Capitalist Globalism In Crisis
Part II: Understanding the Global Economic
Crisis By Robin Hahnel
In today's global economy what is produced, consumed, and invested in every country is largely determined by the logic of wealth holding in the highly leveraged, largely unregulated global credit system. Usually the credit system--and production, consumption, and investment that depend on it--hum along relatively smoothly benefiting some people far more than others, to be sure. But sometimes things go awry from every perspective. Business slows to a crawl. Factory gates close and investment projects are abandoned in mid-stream. Workers are laid off in huge numbers. Fortunes disappear. All this despite the fact that productive capabilities remain just as great as when everything was humming along. Understanding how modern capitalist economies can plunge into crisis requires understanding something about credit, wealth holding, exchange rates, interest rates, exports, and imports.
If you barter your carrots for my potatoes nothing that happens to me after our transaction can affect you. You already have the potatoes you wanted in exchange for your carrots. But suppose you sell your carrots to someone else for money, planning to use that money later to buy my potatoes. When you are ready to buy from me I may decide not to sell to you after all, or I may raise my price, or refuse to accept your money because I fear it may not be accepted by others. Worse, if you sell your carrots to someone else on credit, the possibilities for disruption increase. After eating your carrots your buyer may fall ill and die, lose his job, or pay other creditors who had prior claims and therefore end up with nothing left to pay you. You no longer have your carrots. You can't get the money you are owed for them. So you also can't buy the potatoes you wanted to buy from me.
So the risk of disruption in a sequence of exchanges, and therefore in a sequence of production and consumption activities, is greater under monetized exchange than barter exchange, and riskier still when exchanges are based on credit. What role do banks play in all this? You deposit money into a bank account for safety, convenience, and the interest that banks pay on deposits. The bank accepts your deposits so it can loan out your money at a higher rate of interest than it paid you. The bank does not simply introduce lender to borrower and then collect a fee if the two decide to consummate the loan. Instead, the bank takes your deposit, according you the legal right to withdraw any or all your money whenever you want. Then the bank turns around and loans to a borrower who is under no obligation to repay the principle, much less the interest, until a specified date in the future. If depositors insist on withdrawing more money than the bank kept in reserve after loaning funds to borrowers, and if borrowers spurn pleas for early repayment, the bank will be unable to meet its financial obligations, in which case we say it is insolvent, and may be declared legally bankrupt. Once banking is recognized for what it is--making loans with other people's money--the potential for problems should come as no surprise. Future markets, options, derivatives, buying on the margin, hedge funds, and a host of other financial innovations all do one of two things. They either increase the number of ways it is possible to speculate, or they increase the amount of "leverage" speculators can obtain by using less of their own money and more credit to buy something they hope to re-sell at a higher price. If extensions of the credit system provide funding for some productive activity that otherwise would not have taken place, they can be beneficial. But any extension, even those that do increase economic productivity, also increases the danger of the credit system disrupting transactions by either increasing the number of things that might go wrong or by compounding the damage if the credit system comes crashing down. New "financial products" add new markets where "bubbles" can form and burst. Increased leverage compounds the damage from any bubble that does burst. A "bubble" is simply a rising price that becomes a kind of self-fulfilling prophesy. If the price of something rises people who buy it because they want to use it will look for less expensive substitutes and buy less of the good whose price has risen. But if the price of something is rising it is rational for speculators to buy more of it pulling the price even higher in anticipation of being able to sell it later for a profit. This is how speculative buying can build a "bubble." A bubble can burst if a few notable speculators switch from buying to selling, and other speculators become convinced the price is headed down and also decide to switch from buying to selling. In general, the greater the percentage of market participants who are speculators, the more susceptible a market will be both to bubble formation and bursting. Recent changes in the global credit system have created more markets dominated by speculators operating with greater leverage.
