[News] Why a Global Economic Deluge Looms
Anti-Imperialist News
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Thu Jun 15 13:22:08 EDT 2006
http://www.counterpunch.org/
June 15, 2006
"The Demons of Greed are Loose"
Why a Global Economic Deluge Looms
By GABRIEL KOLKO
People who know the most about the world
financial system are increasingly worried, and
for very good reasons. Dire warnings are coming
from the most "respectable" sources. Reality has
gotten out of hand. The demons of greed are loose.
What is that reality? It includes a number of
factors. Alone they would be exceedingly serious;
combined, they are very likely to be lethal.
First of all, the International Monetary Fund
(IMF) has been undergoing both a structural and
intellectual crisis. Structurally, its
outstanding credit and loans have declined
dramatically since 2003, from over $70 billion to
a little over $20 billion today, leaving it with
far less leverage over the economic policies of
developing nations--and even less income than its
expensive operations require. It is now in deficit.1
A large part of the IMF's problems are due to the
doubling in world prices for all commodities
since 2003 -- especially petroleum, copper,
silver, zinc, nickel, and the like -- that the
developing nations traditionally export. While
there will be fluctuations in this upsurge, there
is also reason to think it may endure because
rapid economic growth in China, India, and
elsewhere has created a burgeoning demand that
did not exist before, when the balance-of-trade
systematically favored the rich nations.
The U.S. has seen its net foreign asset position
fall as Japan, emerging Asia, and oil exporting
nations have become far more powerful over the
past decade, and have increasingly become
creditors to the U.S.2 As the U.S. deficits
mount, with its imports being far greater than
its exports, the value of the dollar has been
declining -- 28 per cent against the euro from 2001 to 2005 alone.
Equally important, the IMF and World Bank were
severely chastened by the 1997-2000 financial
meltdowns in East Asia, Russia, and elsewhere,
and many of the two institutions' key leaders
lost faith in the anarchic premises, descended
from classical laisser-faire economic thought,
which guided policy advice until then. "{O]ur
knowledge of economic growth is extremely
incomplete," many in the IMF now admit, and "more
humility" on its part is now warranted.3
Worse yet, the whole nature of the global
financial system has changed radically in ways
that have nothing whatsoever to do with
"virtuous" national economic policies that follow
IMF advic. These are ways the IMF cannot control.
The investment managers of private equity funds
and major banks have displaced national banks and
international bodies such as the IMF, moving well
beyond the existing regulatory structures and
they have "reintermediated" themselves between
the traditional borrowers, both national and
individual, and markets. They have deregulated
the world financial structure, making it far more
unpredictable and susceptible to crises. They
seek to generate high investment returns, which
is the key to their compensation, and they take mounting risks to do so.
A "brave new world" has emerged in the global
financial structure, one that is far less
transparent because there are fewer reporting
demands imposed on those who operate in it.
Financial adventurers are constantly creating new
"products" that defy both states and
international banks. The IMF's managing director,
Rodrigo de Rato, at the end of May, 2005,
deplored these new risks -- risks the weakness of
the U.S. dollar and its mounting trade deficits have magnified greatly.4
In March of this year the IMF released Garry J.
Schinasi's book, Safeguarding Financial
Stability, giving it unusual prominence then and
thereafter. In essence, Schinasi's book is
alarmist, and it both reveals and documents in
great and disturbing detail the IMF's deep
anxieties. Essentially, "deregulation and
liberalization", which the IMF and proponents of
the "Washington consensus" advocated for decades,
have become a nightmare, creating "tremendous
private and social benefits" but also holding
"the potential (although not necessarily a high
likelihood) for fragility, instability, systemic
risk, and adverse economic consequences."
Anyone who reads the data in Schinasi's superbly
documented book will share his real conclusion
that the irrational development of global
finance, combined with deregulation and
liberalization, has "created scope for financial
innovation and enhanced the mobility of risks".
Schinasi and the IMF advocate a radical new
framework to monitor and prevent the problems now
able to emerge, but success "may have as much to
do with good luck" as policy design and market
surveillance.5 Leaving the future to luck is not
what economics originally promised. The IMF is desperate, and not alone.
