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Today's
global economy: as imbalanced as Humpty Dumpty
by Ann Pettifor
Tuesday, 22 June 2004
Intro
Bill Gross is a man who manages $400bn of assets for Pimco, a US investment fund. According to the FT he is known to "move markets". So when he says there is "too much debt, geopolitical risk and several bubbles" in the global economy, and that these have "created a very unstable environment which can turn any minute" (FT 17 June, 2004) - the markets take him seriously. So should we. After all he is echoing the analysis of the new economics foundation's (nef's) current annual report on the global economy - "Real World Economic Outlook: Debt and Deflation - the Legacy of Globalisation"[1].
In that report, we argued that the global economy is at a tipping point; that the imbalances caused by what is celebrated as "globalisation" have rendered our world dangerously unstable.
How did the leading economists and politicians of the day create a world that has become so divided, so unjust, so threatening and unsustainable? What can be done to restore economic balance and stability, or have things gone too far? And what is the link between financial instability, the current international financial architecture and proposals for restoring stability to global climate?
These are the three questions I hope to address in this article.
How did global imbalances come about?
The story goes back some way. We are now living through a third wave of what is euphemistically called, "globalisation". While many of its advocates argue that "there is no alternative" and that "globalisation" cannot be ended abruptly, in fact recent history provides evidence of two such abrupt and very unpleasant endings to periods of financial, trade and labour liberalisation.
The first wave of globalisation was brought to a devastating end by the First World War. Not long after that war, bankers persuaded politicians that it was best to once again remove all constraints on flows of capital and trade; and to tie economies to the "gold standard"[2].
While the gold standard suited the interests of international creditors, it harmed the interests of governments, because it stripped them of key powers (e.g. fixing the exchange rate or the interest rate and being required to lower demand and cut spending to suit the interests of foreign creditors, not domestic priorities). This lack of policy autonomy by governments in turn hurt their voters, ordinary people; those not engaged in international finance and trade. And it exacerbated the democratic deficit, as politicians were more concerned to please international capital markets than domestic electorates. As a result electorates became disillusioned with democratic institutions.
Under the gold standard elections were not easily won by politicians that offered their voters a menu of lower consumption, increased unemployment, cuts in public spending etc. Nevertheless after much bullying by bankers and economists, unwise politicians like Churchill once again bowed to their interests and in 1925 allowed capital to roam free, again under the banner of the "gold standard" tied governments to the interests of international creditors.
The system whereby capital flowed freely, but governments were constrained in their room for manoeuvre, remained in place until the crash of 1929 and the Great Depression of the 1930s. Many believe that it was globalisation that caused the crash, and so the system was once again discredited and brought to an abrupt end. The international financial architecture put in place by bankers had collapsed - for a second time.
In 1944, before the end of a devastating world war, world leaders, and a group of economists including John Maynard Keynes, gathered at Bretton Woods, and vowed, effectively, never to allow the bankers to rule the world again. Instead, they created a new and more stable international financial architecture - the Bretton Woods System. Under this system, Bretton Woods
- imposed controls over the movement of capital - "exchange controls";
- which restored to governments vital powers to fix interest rates and
set exchange rates;
- thereby regaining the initiative for governments, giving them room
for manoeuvre, or policy autonomy;
- encouraged governments to ration foreign imports and balance these
with exports; and
- introduced a system of international co-operation and co-ordination
to ensure that currencies did not drift too far apart in value;
- created the "key-currency standard" whereby, through international co-operation, the dollar helped anchor and co-ordinate the value of world currencies, by linking its value to gold, so each dollar was worth 1/35 of an ounce of gold, or $35 an ounce.
This system, the Bretton Woods System, remained in place for almost 30
years. During that period the world, including continents like Africa,
enjoyed unprecedented economic stability; rising growth in income; expanded
trade, while countries remained in balance. At the same time the world
enjoyed a period of political stability (helped in part by the Cold War).