There are two rules of behavior in any credit system, and both rules become more critical to follow the more extended the system. Rule number one is the rule all participants want all other participants to follow: Don't Panic! If everyone follows rule number one the likelihood of the credit system crashing is lessened. Rule number two is the rule each participant must be careful to follow herself: Panic First! If something does go wrong, the first to collect her loan from a troubled debtor, the first to withdraw her deposits from a troubled bank, the first to sell her option or derivative in a market when a bubble is about to burst, the first to dump a currency when it is "under pressure," will lose the least, while those who are slow to panic will take the biggest losses. Once stated, the contradictory nature of the two logical rules for behavior in credit systems make clear the inherent danger in this economic arrangement.
While most of us who live month to month don't have to worry about it, how to hold their wealth is the chief economic concern for the tiny minority who own most of it. If they hold their wealth in dollars it "earns" nothing and could be "eaten away" by inflation or depreciation of the dollar relative to other currencies. If they hold their wealth in stocks they will get dividends, but they may suffer "capital loses" if the price of the stock should fall. If they hold their wealth in bonds they will get yields, but they may suffer capital losses if bond prices fall. If they hold their wealth in foreign currencies, foreign stocks, or foreign bonds they have similar worries. There's just no foolproof way to "salt" wealth away and be secure that it will not erode even if one were willing to forswear any interest in "earnings" from wealth, much less if one wants to try to make a killing. All of which leads to the following rules for those with significant wealth; Rule number one: Get your priories straight. Remember that how to hold your wealth should be your major economic concern, and whether or not your government is helping you preserve or enlarge your wealth, or making it more difficult, should be your first criterion for supporting or opposing any government. Rule number two: There is no such thing as "salting" wealth away. You must choose to hold your wealth in some particular form. Rule number three: There is no risk free way to hold wealth. Even governments sometimes default on bonds, and even insuring wealth is useless if the insurer goes bankrupt. Financial advisors draw three conclusions from all this: (1) Don't put all your eggs in one basket, diversify your portfolio. (2) Remember that the secret to wealth holding is "knowing when to hold' em and when to fold 'em," i.e., when to stay with one type of asset, and when to sell that asset and buy a different one. Moreover, this decision should be guided by rule number two for proper behavior in credit systems: Panic First. And (3) the best "sucker play" is to find high yield investments where someone else (foolishly) assumes the risk by agreeing to pay you if your investment goes bust.
Foreign Currencies or Exchange
A currency is simply the "money" of a sovereign nation, the accepted means of exchange for goods and services in that country. "Convertible" currencies are currencies that can be bought and sold by anyone in international currency markets. The "price" any currency sells for is called its "exchange rate," or "value," and this price is usually quoted in terms of how many U.S. dollars a unit of that currency will buy. If a unit of a currency buys fewer dollars than yesterday, we say it has "depreciated" or "been devalued." If it buys more dollars than yesterday we say it has "appreciated" or "been revalued." Nowadays we operate under a system of "flexible" or "floating" exchange rates so that any particular currency appreciates or depreciates on a day-by-day basis according to fluctuations in the supply and demand for that currency in the international currency market. On the other hand, the present system of flexible exchange rates is hardly one in which governments and central banks never intervene in the currency markets. As a matter of fact, central banks frequently intervene using foreign exchange reserves to buy their own currencies to prevent depreciation, or selling their own currencies to prevent appreciation. Selling one's own currency is never a problem since countries can always print more of their own currency. But a central bank must have reserves of foreign currencies with which to intervene and buy its own currency to prevent devaluation, and "foreign exchange reserves" can run out. Moreover, governments frequently negotiate agreements with one another promising to help keep the values of their currencies within a specific "band." Governments "honor" these agreements by making the necessary interventions, buying and selling their currencies when its exchange rate threatens to deviate from the band they had agreed to.
