CHINA AND THE GLOBAL CRISIS
Denial as the storm gathered
By Henry C K Liu
China's response to the current global financial crisis is predicated on the reality of the international situation and the separate responses of other major economies around the world.
It took more than a year for US President George W Bush, in whose country the decades-long credit joyride finally imploded in August 2007, to belatedly acknowledge that the financial crisis resulting from decades of US monetary indulgence and fiscal irresponsibility is not merely a passing shower needed to deflate the latest debt bubble in the housing sector of the US economy.
The credit turmoil turned out to be a catastrophic, global, financial
perfect storm of unprecedented dimension that will cause serious structural damage to all market economies around the world. It may even spell the end of the cowboy finance capitalism of the past two decades in which risks are socialized and gains privatized, with debt manipulated to act as phantom capital and high returns on pension funds of workers paid for with permanent loss of employment and regressively low wages for those still working.
Snake-oil theory of big market, small government
For decades, aggressive globalization and wholesale deregulation of finance have been propagated by the flawed US ideology of faith-based, capitalistic, free-market fundamentalism and of the alleged merits of government nonintervention in markets.
The snake-oil slogan of "big market and small government" has been promoted around the world as a win-win, neo-liberal miracle, good for all trade-participating economies and regurgitated tirelessly by neo-comprador economies such as that of Hong Kong. Ironically, free-market Hong Kong finds it necessary to turn to socialist China for government bailouts whenever its free market slows, while it continues to mindlessly boast the superiority of its free-market regime.
Hong Kong's infatuation with US propaganda notwithstanding, the fact is that US ideological imperialism on free-market fundamentalism allowed the financial crisis that began in the US in August 2007 to quickly lead to interconnected market failure in advanced, emerging and developing economies alike the world over.
Predatory dollar hegemony
The exporting economies have been lured into shipping real wealth to the US in exchange for US debt denominated in fiat dollars, which cannot be spent in their own domestic economy without monetary penalty and which must be returned to the US as capital to finance US sovereign debt. The adverse effects of this predatory monetary regime, known as dollar hegemony, differ on economies at different stages of development. But one common effect can be observed clearly: the helpless working poor in all trading economies around the world, who had no voice in economic, trade and monetary policymaking, did not benefit throughout the phantom boom phase from trade globalization and are now suffering the most in these days of reckoning when the boom bust.
US neoliberal trade globalization, having promised a primrose garden of economic growth, has instead led the global economy into a jungle of poison reed, resulting in the worst financial disaster in a century, setting the whole world ablaze with a financial firestorm. This unhappy fate was finally acknowledged as having been policy-induced by Alan Greenspan, the former chairman of the US Federal Reserve who was largely responsible for the monetary indulgence that had caused this hundred-year financial perfect storm. Greenspan confessed before Congress that his trust on transnational finance institutions for self-regulation as a survival instinct had been misplaced, leading him to a flawed policy in support of anarchical financial deregulation and permissive risk management.
Still, Greenspan left unmentioned his equally misplaced faith in central bank ability to mitigate the adverse effect of burst bubbles by creating larger sequential bubbles with more liquidity. The Federal Reserve under Greenspan repeatedly created money faster than the global economy could profitably absorb, creating serial bubbles denominated in fiat dollars. Greenspan insisted that it was not possible, nor desirable to identify an economic bubble in the making as he was inflating it with easy money lest economic growth should be prematurely cut short. It was a perfect example of the rule that intoxication begins when a drinker becomes unable to know its time to stop drinking.
On a more fundamental level, politically independent central banking under Greenspan, instead of being a market-stabilizing force, has become part of the destabilizing causes of recurring economic bubbles. The Hong Kong Monetary Authority (HKMA), the self-styled central bank notwithstanding the peg of the Hong Kong dollar to the US dollar at a fixed rate of 7.8 to 1, thus rendered itself to the status of a monetary policy subsidiary of the US Federal Reserve. When the US Fed eases monetary stance, HKMA must also ease to sustain the currency peg. Thus Hong Kong has been exposed to a contagious bubble from the US bubble.
HKMA chief executive Joseph Yam has for decades held up Greenspan as his policy guru, tirelessly declaring himself publicly without shame as a faithful disciple of the Wizard of Bubbleland. Greenspan has confessed publicly his policy blunder. The people of Hong Kong, now suffering the pains of the Greenspan virus, have yet to hear from the self-important Mr Yam to whom the people of Hong Kong pay an obscenely high salary, several times that of Greenspan as chairman of the Fed.