In the words of the distinguished historian, Barry Eichengreen
"In retrospect, the three decades following World War II seem to have been a golden era of tranquillity in international capital markets, a fulfilment of the benediction "May you live in dull times". …Sovereign defaults and liquidity crises were relatively rare"[3].
The creation of an unstable and unjust international financial architecture.
In the late 1960s, the US began to build up a deficit, as a direct result of military spending on the Vietnam War. As Michael Hudson argues in nef's Real World Economic Outlook,
"If the United States had followed the creditor-oriented rules to which European governments had adhered after the two World Wars, it would have sacrificed its world position. Its gold would have flowed out and Americans would have been obliged to sell off their international investments to pay for military activities abroad. This was what the US officials had demanded of their allies in World Wars I and II, but the United States was unwilling to abide by such rules itself.[4]"
Instead President Nixon in August, 1971, announced unilaterally that the dollar would no longer be linked to gold; and that the US would no longer honour its debts in gold. Instead it would offer its creditors paper money - US dollars. Furthermore it proposed that US Treasury Bills become the new key-currency standard.
As Hudson notes:
"The key-currency standard, based on the dollar's convertibility into gold, was dead. The US Treasury Bill standard - that is the dollar-debt standard based on dollar inconvertibility - was inaugurated."
In other words gold as an asset that governments held as reserves, or exchanged, as payments on debt, were to be supplanted by US Treasury Bills - or US debt.
Today, poor countries like Rwanda or Honduras do not hold gold reserves as an indication of their balance of payments, or relative economic health; nor do they hold gold as a hedge against speculation. Instead they hold US Treasury Bills. These are low-cost loans to the United States - offered at no more than 3% - and hundreds of billions of dollars of these loans are held now by Central Banks around the world, by all countries, including developing countries.
"The largest international flow of fixed-income debt today takes the form of borrowing by the world's richest nations at (probably) negative real interest rates from countries with very large numbers of poor". Larry Summers, Business Times, 09 March 2004.
America now imports half as much again as it exports Not only does it have the biggest deficit run by a G7 economy in the past 30 years, but it needs to raise from abroad an annual $660 billion, or $2 billion a day. America's net foreign liabilities now amount to almost $2.8 trillion, equivalent to 2% of GDP. No wonder it needs to mobilise the savings of foreigners! [5]
Until recently loans to the US, in the form of US Treasury Bills were
regarded as the world's safest investment; the US could always be relied
upon to pay its debts. But as the US deficit has ballooned, so foreign
private investors have lost confidence in the ability of the US to repay
its debts. Commercial investors have withdrawn from the US Treasury Bill
market, which partly explains the fall in the dollar. As a result the
US's debts are today largely financed by the official sector - Central
Banks (backed by taxpayers) - which financed a third of the US's current
account deficit in the first three quarters of 2003. If they had not done
so, a dollar collapse would almost certainly have happened. Instead the
dollar drifted downards by about 14%.
The largest holdings of US Treasury Bills are by Asian Central Banks -
so that it is Asian taxpayers, mainly Japan (which poured $32bn into US
Treasuries in March, 2004), but including the poor taxpayers of India
and China - who today effectively finance the US deficit (and thereby
US consumption). In 2002 and 2003 the gross reserves held by these economies
rose by $718billion. In other words more than $700 billion of their precious
savings and surplus from trade, was transferred to the US in the form
of low-cost loans over two years.
Recently the US administration has encouraged the devaluation of the dollar,
as a way of helping balance its trade books. (A lower dollar makes US
exports more competitive). By doing so, it has effectively cut the value
of the debts (US Treasury Bills) it owes to Asian and other taxpayers.
Nef has calculated that India lost $12 billion in 2003, as a lower dollar
eroded the value of its US Treasury Bill reserves. India is not a country
that can afford to lose $12 billion - money which could have been better
spent on the development of its people.
Why do Asian Central Bankers behave in this way? Partly to avoid the collapse of the US dollar, which would then allow US exports to compete unfairly with Asian exports. Thus does a world of free capital flows end up with governors of Central Banks managing and engineering trade, in order to maintain some stability, and restrain protectionist tendencies back home.
