Page 1 of 2 Capitalism at the crossroads
By Chan Akya
It is truism that the world economy now stands at the crossroads, with a system
that brought much prosperity to most parts of the world in the past two
decades, namely the combination of laissez faire capitalism and globalization,
being blamed for a bulk of the world's ills.
Socialists and communists are churning out volume after volume of indictments
on the capitalist system, essentially using the first opportunity in two
decades to vent all of their pent-up frustrations at being marginalized into
obscure think-tanks and regular professorial salaries.
A few weeks ago, when I wrote
Deaf frogs and the pied piper (Asia Times Online, September 30, 2008),
I intended the article as
much a defense of capitalism as a criticism of market intervention by sundry
participants ranging from Asian central banks to credit rating agencies. My
end-of-year article
Ask not for whom the bells toll (Asia Times Online, December, 25, 2008)
took a look at the startling similarities between the runts of the global
markets, namely developing countries, and the apparent safe-haven investments,
namely the developed Group of Seven leading industrialized nations.
In the weeks since then, calls for regulatory and government intervention into
free markets have only intensified; whether related to the bailout of the US
auto industry, Germany's fiscal package aimed at boosting its economy or the
events surrounding the scandal at an Indian computer services company.
Socialists have used these events to triumph the failures of capitalism and the
need for Keynesian intervention in the modern economy.
Paul Krugman at the New York Times goes so far as to use the events of the
current crisis to cast aspersions on the entire Chicago school of economics and
its most notable exponent, namely Milton Friedman. In a recent article he
wrote:
Milton Friedman, in particular, persuaded many economists that
the Federal Reserve could have stopped the Depression in its tracks simply by
providing banks with more liquidity, which would have prevented a sharp fall in
the money supply. Ben Bernanke, the Federal Reserve chairman, famously
apologized to Friedman on his institution's behalf: "You're right. We did it.
We're very sorry. But thanks to you, we won't do it again."
It turns out, however, that preventing depressions isn't that easy after all.
Under Mr Bernanke's leadership, the Fed has been supplying liquidity like an
engine crew trying to put out a five-alarm fire, and the money supply has been
rising rapidly. Yet credit remains scarce, and the economy is still in free
fall.
This is gross misstatement of facts. Credit is very much
being made available by banks to viable corporate entities and individuals
whether in the US, Britain or Japan. However, on a net basis after taking into
account companies and individuals declaring bankruptcy, credit formation is
negative; exactly what you would expect when an economy slides into recession.
People like Krugman criticize the banks for taking government money in the form
of bailouts (which I oppose in any event but that's besides the point in the
current discussion) and then not lending the funds to citizens of that country.
That line of thinking highlights the intellectual pitfalls of these economists,
who fail to understand the difference between the concept of cash as defined by
the money in your pocket and funds as defined by the accounting or book entry
transfers between institutions.
The key factor in the translation of funds to cash is the velocity of money in
the banking system; which declines in a recession. Thus, if an economy has a
velocity of 10x in normal times and has a billion of cash, total fund flows are
10 billion; however, as a recession bites and velocity goes to 3x, then even a
doubling of cash available will not improve the overall monetary situation.
What the US Fed and others have been trying to do is to make good the funds
situation of the banks as the velocity of money drops and leaves various
financial arrangements stranded; this is by no means a way to make cash
available to companies and individuals directly.
You could only count a monetary stimulus when the total utilization of funds in
the economy is higher than previously; this is impossible for the US and other
G-7 economies now, as I argued in various articles over the course of 2008, as
they confront a balance sheet recession. In two articles towards the end of
last year Party's
Over (Asia Times Online, November 14, 2008) and
Party's Beginning (Asia Times Online, November 15, 2008), I laid out my
arguments for the G-7 countries to spend their fiscal stimulus on the parts of
the world with profit potential aligned with demographic realities; namely
developing countries starting with the big Asian nations, such as China.
Far from being a call to Keynesian spending, my argument remains that G-7
governments can actually address their goals of broad economic improvements and
make a profit in the bargain by supporting the consumption ethic in developing
countries. In any event, any activity that is likely to produce a profit
eventually is hardly Keynesian, almost by definition.
Europe in dire straits
Intellectual sophistry of the kind displayed by Krugman will meet its
come-uppance over the course of this year when Europe as a combined entity
falls flat on its face. Much like the most open countries in the continent -
Iceland, Britain and Switzerland - all slid into crisis mode over the course of
2008, this year will bring the decline of the main euro-bloc countries.
In a series of ratings announcements since last week, the much-maligned
agencies have made it clear that a whole raft of European countries - Ireland,
Greece, Spain and Portugal - will likely be downgraded over the next few
months. Others such as Italy are living on borrowed time in any event; leaving
for the moment only Germany and France as stable members of the trading bloc.
On Wednesday (January 14), Ireland announced that a continued worsening of the
economy would push it to call the International Monetary Fund for assistance:
the country nationalized its banking system last year and faces a significant
downturn as its tax-efficient Dublin financial center is hollowed out by
investment losses.
Even Germany and France appear imperiled by the decline in their banking
systems; as well as the first shots of economic stimulus - Germany declared a
50 billion euro (US$66 billion) stimulus package last weekend - are applied to
counteract the scary economic decline. French President Nicolas Sarkozy was
apparently too busy playing geopolitics over the course of 2008 and will now
have to rush various stimulus efforts.
If the interventionist European system was all that superior to laissez faire,
as Sarkozy suggested last year, why then are all these countries in as much if
not more trouble than the United States? My own current state of disenchantment
with the US stems from its apparent abandoning of capitalist principles for the
short-term succor that is offered (but unlikely to be actually delivered) by
socialist intervention.
The effects of this upcoming mess in European finances are visible across the
markets already. Standard & Poor's downgraded Greece by one notch on
Wednesday (January 14) and signified more pain to come in the next few months.
Meanwhile, the first few auctions of government debt in Europe last week proved
quite difficult to sell; indeed, Germany had the dubious distinction of opening
the year with a failed bund auction, when its 6 billion euros (US$8 billion) in
debt offering attracted only around 4 billion euros of demand.
Going forward, various other countries including Spain and Italy are likely to
face investor resistance when they attempt to borrow excessively in the
European bond markets. Even as the European Central Bank pushes interest rates
to zero, we could well see borrowing costs for European governments rising
sharply over the course of this year.
With all the talk of stimulus and intervention, the bald facts are that
taxpayers in the G-7 have neither the current income nor the expectation of
sufficient future income to actually repay all of the new debt being raised to
pay for government intervention. There is unlikely to be adequate profit
generation from these activities to broaden the economic slate or even generate
extra cash flow that can be used later on to repay debt.
Auto industry example
Another favorite talking point of the left wing is the case for intervening in
the auto industry. The argument is that a government that sends a couple of
trillion dollars towards Wall Street can certainly afford a $100 billion
bailout of Detroit. As evidence, these interventionists point to the auto
industries of Europe and Japan, which continue to survive due to heavy
government subsidization and intervention.
Once again though, they have mistaken cause with effect. The travails of
American automakers can be laid at their own doors rather than at those of the
governments in Europe and Japan; which is not to suggest that the latter group
is blameless but that the former group did not function as capitalists should.
An industry rife with overcapacity is most likely to have significant
share-price discounts applied on its valuations even as credit spreads remain
at broadly elevated levels signifying omnipresent
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