Note that if a country's currency depreciates it takes less of a foreigners' currency to buy the amount of the depreciated currency needed to buy exports from that country. In other words, when a country's currency depreciates the country's exports become cheaper for foreigners to buy and they will buy more. In turn, increased demand for exports can increase domestic production and employment. When a country's currency depreciates it also takes more of its currency to buy the amount of a foreign currency needed to buy imports from other countries. In other words, when a country's currency depreciates imports become more expensive and consumers switch from buying imports to domestically produced goods. This also stimulates domestic production and employment. Conversely, when a country's currency appreciates demand for its exports decreases and domestic demand for imports rise which depresses domestic production and employment but stimulates production and employment in countries with whom one trades.
Interest Rates and Exchange Rates
Finally, what is the relation between interest rates and exchange rates? Suppose interest rates in the U.S. rise relative to interest rates in Germany. This means lenders can get paid more for lending in the U.S. than lending in German, so the wealthy in both countries will now want to lend more of their wealth to the U.S. government by buying U.S. treasury bonds and less to the German government by buying German government bonds. To switch from German bonds to U.S. bonds wealth holders must sell the German bonds for German marks, use the German marks to buy U.S. dollars, and then use the U.S. dollars to buy U.S. bonds. This increases the supply of marks and the demand for dollars in the international currency markets, causing the mark to depreciate and the dollar to appreciate. As a result, any country that allows its interest rates to rise above interest rates in other countries risks an appreciation of its currency, and any country whose interest rates fall below rates in other countries risks depreciation of its currency. In recent years the mobility of global wealth has increased substantially. In constant search for the best way to hold their wealth, investors move trillions of dollars of wealth across borders in days, and even hours, in response to changes in relative interest rates thereby inducing large increases and decreases in the supply and demand for different currencies. Increasing volatility in foreign exchange markets is largely because a greater percentage of participants in these markets are motivated by wealth holding, or speculative motivations. The size and mobility of "liquid" global wealth moving in response to changes in relative interest rates, in "deregulated" world capital markets, often swamps the activity of those buying foreign exchange as a necessary means to carry out foreign trade.
The Standard Explanations of the Asian Crisis
First let's dispense with the explanation for the Asian crisis that is preferred by those who orchestrated the great experiment in deregulation and globalization in the first place. People such as Secretary of the Treasury Robert Rubin, IMF Managing Director Michel Camdessus, Fed Chair Alan Greenspan, and their mouthpieces like Bill Clinton and Tony Blair, blame the Asian crisis on "crony capitalism," "lack of transparency," and policy failures of the governments of affected economies. They make no mention of dangers built into the international credit system and the policy failures of the IMF, the World Bank, and the U.S. Treasury Department and Federal Reserve Bank.
On November 10, 1998 Camdessus defended the IMF from what he termed "heavy criticism" in an op-ed piece in the Washington Post. Of course, he was not referring to the "heavy criticism" victims of IMF policy and organizations that represent them such as the Fifty Years is Enough Campaign have voiced for decades. Objections from these sources that IMF policy sacrifices the interests of poor, third world citizens to the interests of wealthy, international investors by prioritizing debt repayment over economic development were deemed to merit no response. But Camdessus was sufficiently stung by criticisms from the likes of Henry Kissinger, Jeffery Sachs, and Paul Krugman that he finally lashed back in public at detractors who must have seemed to Camdessus like rats, who at the first sign of a leak, deserted the IMF cruise ship on which they had enjoyed free luxury berths for years. Camdessus defended the IMF from its new establishment critics as follows: "To my great surprise Kissinger actually suggested that the IMF 'too often compounds the political instability' and 'weakens the political structure' in countries it seeks to help by urging 'nearly invariable remedies' that 'mandate austerity' and include reforms that are too ambitious." Instead Camdessus insisted that "the sources of the continuing Asian economic crisis originated in serious deficiencies in national economic policies," and "the very success of these economies made it especially difficult for political leaders in the region to accept the quiet counsel (yes possibly too quiet!) of the IMF, the World Bank, and other institutions to reform their financial systems and correct the glaring deficiencies of corporate governance." Instead of concluding that IMF policies had been wrong--besides perhaps speaking too softly while wielding their big stick--Camdessus offered the following lesson: "What Asian countries, Russia and too many other countries did not do was build sound financial systems quickly enough and give enough attention to the proper phasing and sequencing of capital account liberalization. Their 'disorderly' liberalization [removal of government restraints to credit transactions] now threatens to give liberalization itself an undeserved bad reputation. But orderly liberalization is the correct ultimate goal."
