Friday, 14 September 2007
The financial panic that never was by CHRIS HARMAN For Socialist Review [September 2007] As we go to press the financial panic that made the headlines across the world in August seems to have subsided. The message now from many of those who panicked is that nothing was or is amiss. After all, they say, the panic was only in the financial sector, not "the real economy". But it was not so simple. It resulted from old fashioned financial chicanery. Banks, hedge funds and wealthy individuals (you had to invest a minimum of $5 million to take part) set out to make easy profits by providing mortgages at high interest rates to Americans too poor to borrow from the usual sources. As this "subprime mortgage market" boomed, financial interests across the world clamoured to take part, borrowing billions from each other to get a share of the action. There was hardly a respectable bank in the world not involved. Then a slide in house prices and a slowdown in the US economy suddenly combined to make the poor too poor to keep up with their mortgage repayments. Bankers, hedge funds and rich parasites could not extract from them the money they needed to pay back other bankers, hedge funds and rich parasites. Two hedge funds connected to a major US bank came close to going bust, as did two state banks in Germany. For a day or two it looked as if the whole process of borrowing and lending which keeps businesses going might grind to a halt, since no financier was certain whether any other had the funds to repay any debts. This was the "credit crunch". Then on 18 August an emergency meeting of the US Federal Reserve Bank agreed to provide extra support to those in most trouble (those financiers, or course, not the poor mortgage borrowers), and everything suddenly seemed all right. Except what happened was not some accident. It was a rerun in slightly different conditions of the stock exchange panic of 1987 and the collapse of the hedge fund Long Term Capital Management in 1998. On those occasions the actions of the US Fed were enough to prevent a more immediate general crisis - only for it to return with a vengeance on both occasions within two and half years. This was because the financial chicanery was a reflection of more fundamental imbalances within the world system which could not be ignored for ever. The imbalances this time are much more serious than a decade or two ago. The world economy was only able to recover from the recession of 2001-2002 because of US consumers and the US government borrowing massively to spend well beyond their incomes, by a total of around $400 billion a year. But a point was bound to arise when such a balancing act could not work any more. The fear on 17 August was that this point had already been reached. The action of the US Fed the next day postponed the day of reckoning, but no one knows for how long. Meanwhile, more than a million working class Americans face the loss of their homes this year. Market turmoil & US-China rivalries by VAUGHAN GUNSON Alex Callinicos in an article for the British Socialist Worker (4 August, 2007 http://www.socialistworker.co.uk/art.php?id=12625) asked whether the world economy was on precipice. Recent economic growth has been stimulated by a “sea of credit”, argues Callinicos, created by the central banks of the world’s leading capitalist countries, in particular the US Federal Reserve, who’ve kept interest rates historically low. This has created a boom in speculative investment which is now showing signs of coming unstuck. In his article, Callinicos refers to the $1.2 trillion dollars of foreign currency reserves that China has built up over the last decade. Trade between China and the US has been heavily weighted in China’s favour, with 70% of goods sold at WalMart made in China. With their massive stocks of US currency China has then being buying up US government bonds issued by the US Federal Reserve, the chief mechanism by which the interest rates in the US have been kept low. China is now in a position to put economic pressure on the US. China could collapse the US economy if it stopped buying up US debt and flooded the market with its reserves of US bonds. This is not a position the US ruling class want to be in. We don’t often feature articles by people who’ve served in the Reagan administration or who’ve worked for the Wall Street Journal , but the one included below by Paul Roberts, writing for Counterpunch, shows quite clearly the economic threat that China poses to the US. China has long been identified by Washington as the country which would emerge as the US’s main economic and military rival. The US invaded Iraq to control the oil and gas reserves of the Middle East, and therefore gain leverage over China, whose economy is heavily reliant on imported oil and gas. Thanks to the heroic Iraqi resistance and global grassroots opposition to the war, that strategy is turning into a disaster for the US ruling class. This has increased the confidence of rival imperialist powers, like China, Russia and the European Union. The willingness of the China to assert its growing economic power will be only increase the anxiety of the US ruling class. If the world economy does collapse then this will further heighten tensions between the US and China. This increases the possibility of a much bigger Middle East war, if the US ruling class decides it must achieve its original intentions, or it could lead to another conflict in a different part of the world where the interests of these two capitalist powers collide. One Big Reason Markets are Plunging: China's Threat to the Dollar is Real by PAUL CRAIG ROBERTS From Counterpunch [10 August 2007] – shortened Twenty-four hours after I reported China’s announcement that China, not the Federal Reserve, controls US interest rates by its decision to purchase, hold, or dump US Treasury bonds, the news of the announcement appeared in sanitized and unthreatening form in a few US news sources. The Washington Post found an economics professor at the University of Wisconsin to provide reassurances that it was “not really a credible threat” that China would intervene in currency or bond markets in any way that could hurt the dollar’s value or raise US interest rates, because China would hurt its own pocketbook by such actions. US Treasury Secretary Henry Paulson, just back from Beijing, where he gave China orders to raise the value of the Chinese yuan ‘without delay,” dismissed the Chinese announcement as “frankly absurd.” Both the professor and the Treasury Secretary are greatly mistaken. First, understand that the announcement was not made by a minister or vice minister of the government. The Chinese government is inclined to have important announcements come from research organizations that work closely with the government. This announcement came from two such organizations. A high official of the Development Research Center, an organization with cabinet rank, let it be known that US financial stability was too dependent on China’s financing