The poor are financing the rich
Because Central Banks operate under conditions of great secrecy these facts are not widely known to the citizens of poor countries - or indeed of rich countries like Japan, the US's biggest creditor. However, they explain in part why the World Bank is concerned that, since 2001
"developing countries have become net lenders to developed countries"[6]. (our italics).
These flows from south to north, from the poor to rich, are not just taken up by the flow of savings or loans to finance US consumption. Poor countries are also transferring debt payments, international corporations are remitting profits to rich countries, and developing countries paying over the odds for imports from rich countries. Furthermore, loose regulation of capital flows ensures "capital flight" from their countries into banks in London, New York and Zurich. But the holding of US Treasury Bills represents a significant proportion of the savings that flow from poor to rich.
The "Hoover" effect
As a result, the international financial architecture created by globalisation's advocates acts as a "hoover" - scooping up wealth from the poorest countries and transferring it to the richest. In other words, instead of capital flowing from where it is plentiful to where it is scarce - or indeed "trickling down" - (something neo-liberals imply is as natural a law of economics as gravity is a law of physics) - capital and wealth is flowing from the poor to the rich.
The imbalances at home
And it is not just doing so at an inter-governmental level. The "hoover effect" works within liberalised economies where the rich, those who own assets, have watched those assets become enormously inflated as a share of GDP (despite the anti-inflationary protestations of orthodox economists and central bankers); while the rest of society, workers, farmers and shop-keepers included, have found their wages, commodities and other prices falling, or deflating, as a share of the whole economy.[7]
The results are everywhere to be seen. The poor are getting poorer, and the rich are getting richer. Worse, the poor are becoming more indebted.
The creation of a credit bubble
By de-regulating capital flows, governments began the process of de-regulating lending and credit. The result is visible everywhere; an explosion of mortgage and credit card credit. The corollary of high levels of credit, are high levels of debt.
Those who do not own assets, like for example, new entrants into the housing market, invariably have to borrow to acquire a home. The state in western economies, has, on the whole (and under pressure from the dominant economic orthodoxy), abandoned its role as a provider of homes to the poor. Thus homes have to be purchased on markets. In the Anglo-American economies, markets in property have become unsustainable bubbles, the bubbles that Bill Gross, the Pimco fund-manager, is so concerned about.
So individual consumers are borrowing - to buy a roof over their heads, to pay for life's necessities as well as life's luxuries. And they have been cheered on in this consumption by Central Bankers and Finance Ministers.
Consumers as heroic as Atlas
Which brings us to one of the most unsustainable aspects of the global economy: its over-reliance on the consumers of the US, Britain, Australia and other economies to spend, spend, spend…. consume, consume, consume.
Like Atlas, individual consumers are propping up their economies - and in turn propping up the global economy - by borrowing and spending.
While some central bankers may tut, tut about this, they all know that without the excessive consumption (and borrowing) of these individuals and households, the global economy would have crashed well before 2004. Thanks to the heavy indebtedness of corporates, that sector has played little part in the post 2001 recovery (which helps to explain the "jobless recovery" in the US). And thanks to strict spending limits imposed by neo-liberal economic dogma, governments have not been able to play a part in stimulating the economy.
So the US and UK economies (which play a large part in the global economy) and which should be supported by the three-legged pillars of the consumer, the corporate and governmental sectors, have instead, over the past few years, been balancing precariously on one leg, that of private consumption.
Sony Kapoor, a consultant to Jubilee Research, has produced figures showing that US consumer spending makes up as much as 60% of total US GDP. So when US consumption falls, the economy will slow dramatically. Between 1999 and 2003 this consumer spending grew by 10%, while the economy only grew by 6%. Thus the consumer was pulling the economy up by its bootstraps, so to speak, while the heavily indebted corporate and governmental sectors were acting as a countervailing force, pulling it downward. In the UK consumer spending has increased by an annualised 4.5%, while GDP growth, for the same reasons as in the US, has been only 2.5%. What is scary is that the OECD, which has been tracking consumer confidence, produced a chart in May, 2004 showing that consumer spending is on a downward trend…….