What do the great global liberalizers like Camdessus who is too politically savvy to use the phrase in a public statement in a major daily mean by "crony capitalism?" They mean corruption and bribery combined with an unwise inclination on the part of governments to meddle with the market. While East Asian governments are no doubt as corrupt as any other, what distinguished them was that their government agencies and central banks engaged in strategic planning in collaboration with businesses and banks to keep wages low and direct the flow of investment into industries well positioned to export to international markets. In other words, their great sin was they "market meddled" to implement the IMF-sponsored export-led growth strategy. That is a lot more useful purpose to their "cronyism" than displayed by the "crony" U.S. Federal Reserve Bank a few months ago when it helped orchestrate the bailout of Long Term Capital Management hedge fund to protect the interests of some "crony" U.S. banks who stood to lose hundreds of billions if Long Term went under.
By "lack of transparency" critics insinuate that the East Asian governments successfully concealed damning information about the state of their economies from international investors. But those who succeed in the international market place seldom do so by revealing their weaknesses to investors. Asian governments acted no different in this regard than any government seeking to attract international investment ever has. Moreover, it is hard to believe that Asian governments as corrupt as their critics claim, would have proved difficult for wealthy international banks and investment houses, staffed by the brightest graduates from the top Business Schools in the United States and Europe, to bribe for any information they thought might be useful to them before risking hundreds of billions of dollars. The East Asian tigers were hardly the kind of governments to successfully play a wicked game of pulling the wool over the eyes of the international investment establishment--who, in a blatantly contradictory myth--are also portrayed as omniscient, far-sighted managers of the world's productive resources.
But blaming the governments of economies that were victimized by the operation of international capital markets for failing to "give enough attention to the proper phasing and sequencing of capital account liberalization" is the most absurd claim of all. Liberalization, remember, is simply opening the doors and removing limitations on international speculative activity. At every stage the IMF praised governments that liberalized rapidly and criticized governments that paid more "attention to proper phasing and sequencing." At every stage the IMF threatened cautious governments that they would lose out on the benefits of international investment that would flow instead to countries that "liberalized" more quickly and completely. And whenever the IMF gained leverage over any of these governments guilty of "disorderly liberalization," they compelled them to accede to even more hasty and ill-advised reforms. This line of argument is a classic case of blaming the victim.
If Camdessus is interested in a better defense against the charge that misguided IMF policies had permitted the crisis to evolve and then aggravated the crisis once it appeared, he should plead that the IMF is largely powerless in the face of global capital markets that have outgrown their tamer. There is some truth to this. But if the IMF pleads this defense on its own behalf, it would have to stop blaming the victims for the crisis. For surely if the IMF is powerless to prevent the crises, then how much less powerful third world and "emerging market" governments must be to ride the tides of global capital sweeping in and out of their economies. But Camdessus won't cop this at least plausible plea because it leads to a guilty plea to a greater crime--the crime of having helped whip the swells of global capital to monsoon proportions, and having ordered the dismantling of restraining walls and dikes that provided precious little protection in the first place. What the IMF has most to answer for is the leading role it has played in liberalizing the international credit system whose unrestrained dangers now frighten even those it was designed to serve.
What Actually Turned the Asian Boom into Bust?