As the Argentina financial meltdown proved,
countries that do not succumb to IMF and banker
pressures can play on divisions within the IMF
membership, particularly the U.S., comprising
bankers and others to avoid many, although
scarcely all, foreign demands. About $140 billion
in sovereign bonds to private creditors and the
IMF were at stake, terminating at the end of 2001
as the largest national default in history. Banks
in the 1990s were eager to loan Argentina money
and they ultimately paid for it. Since then,
however, commodity prices have soared and the
growth rate of developing nations in 2004 and
2005 was over double that of high income nation,
a pattern projected to continue through 2008.
As early as 2003 developing countries were
already the source of 37 percent of the foreign
direct investment in other developing nations.
China accounts for a great part of this growth,
but it also means that the IMF and rich bankers
of New York, Tokyo, and London have far less
leverage than ever. Growing complexity is the
order of the world economy that has emerged in
the past decade, and with it has come the
potential for far greater instability, and dangers for the rich.
High-speed Global Economics
The global financial problem that is emerging is
entwined with an American fiscal and trade
deficit that is rising quickly. Since Bush
entered office in 2001 he had added over $3
trillion to federal borrowing limits, which are
now almost $9 trillion. So long as there is a
continued devaluation of the U.S. dollar, banks
and financiers will seek to protect their money
and risky financial adventures will appear
increasingly worthwhile. This is the context, but
Washington advocated greater financial
liberalization well before the dollar weakened.
The world now has a conjunction of factors that
have created a far greater risk than the
proponents of the "Washington consensus" ever believed possible.
There are now many hedge funds, with which we are
familiar, but they now deal in credit derivatives
and numerous other financial instruments. Markets
for credit derivative futures are in the offing.
The credit derivative market was almost
nonexistent in 2001, grew fairly slowly until
2004 and then went into the stratosphere,
reaching $17.3 trillion by the end of 2005.
What are credit derivatives? The Financial Times'
chief capital markets writer, Gillian Tett, tried
to find out. She failed. About ten years ago some
J. P. Morgan bankers were in Boca Raton, Florida,
drinking, throwing each other into the swimming
pool, and the like, and they came up with a
notion of a new financial instrument that was too
complex to be easily copied (financial ideas
cannot be copyrighted) and which was sure to make
them money. But she was highly critical of its
potential for causing a chain reaction of losses
that will engulf the hedge funds that have leaped
into this market.6 It for reasons such as these,
as well as others, even more opaque, such as
split capital trusts, collateralized debt
obligations, and market credit default swaps,
that the IMF and financial authorities are so worried.
Banks simply do not understand the chain of
exposure and who owns what. Senior financial
regulators and bankers now admit as much. The
Long-Term Capital Management hedge fund meltdown
in 1998, which involved only about $5 billion in
equity, revealed this. The financial structure is
now infinitely more complex and far larger. The
top ten hedge funds alone in March 2006 had $157
billion in assets. Hedge funds claim to be honest
but those who guide them are compensated for the
profits they make, which means taking risks. But
there are thousands of hedge funds and many
collect inside information, which is technically
illegal but it occurs anyway. The system is
fraught with dangers, starting with the
compensation structure, but it also assumes a
constantly rising stock market and much, much
else. Many fund managers are incompetent. But the
26 leading hedge fund managers earned an average
of $363 million each in 2005; James Simons of
Renaissance Technologies earned $1.5 billion.
There is now a consensus that all this, and much
else, has created growing dangers. We can put
aside the persistence of imbalanced budgets based
on spending increases or tax cuts for the
wealthy, much less the world's volatile stock and
commodity markets which caused hedge funds in May
to show far lower returns than they have in at
least a year. It is anyone's guess which way the
markets will go, and some will gain while others
lose. Hedge funds still make lots of profits, and
by the spring of 2006 they were worth about $1.2
trillion worldwide, but they are increasingly dangerous.