Sadly, no matter what happens, consumers can't win. If they carry on borrowing and spending, they are simply stacking up problems for the future. However, if they stop borrowing and spending, they will help precipitate a crash, or at least a dramatic slowdown. With a slowdown companies make losses; job losses follow; people begin to feel insecure and worry about their debts. They sell property (and other assets) to pay off, or limit debts; house prices fall, and with them the prices of other goods and services. With a fall in prices and wages, i.e. in a deflationary environment, debts rise in real terms. (Inflation, in contrast, erodes the value of debt).
In other words, we project a lose-lose situation for the very consumers who now heroically prop up the economies of developed countries. No wonder the governor of the Bank of England is issuing stark warnings……
What can be done about these imbalances?
"Bankers provide you with an umbrella when the sun is shining, and take it away when it starts to rain". Anon.
It is a truth universally acknowledged, that bubbles cannot be deflated or burst without causing immense destruction of value, and without widespread personal and social suffering and political upheaval. So while Central Bankers are beginning to rein in spending, by increasing interest rates, if they do it too fast, the one-legged economies of the US and UK, which in turn are driving e.g. the Chinese economy, could collapse.
So there are few answers as to how to deal with the huge imbalances in the global economy. The gambling, speculating and betting undertaken by those who make money from money - the financial rentiers - is dangerously destabilising - but how to rein them in?. Warren Buffet, a US investor worth $15bn and adviser to Arnold Schwarzenegger, calls hedge funds "weapons of mass destruction" - because no one knows how much they have in liabilities. And when those liabilities "unwind", the consequences will be immensely destructive.
In the Real World Economic Outlook, we propose three fundamental changes:
- Taming financial markets through the re-introduction of capital
controls, restraints in the growth of credit; the establishment of an
International Clearing Agency; and a Tobin Tax;
- "Upsizing" the state, empowering governments to once
again exercise policy autonomy, and respond to democratic mandates
- "Downsizing" the single global market in money as
well as goods - amongst the more utopian ambitions of globalisastion
advocates - by introducing an international trading system based on
the concept of "appropriate scale".
- To maintain our environmental life support system we need a new, just and sustainable mechanism for allocating fuel emissions: contraction and convergence.
By allowing money to become a fetish in itself, by worshipping at the temple of money, economists and politicians have lost their way, and as in 1917 and 1929 - threatened us all with war and destruction.
The first step towards re-stabilising the global economy, must be to make money the servant of the global economy, not its master.
How can this be done, you ask, in an age of technological advance? Governments will have to find ways, and with political will, can find ways. Certainly a crash along the lines of 1929, or even the slow and horrible decline of the Japanese economy post 1990, will be enough to concentrate minds. The problem will not, in my view be, how to find ways of controlling capital. Instead a much bigger challenge will be how to limit the claims that pension funds, insurance companies, hedge funds etc. will make on taxpayers through their governments - as they seek compensation for their massive losses? These claims must be limited - after all taxpayers were not consulted about these reckless financial strategies. Nevertheless many millions of taxpayers (pensioners) will suffer losses too, and so compromises will have to be found. However, taxpayers could use compensation as leverage to impose capital controls.
Secondly, and most importantly we need to transform the international financial system so that it is no longer geared to suit the interests of one particular, dominant economy.
International Clearing House
That is where Jane d'Arista's revival of Keynes's ideas for an International Clearing Agency (ICA) are so vital. Under such a scheme, the US would no longer be the single holder of the asset that makes up each country's reserves. Furthermore the ICA would be managed by the countries participating, with symmetrical voting arrangements that would not allow a small group of countries to dominate.
The ICA would operate pretty much as clearing banks do at national level. For example an importer would pay for machinery from country B by writing a cheque in their own bank account, and in their own currency. The seller in country B would deposit the cheque in their bank, and receive credit in their own currency at the current rate of exchange between the two currencies . At the end of the day, the ICA would net all cheques exchanged between the two countries and pay the difference by debiting or crediting their Central Banks. All international reserves would be held by the ICA, and that would provide the means for determining changes in exchange rates.