The truth is quite simple: international investment flooded into East Asia in the 1980s and 1990s because East Asia was a more profitable place to invest than anywhere else, and there was a sea of global wealth looking for dry land. Later, when investments financed by international capital became less profitable, investors took flight, and the chickens came home to roost in a highly leveraged global credit system. Corporations in the U.S. and Europe enjoyed skyrocketing profit margins during the 1980s, but corporate strategy in the advanced economies was to downsize rather than invest rising profits at home. Japan was rolling in foreign exchange from decades of trade surpluses making the yen king of the currencies. With an appreciating yen it was cheap for Japanese corporations to buy foreign currencies to buy or build subsidiaries in other Asian countries. And long-term Japanese strategy--read "crony capitalism"--called for transferring production of standard manufactured products to subsidiaries abroad to take advantage of cheaper foreign labor. In short, the Japanese--the biggest investors in East Asia--were busy rebuilding what they once called the "Japanese Asian Co-Prosperity Sphere." Neither Latin America, burdened by bad debt, nor stagnant African economies were attractive outlets for international capital during the late 1980s and early 1990s. The former "socialist" economies in East Europe and the former Soviet Union were tempting but not yet able to absorb large amounts of international capital quickly, and much riskier in any case. The East Asian tigers were simply the best investment opportunities in the late 1980s and early 1990s. Disciplined work forces, low wages, pliable yet reliable governments, and no need to worry about inadequate internal markets to buy the goods in the early years because the host governments agreed the more goods destined for export the better. These were countries where, when the crisis hit, ordinary citizens carried gifts of family gold to Korean banks to help the banks meet foreign payments and thereby avoid "shaming" the nation. A creditor's dream.
But the storied Asian development model suffered from a problem known as the "fallacy of composition." When you are the first Asian export-oriented economy, you are competing with high-cost Western producers. Your cheap workers, low taxes, and lax environmental laws allow you to underprice your competition and still make a bundle. But as more tigers joined the export-led growth circus, the circus wagons slowed under their weight. As the East Asian exporting economies competed more and more with each other rather than with Western producers, regional recession became more and more likely. Investments lost their luster and became less profitable than expected by both lender and borrower--a situation that leads to problems in any highly leveraged credit system--even if there are no further complications.
But there were exacerbating complications: Many Asian banks "borrowed dollars short" and loaned local currency "long." This means Asian banks borrowed dollars from international investors at high interest rates that fell due for repayment quickly. The banks used the dollars to buy local currency and make loans to Asian businesses at even higher interest rates, but these loans did not come due for longer periods of time. As long as new short-term dollar loans were available to the Asian banks, and as long as the Asian businesses were enjoying booming sales and high profit margins, the arrangement worked just fine for all concerned. The bubble kept growing. International lenders got rapid turnover and high yields on their dollar investments. Asian banks earned high profits from a high volume of business conducted with a large spread between the interest rate they charged Asian businesses and the interest rate they paid international investors. And Asian businesses expanded their profit margins by leveraging their own financial investment with seemingly unlimited borrowed money. As long as the local currency remained reasonably stable vis-a-vis the dollar, which it would as long as export sales were strong, loans repaid in local currency could be converted to dollars and used to repay the dollar loans without any problem. This is just the happy coincidence of events that makes the lucky participants "thick as thieves," and that textbooks love to use to illustrate the benefits of credit systems. But what happens when something goes wrong?
When competition among tigers led to falling export sales, Asian businesses could not repay their high interest loans from Asian banks. Moreover, falling export sales lowered international demand for the Asian currencies leading to depreciation which made dollars more expensive for Asian banks to buy. For both reasons Asian banks could not repay their short-run dollar debts in the usual manner--by selling local currency from repaid loans for dollars. Instead Asian banks were forced to pay dollar lender Peter by borrowing even more from some new dollar lender Paul in the international capital markets. But this only helps if the underlying problem with Asian export businesses is short lived. If it persists, as it did, the stop-gap solution only aggravates the problem farther down the road because there are still more dollar debts, now to Paul as well as Peter. When the Asian banks finally couldn't meet payments on their dollar loans it was too late. Their outstanding debt was too big and too short-term. As they scrambled to convert what local currency they had into dollars to meet their payment deadlines, they further depreciated the local currency. When the international investors and currency speculators and local wealthy elites caught on to what was happening they obeyed Rule number 2: Panic First. New dollar loans dried up overnight and more local currency was dumped on the exchange market, causing further depreciation. While it is true that the devaluations could have made manufactured exports cheaper and more attractive to buyers abroad, it was already too late to save the exporting companies. They were saddled with too much bad debt and couldn't get new credit from their local banks, which were also saddled with too much bad debt, and in turn couldn't get new credit from the international capital markets. At this point there was no possibility of paying international investors Peter or Paul the dollars they were owed since the bottom had fallen out of the local currency making the dollars necessary for repayment prohibitively expensive. Moreover, factories couldn't produce exports for sale because they had no money to buy the imported inputs needed to make them, a condition made worse as the price of those inputs was multiplied due to depreciating local currencies.
