Friday, June 20, 2008

The debt spiral of the West

A world still half red

By Julian Delasantellis

Do you ever wake up in the morning, and realize that you wish that you didn't feel as good as you do? You're up, the sun is shining, the birds are singing, the traffic reporter says that the roads are free and clear, even the drive-thru lane at Starbucks is open, with your favorite - a vente double half calf extra shot mocha frappachino in a fair-trade blend, with a Carly Simon CD on the side - ready to serve up.

Yes, you sure got a problem here and need to find some remedy. If this was the 1970s, you could always go and see a first-run movie that would get rid of your happiness pretty fast. This was the heyday of dour, depressing directors such as Ingmar Bergman and Woody Allen, and their films, best exemplified by Bergman's 1972 Cries and Whispers or Allen's 1978 Interiors were guaranteed to take the spring out of the step of those with even the perkiest perspective. The consummate opus of the genre, Allen's 1987 September, was so depressing that the Financial Times review of it recommended that it be shown to manic depressives in their up phase.

I don't know about you, but these days, when I feel that the aura on my rose-colored glasses is a just a bit too rufescent for my liking, all I have to do is access the writings of Ambrose Evans-Pritchard, an economics columnist for the Daily Telegraph in London. These well disabuse one of the notion that everything, or, for that matter, just about anything, is all right with the world economy.

The son of Cambridge University anthropology don E E Evans-Pritchard, Ambrose first came to prominence in the 1990s, writing rabidly unflattering columns about president Bill Clinton as the Sunday Telegraph's Washington bureau chief. In this, he was surely a distinctive voice, in that his refined, melodious Trinity College and Cambridge University accent must undoubtedly have contrasted greatly with the Arkansas trailer park twang of the rest of, in Hillary Clinton's famous words, the "vast right-wing conspiracy" out to get her husband.

Freed from that pesky, inconvenient albatross of other journalists, the need to provide facts and documentation to back up their writings, Evans-Pritchard accused Clinton of everything from being an active agent in the 1993 suicide of Clinton White House aide Vincent Foster to knowing complicity in the 1995 Oklahoma City federal building bombing that killed 169 people.

Recalled from Washington to become the Telegraph's Brussels/European Union bureau chief from 1999 to 2004, he most recently has been writing and blogging on matters of general interest in finance and economics. Apparently, with his now much better adjusted doses of Prozac (just kidding, Ambrose, just kidding! ) he now contributes some very unique ideas to the worldwide debate on money matters.

Head for the panic room
True, if you're looking for commentary on how productive and bountiful the current world economic situation is, this probably is the wrong place to look. Last year, his speculations that the Chinese government was switching from US dollars to euros as the currency to hold their reserves in caused sharp dollar selloffs. This year, just looking at some of the recent titles of his postings, is enough to send you bounding in terror towards the panic room.

"Water crisis to be biggest world risk" went one, "Crisis may make 1929 look a walk in the park." One of the best is this recent blog post, "A 50-50 chance that climate change will destroy civilization this century."

Give the devil his due - in the finest Fleet Street tradition, the man knows how to sell newspapers, or, more important these days, drive eyeballs to the Telegraph's web site.

Last week, in a column devoted to the growing inflationary threat in the capitalist economies, Evans-Pritchard posed this unique way to look at the world economy.
The West is in the full grip of a debt deflation as years of credit abuse come back to haunt it. The East - loosely speaking - is in the blow-off phase of an inflationary boom. Russia, Ukraine, Vietnam and the Gulf are out of control. China has dithered beyond the point of no return. It is they who have repeated the errors of the 1970s, not the West. The two camps face radically different problems at this point.
In March, 1946, another British observer, then ex-prime minister Winston Churchill, in a speech at Westminster College in Fulton, Missouri, also looked out onto the world and found a way to divide it into two, diametrically opposed blocs.
From Stettin in the Baltic to Trieste in the Adriatic, an iron curtain has descended across the continent. Behind that line lie all the capitals of the ancient states of Central and Eastern Europe. Warsaw, Berlin, Prague, Vienna, Budapest, Belgrade, Bucharest and Sofia, all these famous cities and the populations around them lie in what I must call the Soviet sphere, and all are subject in one form or another, not only to Soviet influence but to a very high and, in many cases, increasing measure of control from Moscow.
This was the famous "Iron Curtain" speech, the first usage of the term that would come to dominate the standard view of the international system from then, less than a year after the defeat of Nazi Germany, all the way to the fall of the Berlin Wall in 1989, and the collapse of the Soviet Empire following the failed communist revanchist coup attempt in 1991. At the time Churchill gave his speech, Mao Zedong's victory in the Chinese civil war and the subsequent establishment of communist dominion in the country, was still more than three years away.

Following that, it was easy to look at a map and see a huge swath of the Earth's surface, from the western border of East Germany, thousands of miles east to the Pacific coast of China, colored red, denoting communist influence, with perhaps nations such as India, somewhat sympathetic to the USSR during the Cold War, but never an actual Soviet satellite, colored in a paler shade of pink.