But it could do even more than that. If the ICA held the government securities of its member countries as backing for international reserves, it could create liquidity, i.e. make loans to countries in deficit and at times of crisis. By creating a true lender of last resort, the ICA would be able to contain damaging crises and maintain the financial stability needed for balanced growth in the global economy.
Contraction and Convergence
High levels of western consumption financed by debt are not sustainable in economic or environmental terms. The competitiveness of the global economy, exacerbated by the tensions caused by free-flowing, un-regulated capital flows, is forcing down prices for amongst other "bads", air transport, which in turn is dramatically worsening fossil fuel emissions. Something must be done. The new economics foundation (nef) favours the proposal developed by Aubrey Meyer at the Global Commons Institute to contract and converge fossil fuel emissions on an internationally equitable basis.
Central to the "contraction and convergence" proposals for maintaining our environmental life support system, is the idea of issuing fossil energy emission permits - to every citizen on earth - which could amount to a citizens income.
However, a key question that arises is this: in what currency should these permits be distributed by the international agency responsible? Under the current system, the dollar would once again be the preferred currency, which would reinforce current US consumption habits; but also help maintain a system whereby the US "hoovers up" resources from the rest of the world.
Rather than a new global currency, we propose that permits are bought and sold on the international markets through the International Clearing Agency discussed above. That way, a neutral institution, not dominated by a small group of nations, but instead exercising greater symmetry of voting rights, would be responsible for ensuring that the distribution of emission permits is undertaken in a way that maintains stability and balance in the global economy.
Conclusion
We live in dangerous times, but few are aware of the risks spooking the global economy and the global environment. Most of our fellow citizens remain blissfully unaware of threats to their livelihoods. For many in the west the illusion of affluence and the utopian belief that the party will go on forever, is encouraged by those reaping huge gains from credit, from gambling and speculation and from the property bubble. Worse than that, the "guardians of the nation's finances" -elected politicians and appointed central bankers - have abrogated their role, and far from slowing down consumption and borrowing - have raised the stakes by stoking it higher, and made the health of the whole global economy dependent on unsustainable levels of consumption.
The guardians of the world's most precious resources - including oil - have proved inept at managing and protecting those in ways that do not threaten the environment, and provide for future generations. By following a path of military violence and occupation our leaders have succeeded in pushing up the price of oil, while doing little to diversify energy use, and end dependence on a fossil fuel that is leading to more and more severe weather events.
There is a great deal of work to be done in fleshing out alternatives, and in building a safer, sustainable and more stable world. However the first task is to educate, first ourselves, and then our neighbours. Only when we all have a much deeper understanding of the economic and environmental impacts of our international system, can we achieve real change.
Of all the threats facing our world, ignorance is perhaps the greatest.
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[1] Edited by Ann Pettifor and published by Palgrave Macmillin in 2003. Available from www.jubileeresearch.org. or www.palgrave.co.uk
[2] This system ensured that international creditors, buying and selling in markets as diverse as Peru, India and South Africa, could always guarantee the value of their assets, by linking these values to a universally agreed value for gold, which in turn was linked to currencies. So if a currency fell or rose too much relative to the value of gold held in reserves, it had to be "adjusted" - to ensure stability in international prices. In other words, governments were obliged by bankers to periodically "balance their books", and "structurally adjust" their economies (i.e. lower demand, raise unemployment, cut public spending and open up markets) to stabilise prices and build up a new surplus of gold - which could be used to compensate foreign creditors and investors.
[4] "Real World Economic Outlook" ed. Ann Pettifor, Chapter 18: "The dollar bill: who picks up the tabl?" by Michael Hudson. Page 174.
[5] Economic Policy Institute - www.epi.org December, 2003.
[6] See the World Bank's Global Development Finance, 2003 and 2004.
[7] See Chapter 2 of Real World Economic Ourlook "Globalisation and its consequences" by Romilly Greenhill.
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