trade globalization was beginning to face complex
resistance worldwide by the second term of the Clinton presidency. The momentum
of resistance after Clinton would either slow further globalization or force
the terms of trade to be revised. The Asian financial crises of 1997 revived
economic nationalism around the world against US-led neo-liberal globalization,
while the North Atlantic Treaty Organization (NATO) attack on Yugoslavia in
1999 revived militarism in the EU. Market fundamentalism as espoused by the
United States, far from being a valid science universally, was increasingly
viewed by the rest of the world as merely US national ideology, unsupported
even by US historical conditions. Just as anti-Napoleonic internationalism was
in essence anti-French, anti-globalization and anti-moral-imperialism are in
essence anti-US. US unilateralism and exceptionalism became the midwife for a
new revival of political and economic nationalism everywhere. The Bush Doctrine
of monopolistic nuclear posture, preemptive wars, "either with us or against
us" extremism, and no compromise with states that allegedly support terrorism
pours gasoline on the smoldering fire of defensive nationalism everywhere.
Alan Greenspan in his October 29, 1997, congressional testimony on "Turbulence
in World Financial Markets" before the Joint Economic Committee said that "it
is quite conceivable that a few years hence we will look back at this episode
[Asian financial crisis of 1997] ... as a salutary event in terms of its
implications for the macro-economy". When one is focused only on the big
picture, details do not make much of a difference: the Earth always appears
more or less round from space, despite that some people on it spend their whole
lives starving and cities get destroyed by war or natural disasters. That is
the problem with macro-economics. As Greenspan spoke, many around the world
were waking up to the realization that the turbulence in their own financial
markets was viewed by the US central banker as having a "salutary effect" on
the US macro-economy. Greenspan gave anti-US sentiments and monetary trade
protectionism held by participants in these financial markets a solid basis and
they were no longer accused of being mere paranoia.
Ironically, after the end of the Cold War, market capitalism has emerged as the
most fervent force for revolutionary change. Finance capitalism became
inherently democratic once the bulk of capital began to come from the pension
assets of workers, despite widening income and wealth disparity. The monetary
value of US pension funds is more than $15 trillion, the bulk of which belongs
to average workers. A new form of social capitalism emerged that would gladly
eliminate the worker's job in order to give him or her a higher return on his
or her pension account. The capitalist in the individual is exploiting the
worker in the same individual. A conflict of interest arises between a worker's
savings and his or her earnings. As Pogo used to say: "The enemy: they are us."
This social capitalism, by favoring return on capital over compensation for
labor, produces overinvestment, resulting in overcapacity. But the problem of
overcapacity can only be solved by high-income consumers. Unemployment and
underemployment in an economy of overcapacity decrease demand, leading to
financial collapse. The world economy needs low wages the way the cattle
business needs foot-and-mouth disease.
The nomenclature of neo-classical economics reflects, and in turn dictates, the
warped logic of the economic system it produces. Terms such as money, capital,
labor, debt, interest, profits, employment, market, etc have been
conceptualized to describe synthetic components of an artificial material
system created by the power politics of greed. It is the capitalist greed in
the worker that causes the loss of his or her job to lower-wage earners
overseas. The concept of the economic man who presumably always acts in his
self-interest is a gross abstraction based on the flawed assumption of market
participants acting with perfect and equal information and clear understanding
of the implication of his actions. The pervasive use of these terms over time
disguises the artificial system as the logical product of natural laws, rather
than the conceptual components of the power politics of greed.
Just as monarchism first emerged as a progressive force against feudalism by
rationalizing itself as a natural law of politics and eventually brought about
its own demise by betraying its progressive mandate, social capitalism today
places return on capital above not only the worker but also the welfare of the
owner of capital. The class struggle has been internalized within each worker.
As people facing the hard choice of survival in the present versus well-being
in the future, they will always choose survival, and social capitalism will
inevitably go the way of absolute monarchism, and make way for humanist
socialism.
Henry C K Liu is chairman of the New York-based Liu
Investment Group.
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