Red becomes green

China began moving away from doctrinaire communist economic management in the late 1970s; after 1991, except for a few ink blots in Cuba and North Korea, the red of nations under communist economic management was erased from the map. The free market economic ideology of the capitalist ethic reigned planet wide, and, as illustrated in books such as Francis Fukuyama's 1992 The End of History and the Last Man, would surely do so for ages on ages to come.

And now, less than 20 years past the total victory of their free market anti-government ideology, the two nations that espoused it most aggressively and enthusiastically, Great Britain and the United States, are mired in an economic calamity wholly derived from their boundless hubris. Meanwhile, those nations of the East, prostrate and defeated back then, are now powering forward with the strongest economic performances on the planet, economic growth so strong that the unmistakable, definitive sign of too rapid economic growth, inflation, is now moving to the fore as the world's most serious economic malady.

Today, the anticommunist nations that led the fight in the Cold War would be filled in with red on the map, denoting the dire situation of all the public and private debt they are laboring under, while the former communist nations would be colored green, representing both their very healthy economies and huge swollen foreign exchange reserve surpluses.

How did this happen? How is it, as foretold in the book of Matthew, that the "first shall be last; and the last [shall be] first?"

Economic statistics show clearly the contrast between the two worlds. For the first quarter of 2008, economic growth in four of the countries with the most fervent dedication to the free market ideology, the US, Britain, Spain and New Zealand, averaged just over 2.5%. What these countries have in common is that in recent years they all have allowed themselves to fall victim to housing booms and bubbles that are now deflating.

In contrast to the travails of the winners of the early 1990s, an axis of the Cold War's losers, Russia, Ukraine, Vietnam, India and China, continued to bound ahead in this year's first quarter; their GDP growth averaged just under 8.5%. As Evans-Pritchard implies, if you're talking about strong economic growth these days, you're most likely talking about something happening in these countries, not in free market capitalism's most recently fervent cheerleaders.

So what happened?

In my review of Alan Greenspan's autobiography last October, I wrote of an article I remembered reading in an academic journal around the fall of the Berlin Wall, by an author whose name I have since forgotten. His contention was that, with the threat of the communist world gone, nothing would then stand in the way of the corporate funded and minded rulers of the capitalist world totally losing their acquisitive inhibitions; they would aggressively move towards shaping and forming government regulations to their liking.

Out of ignorance to the actual author's name, I called him "Brain".
As I remember, Brain's apprehension was centered around his contention that, with the communist threat no longer stalking the corporate suites of the capitalist world, the capitalists would no longer be under any restraint to throw off the shackles that had been inhibiting them from a total campaign of rape and pillage of the middle and working classes of the capitalist world, indeed, of the entire planet. Brain's argument was that, during the Cold War, the governments of the capitalist world tamped down on the most avaricious impulses of their ruling class because of fears that the ensuing social dislocations, poverty and unemployment could have been exploited to further the interests of the communist bloc.
Safety-nets cut
The prediction here was that the absence of the communist threat would lead to a much more aggressive dismantling, in order to fund tax cuts for those in upper-income brackets, of the various government social safety nets that had been established to protect society's most vulnerable citizens from the vicissitudes of capitalism.

That, of course, did happen, but, in the credit and debt crisis still bedeviling the capitalist world, we see yet another echo of 1990. The new gilded elite, not satisfied with the gold they could pull out of the dental fillings of the bottom 80% of the population, then moved to generate even more wealth by, essentially, creating it out of thin air.

Last March, I described research reported by Tobias Adrian of the Federal Reserve Bank of New York and Hyun Song Shin of Princeton, elaborating on the new, shadow banking system that flourished in the world's capital markets in the heyday of this decade's credit boom, one that emerged almost totally impervious to any regulatory authority by the governing agencies of the old order.

Adrian and Shin wrote: "A closer look at the fluctuations in balance sheets reveals that the chief tool used by institutions to adjust their leverage is collateralized borrowing and lending."

What this means is that, during this period, whenever the upper-income groups wanted even more on top of what they already had, they found that what with regulation of banking and credit now looked upon with scorn in the period's free market idolatry all they had to do is roll up and bundle some asset, such as subprime home mortgages, securitize them into bonds, then fire them back off into the credit markets to be then borrowed and lent and borrowed and lent on again, as many times as possible.

Then, in 2007, investors, such as those in Bear Stearns' two highly leveraged hedge funds that went belly up about a year ago this time, found that there was no real value, no collateral worth even a fraction of what all these credit market abstractions were valuing these securities at, and the whole thing unraveled.

If you look at today's slowest-growing capitalist economies, you'll see that these are the ones that only a few years ago were luxuriating in the easy money of credit and housing booms now so painfully deflating. (See Of termites and index mania, Asia Times Online, July 3, 2007.)

What about the fast-growing countries? A common military aphorism is that the worse fate that can befall any army is that it wins a war, for that leads to ossified and inflexible strategic thinking for as long as the victorious officers are above ground. On the other hand, losing countries, such as Germany after World War I, go frantically back to the books, think up new ideas, and try to make sure that their humiliation and defeat is never repeated, though they got the next one wrong too.