of US red ink for the US to be giving China orders. An official at the Chinese Academy of Social Sciences pointed out that the reserve currency status of the US dollar was dependent on China’s good will as America’s lender. What the two officials said is completely true. It is something that some of us have known for a long time. What is different is that China publicly called attention to Washington’s dependence on China’s good will. By doing so, China signaled that it was not going to be bullied or pushed around. The Chinese made no threats. To the contrary, one of the officials said, “China doesn’t want any undesirable phenomenon in the global financial order.” The Chinese message is different. The message is that Washington does not have hegemony over Chinese policy, and if matters go from push to shove, Washington can expect financial turmoil. Paulson can talk tough, but the Treasury has no foreign currencies with which to redeem its debt. The way the Treasury pays off the bonds that come due is by selling new bonds, a hard sell in a falling market deserted by the largest buyer. Now let’s examine the University of Wisconsin economist’s opinion that China cannot exercise its power because it would result in losses on its dollar holdings. It is true that if China were to bring any significant percentage of its holdings to market, or even cease to purchase new Treasury issues, the prices of bonds would decline, and China’s remaining holdings would be worth less. The question, however, is whether this is of any consequence to China, and, if it is, whether this cost is greater or lesser than avoiding the cost that Washington is seeking to impose on China. American economists make a mistake in their reasoning when they assume that China needs large reserves of foreign exchange. China does not need foreign exchange reserves for the usual reasons of supporting its currency’s value and paying its trade bills. China does not allow its currency to be traded in currency markets. The other reason is that China does not have foreign trade deficits, and does not need reserves in other currencies with which to pay its bills. Indeed, if China had creditors, the creditors would be pleased to be paid in yuan as the currency is thought to be undervalued. Despite China ’s support of the Treasury bond market, China’s large holdings of dollar-denominated financial instruments have been depreciating for some time as the US dollar declines against other traded currencies, because people and central banks in other countries are either reducing their US dollar holdings or ceasing to add to them. China’s dollar holdings reflect the creditor status China acquired when US corporations offshored their production to China. Reportedly, 70 per cent of the goods on Wal-Mart’s shelves are made in China. China has gained technology and business knowhow from the US firms that have moved their plants to China. China has large coastal cities, choked with economic activity and traffic, that make America’s large cities look like country towns. China has raised about 300 million of its population into higher living standards, and is now focusing on developing a massive internal market some 4 to 5 times more populous than America’s. The notion that China cannot exercise its power without losing its US markets is wrong. American consumers are as dependent on imports of manufactured goods from China as they are on imported oil. In addition, the profits of US brand name companies are dependent on the sale to Americans of the products that they make in China. The US cannot, in retaliation, block the import of goods and services from China without delivering a knock-out punch to US companies and US consumers. China has many markets and can afford to lose the US market easier than the US can afford to lose the American brand names on Wal-Mart’s shelves that are made in China. Indeed, the US is even dependent on China for advanced technology products. Now let’s consider the cost to China of dumping dollars or Treasuries compared to the cost that the US is trying to impose on China. If the latter is higher than the former, it pays China to exercise the “nuclear option” and dump the dollar. The US wants China to revalue the yuan, that is, to make the US dollar value of the yuan higher. Instead of a dollar being worth 8 yuan, for example Washington wants the US dollar to be worth only 5.5 yuan. Washington thinks that this would cause US exports to China to increase, as they would be cheaper for the Chinese, and for Chinese exports to the US to decline, as they would be more expensive. This would end, Washington thinks, the large trade deficit that the US has with China. This way of thinking dates from pre-offshoring days. In former times, domestic and foreign-owned companies would compete for one another’s markets, and a country with a lower valued currency might gain an advantage. Today, however, about half of the so-called US imports from China are the offshored production of US companies for their American markets. The US companies produce in China, not because of the exchange rate, but because labor, regulatory, and harassment costs are so much lower in China. Moreover, many US firms have simply moved to China, and the cost of abandoning their new Chinese facilities and moving production back to the US would be very high. When all these costs are considered, it is unclear how much China would have to revalue its currency in order to cancel its cost advantages and cause US firms to move enough of their production back to America to close the trade gap. To understand the shortcomings of the statements by the Wisconsin professor and Treasury Secretary Paulson, consider that if China were to increase the value of the yuan by 30 percent, the value of China’s dollar holdings would decline by 30 percent. It would have the same effect on China’s pocketbook as dumping dollars and Treasuries in the markets. Consider also, that as revaluation causes the yuan to move up in relation to the dollar (the reserve currency), it also causes the yuan to move up against every other traded currency. Thus, the Chinese cannot revalue as Paulson has ordered without making Chinese goods more expensive not merely to Americans but everywhere. Compare this result with China dumping dollars. With the yuan pegged to the US dollar, China can dump dollars without altering the exchange rate between the yuan and the dollar. As the dollar falls, the yuan falls with it. Goods and services produced in China do not become more expensive to Americans, and they become cheaper elsewhere. By dumping dollars, China expands its entry into other markets and accumulates more foreign currencies from trade surpluses. Now consider the non-financial costs to China’s self-image and rising prestige of permitting the US government to set the value of its currency. America’s problems are of its own making, not China’s. A rising power such as China is likely to prove a reluctant scapegoat for America’s decades of abuse of its reserve currency status.