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<font size=3><a href="http://www.counterpunch.org/" eudora="autourl">
http://www.counterpunch.org/<br><br>
</a></font><font face="Times New Roman, Times" size=4>June 15,
2006<br><br>
</font><h1><font face="Times New Roman, Times" size=5><b>"The Demons
of Greed are Loose"<br><br>
<br>
</i></font><font face="Times New Roman, Times" size=5 color="#990000">Why
a Global Economic Deluge
Looms</b></font></h1><font face="Times New Roman, Times" size=5>By
GABRIEL KOLKO<br><br>
</font><font face="Verdana" size=6 color="#990000">P</font>
<font face="Verdana" size=2>eople 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.<br><br>
What is that reality? It includes a number of factors. Alone they would
be exceedingly serious; combined, they are very likely to be
lethal.<br><br>
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<br><br>
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.<br><br>
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.<br><br>
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<br><br>
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.<br><br>
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<br><br>
In March of this year the IMF released Garry J. Schinasi's book,
<i>Safeguarding Financial Stability</i>, 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."<br><br>
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.<br><br>
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.<br><br>
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.<br><br>
</font><font face="Verdana" size=2 color="#990000"><b>High-speed Global
Economics<br><br>
</b></font><font face="Verdana" size=2>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.<br><br>
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.<br><br>
What are credit derivatives? The <i>Financial Times</i>' 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.<br><br>
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.<br><br>
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.<br><br>
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.<br><br>
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.<br><br>
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.<br><br>
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.<br><br>
</font><font face="Verdana" size=2 color="#990000">* * *<br><br>
</font><font face="Verdana" size=2>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.<br><br>
<b>Gabriel Kolko</b> is the leading historian of modern warfare. He is
the author of the classic
<a href="http://www.amazon.com/exec/ASIN/1565841921/counterpunchmaga"><b>
Century of War: Politics, Conflicts and Society Since 1914</a></b> and
<a href="http://www.amazon.com/exec/obidos/ASIN/156584758X/counterpunchmaga">
<b>Another Century of War?</a></b>. He has also written the best history
of the Vietnam War,
<a href="http://www.amazon.com/exec/obidos/ASIN/1565842189/counterpunchmaga">
<b>Anatomy of a War: Vietnam, the US and the Modern Historical
Experience</a></b>. His latest book,
<a href="http://www.amazon.com/exec/obidos/ASIN/1588264394/counterpunchmaga">
<b>The Age of War</a>,</b> was published in March 2006.<br><br>
He can be reached at:
<a href="mailto:kolko@counterpunch.org"><b>kolko@counterpunch.org</a></b>
.<br><br>
Note<br><br>
1 <i>IMF Survey</i>, March 13, 2006, p. 66.<br><br>
2 Philip R. Lane and G. M. Milesi-Ferretti, "Examining Global
Imbalances," <i>Finance & Development</i>, March 2006, pp.
38-41.<br><br>
3 Roberto Zagha et al, "Rethinking Growth," <i>Finance &
Development</i>, March 2006, p. 11.<br><br>
4 Raghuram Rajan, in <i>Finance & Development</i>, September 2005,
pp. 54, 58; <i>IMF Survey</i>, May 29, 2006, p. 147.<br><br>
5 Garry J. Schinasi, <i>Safeguarding Financial Stability: Theory and
Practice, </i>pp. 8, 14, 17<i>.<br><br>
</i>6<i> Gillian Tett, "The dream machine</i>," Financial Times
magazine, March 25/26, 2006, pp. 20-26. Also <i>Financial Times</i>,
March 20, 2006.<br>
7 <i>Financial Times</i>, May 31, 2006; June 8, 2006.<br><br>
</font><x-sigsep><p></x-sigsep>
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