A great deal of money went from investors in rich
nations into emerging market stocks, which have
been especially hard-hit in the past weeks, and
if they leave them the financial shock will be
great. The dangers of a meltdown exist there too.
Problems are structural, such as the greatly
increasing ratio of corporate debt loads to core
earnings, which have grown substantially from
four to six times over the past year because
there are fewer legal clauses to protect
investors from loss, and to keep companies from
going bankrupt when they should. So long as
interest rates have been low, leveraged loans
have been the solution. With hedge funds and
other financial instruments, there is now a
market for incompetent, debt-ridden firms. The
rules some once erroneously associated with
capitalism -- probity and the like--no longer hold even on paper.
Problems are also inherent in speed and
complexity, and these are very diverse and almost
surreal. Credit derivatives are precarious
enough, but at the end of May the International
Swaps and Derivatives Association revealed that
one in every five deals, many of them involving
billions of dollars, involved major errors. As
the volume of trade increased so did errors. They
doubled in the period after 2004. Many deals were
scribbled on scraps of paper and not properly
recorded. "Unconscionable" was outgoing Fed
chairman, Alan Greenspan's, description. He was
"frankly shocked." Other trading, however, is
determined by mathematical algorithm
("volume-weighted average price" it is called)
for which PhDs trained in quantitative methods
are hired.7 Efforts to remedy this mess only
began in June of this year and they are very far
from resolving a major and accumulated problem that involves stupendous sums.
Stephen Roach, Morgan Stanley's chief economist,
on April 24 of this year wrote that a major
financial crisis was in the offing and that the
ability of global institutions to forestall it --
ranging from the IMF and World Bank to other
mechanisms of the international financial
architecture are utterly inadequate. Hong
Kong's chief secretary in early June deplored the
hedge funds' risks and dangers. The IMF's
iconoclastic chief economist, Raghuram Rajan, at
the same time warned that the hedge funds'
compensation structure encouraged those in charge
of them to increasingly take risks, thereby
endangering the whole financial system.
* * *
The entire global financial structure is becoming
uncontrollable in crucial ways its nominal
leaders never expected. Instability is
increasingly its hallmark. Financial
liberalization has produced a monster, and
resolving the many problems that have emerged is
scarcely possible for those who deplore controls
on those who seek to make money, whatever means
it takes to do so. Contradictions now wrack the
world's financial system, and if we are to
believe the institutions and personalities who
have been in the forefront of the defense of
capitalism, it may very well be on the verge of serious crises.
Gabriel Kolko is the leading historian of modern
warfare. He is the author of the classic
<http://www.amazon.com/exec/ASIN/1565841921/counterpunchmaga>Century
of War: Politics, Conflicts and Society Since
1914 and
<http://www.amazon.com/exec/obidos/ASIN/156584758X/counterpunchmaga>Another
Century of War?. He has also written the best
history of the Vietnam War,
<http://www.amazon.com/exec/obidos/ASIN/1565842189/counterpunchmaga>Anatomy
of a War: Vietnam, the US and the Modern
Historical Experience. His latest book,
<http://www.amazon.com/exec/obidos/ASIN/1588264394/counterpunchmaga>The
Age of War, was published in March 2006.
He can be reached at: <mailto:kolko at counterpunch.org>kolko at counterpunch.org.
Note
1 IMF Survey, March 13, 2006, p. 66.
2 Philip R. Lane and G. M. Milesi-Ferretti,
"Examining Global Imbalances," Finance & Development, March 2006, pp. 38-41.
3 Roberto Zagha et al, "Rethinking Growth,"
Finance & Development, March 2006, p. 11.
4 Raghuram Rajan, in Finance & Development,
September 2005, pp. 54, 58; IMF Survey, May 29, 2006, p. 147.
5 Garry J. Schinasi, Safeguarding Financial
Stability: Theory and Practice, pp. 8, 14, 17.
6 Gillian Tett, "The dream machine," Financial
Times magazine, March 25/26, 2006, pp. 20-26.
Also Financial Times, March 20, 2006.
7 Financial Times, May 31, 2006; June 8, 2006.
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