But it is important to notice that Asian factories, which fueled two decades of rapid growth, have not suddenly vanished. Their plant, machinery, management, and work force are potentially every bit as productive as they were prior to July 1997. The problem is not one of productive potential dissipating, but that these economies are smothered in bad debts which prevent them from getting working capital to start producing again. Whereas the credit system once allowed them to expand production and employment more quickly than they would have been able to otherwise, now that same credit system has them hamstrung.
Were Asian bankers foolish to borrow hard currency short and lend local currency long? With the benefit of hindsight, of course they were. But they were no more foolish than international lenders who made massive unsecured dollar loans to Asian banks whose local loan practices they scarcely monitored. Were Asian governments foolish not to see the fallacy of composition problem in the export lead growth model? Of course they were. But they were no more foolish than the economists at the IMF and World Bank who scornfully dismissed previous development strategies and insisted that only export lead growth would be encouraged--failing to recognize that the success of the strategy hinged on only a few countries pursuing it. With hindsight it is easy enough to blame one group or another. But the underlying problem lay in the dangers lurking in the newly liberalized international credit system that further subordinated decisions about production, consumption, and expanding productive capacities to the logic of speculative wealth holding.
Most of us want to produce and consume. We want to save in case of emergencies and for our retirement. We want to work with more and better tools and equipment. Right now we are forced to do this in an economic system that ties these activities to a credit system. We are told the credit system helps us produce, consume, save, and invest more efficiently. We are never told there may be better ways to organize our economic activities--ways that are equally or even more productive and efficient, ways that allow people to control their own economic destinies and cooperate with one another more equitably. We are seldom told that along with the supposed benefits of wedding production, consumption, saving, and investment to the credit system there are increased dangers. The dangers only become apparent after a crisis has interrupted our economic lives. We are also seldom told that once production, consumption, saving, and investment are governed by the credit system, those few with substantial wealth will be primarily interested in preserving and expanding their wealth through speculation in the credit system. We are not likely to be told this because few of the wealthy even recognize themselves as speculators in the credit system. But that is what they are. They do not work, they do not produce, they trade money for stocks, stocks for bonds, dollars for yen, etc. They speculate that some way to hold their wealth will be safer and more remunerative than some other way. Broadly speaking, the global credit system has been changed over the past two decades in ways that pleased the speculators. As long as the effects on the rest of us were incremental losses of economic democracy and justice, or as long as those affected adversely were the poor and the powerless, in the poorest and least powerful parts of the global economy, attempts to organize people to oppose the changes faced the usual problems of hopelessness, apathy, inertia, fragmentation, and lack of resources. But now that the increased dangers of the liberalized global credit system have become more apparent, the opportunity for a "general reconsideration" is improved. First, we must enlarge the constituency of people aware of the dangers of the system. Second, we must distinguish between changes that would benefit only the speculators--some of whom are also having second thoughts about how well the recent liberalization has served their interests--and changes that will make the lives of the rest of us more productive and safe, as well as more equitable and democratic.
Next month Part III: the IMF's role in the crisis; who is proposing to do what and why; and what choices progressives will have to make about the kinds of policies we support or oppose during the months and years to come.