Winners and losers reversed
This is the simple way to explain why the late 20th century's losers are the 21st century's winners. All of these countries built their success on what you find on page 1 of the Successful Economies 101 textbook - exports. China exported manufactured products, a business hand delivered to it by American and Western manufacturers that wanted to garner the profits that would be generated by paying workers Third World wages to make products to be sold at First World prices.

India is becoming the world's powerhouse in services, a position it found it could assume since that, even in its poverty, it never ignored its educational system, something that the United States, with all its much greater prosperity, regularly does.

Vietnam is taking the overflow in manufacturing spilling out of China, while Russia and Ukraine are prospering through their peddling of hydrocarbon products at today's very dear prices, a condition made highly profitable through the West's allowing the OPEC/world oil company supply restriction oligopoly to operate with unfettered impunity.

In addition, today's winner countries have adopted another principle that today's losers once knew but have since forgotten and are now ignoring - the supreme importance of saving. From the time of the Protestant Reformation of the 16th century it has been well accepted that savings and thrift, by financing productive investment, are critical to the successful long-term operation of capitalist economies. The winning nations are savers, and they earn interest and tomorrow's wealth and power from being so, while today's loser countries, by spending to the last dime and then borrowing some more dimes at punishing rates of interest so they can consume more than they earn some more, are spending their way straight into historical insignificance.

As Evans-Pritchard implies, this dichotomy has enormous implications for the management of the world economy.

The West now simultaneously faces two very different economic problems, inflation and unemployment. The unemployment side of the coin is resultant from the contractionary, wealth-destruction effects of the pricking of the housing/credit bubble. With all that funny money now not being created and injected into the general economy, there's just not enough, despite the near frantic efforts by the US Federal Reserve to recreate the liquidity that the credit bust is destroying, to sustain the previously high levels of domestic originated economic activity and employment.

Then there's the inflationary threat, originating on the other side of the world, resulting out of demand from the newly prosperous nations making their buying presence felt in the world's commodity markets. The desire here is to supply both their rapidly growing economies and their hungry, newly prosperous citizenry.

Two different problems, arising from out of two different regions of the world economy. There is no guarantee, actually, it's fairly unlikely, that a policy initiated to deal with a problem originating in one region can be effectively dealt with through unilateral action in another.

In the United States, inflation is now the main concern, as the daily panic of the nation's gasoline and grocery price signboards surpasses concern for both the subprime/credit crisis and the Iraq war in the nation's nanosecond-long attention span. Many, including a very significant portion of the Federal Reserve Board, favor a spoonful of the true and time-honored inflation fighting medicine, interest rate hikes, to deal with this problem.

Interest hike irrelevance
It is difficult to see how interest rate hikes in the slow-growing west are going to dampen commodity demand in rapidly growing east, at least not without a time lag of very significant duration. If rate hikes lead to an appreciation of the US dollar against the fast-growing counties home currencies, it could actually result in an opposite effect, as these countries' depreciating currencies fuel more boosting of commodity demand and inflation through faster economic growth.

On the other hand, some, particularly in the US Congress, are calling for a sharp upward revision in the yuan, the Chinese national currency. This, they hope, will support employment in the US by making it less profitable for US manufactures to move their factory operations to China. How successful this would be is very questionable - US manufacturers are already scouring other Asian nations looking for new exotic locales to outsource their workforce to. What is certain is that slower economic growth in China and the other current winners could collapse the supports from the US economy's only real current source of growth, the industrial and agricultural export demand from these countries.

Maybe it's time to see a return to respect for efforts, begun at Rambouillet in 1975 with the first G-7 international economic meeting of Western leaders, at international coordination of economic policies. These meetings, still held annually, are now, what with the recent submission to the free market gods of jurisdiction in all things economic, now little more than group photo opportunities, as that the biggest news made from one of these assemblages this decade was George W Bush's copping a feel from German Chancellor Angela Merkel at the 2006 G-8 summit in St Petersburg.

Of course, China, India and Russia, representing the world's new economic order and powerhouses, would merit seats at this table. Russia was included in these conferences in 1997, but only as a sop to a once-great nation that had then fallen on hard times, not as its current status as a major economic power.

At a 2001 summit, George W Bush once said he looked into then Russian president Vladimir Putin's soul and saw virtue; here, the US president would have to reciprocate by letting new Russian President Dimitry Medvedev look into his wallet. Nothing will be accomplished unless the US president, be he Bush or 2009's new resident of the White House, abandons the current US conception of international negotiations as something that is undertaken only with the explicit understanding that the end result will never include any concessions or compromises on US policy positions.
With all these seemingly intractable problems, maybe the question should not be why Ambrose Evans-Pritchard is so pessimistic - it's why everybody else isn't. Had he not died last year, perhaps today's dour economic situation could be material for another depressing Ingmar Bergman movie, perhaps a remake of his dark 1957 classic, The Magician; sometimes it seems that things are so bad these days that one such as this film's title character will be needed to solve all the world economy's varied problems.

Julian Delasantellis is a management consultant, private investor and educator in international business in the US state of Washington. He can be reached at

Original article posted here.

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