Fiat dollar liquidity destroys wealth
This US-induced global financial disaster that now threatens to keep the world in deep economic depression for another decade and more is essentially the product of US ideologically based policy and practices. While substantial damage has already been irreversibly done to the world economy by the collapse of economic bubbles caused by a liquidity flood, particularly to confidence in the market system, the US rescue strategy has been to keep the debt bubble from bursting with indiscriminate injections of liquidity.
Until the US monetary policymakers realize that excess liquidity denominated in fiat dollars cannot create wealth, but rather it destroys wealth, the debt-infested US economy will not begin to recover.
Further damage to the global economy cannot be averted without a fundamental change in US policy that has been exploiting its predatory monetary hegemony. This dollar hegemony grows out of a fiat dollar that has allowed the US to finance its decades-long current account deficit with a compulsory compensatory capital account surplus. This sucks wealth from the exporting emerging economies to the US to keep it as the world's richest economy, consistently consuming more than it produces with the help of debt denominated in fiat dollars that the US could print at will.
Now, in the face of a global firestorm of debt that the US has single-handedly created with its flawed ideology and dysfunctional monetary and trade policies, the international community is being asked to coordinate and follow still misguided US ideologically-constrained bailout measures to help the US deal with a global problem of its own making. Yet the solution lies only in fundamental reform of US policy.
The venue for this audacity was the White House Summit on Financial Markets and the World Economy of November 15, 2008, called by a lame-duck president whose office would last only five weeks beyond the summit. He invited the attendance of leaders of the Group of Twenty countries along with representatives of the United Nations, the World Bank, the International Monetary Fund, the Financial Stability Forum and other international agencies.
[The G-20 members are: Argentina, Australia, Brazil, Britain, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United States, and the European Union.]
The G-20 members combined produce 90% of global gross domestic product (GDP), account for 80% of world trade, and are home to two-thirds of the world's population. The summit was billed as the first of a series of follow-up summits to deal with the urgent and complex crisis.
The summit agenda, set by the US, was for world leaders to exchange views on three "important" issues: (1) to assess the progress made by the international community in response to the current financial crisis; (2) to discuss the causes of the financial crisis; (3) to discuss issues such as the regulatory norms and institutional reform in international finance and try to reach consensus on some principles.
The key issue of the basic flaw in neoliberal market fundamentalism was not on the agenda. World leaders were not asked to deliberate on new alternative economic orders to save the world from US-created impending financial disaster, but to "coordinate" with US efforts to validate flawed US ideology and to save predatory finance market capitalism based on it.
To drive home the point, President George W Bush gave a speech on "The Financial Markets and World Economy" at the Manhattan Institute in New York City on November 13, two days before the White House Summit, in which he claimed:
The leaders attending this weekend's meeting agree on a clear purpose - to address the current crisis, and to lay the foundation for reforms that will help prevent a similar crisis in the future. We also agree that this undertaking is too large to be accomplished in a single session. The issues are too complex, the problem is too significant to try to solve, or to come up with reasonable recommendations in just one meeting. So this summit will be the first of a series of meetings.
It will focus on five key objectives: understanding the causes of the global crisis, reviewing the effectiveness of our responses thus far, developing principles for reforming our financial and regulatory systems, launching a specific action plan to implement those principles, and reaffirming our conviction that free market principles offer the surest path to lasting prosperity.
First, we're working toward a common understanding of the causes behind the global crisis. Different countries will naturally bring different perspectives, but there are some points on which we can all agree: Over the past decade, the world experienced a period of strong economic growth. Nations accumulated huge amounts of savings, and looked for safe places to invest them. Because of our attractive political, legal, and entrepreneurial climates, the United States and other developed nations received a large share of that money.
It is a gigantic stretch of self deception to claim that the leadersattending the summit agreed on anything besides agreeing to meet. Attendance cannot be misrepresented as supportive of biased US views. The fact is that many in the world think that the idea of a global savings glut is a myth. The US is receiving a large capital account surplus only because of dollar hegemony, a geopolitically constructed peculiarity through which critical commodities, the most notable being oil, are denominated in fiat dollars, not backed by gold or other species since president Richard Nixon took the dollar off gold in 1971. This financial crisis is US-sourced and has spread to the rest of the world.
The recycling of petro-dollars into other dollar assets is the price
the US has extracted from oil-producing countries for US tolerance for the oil-exporting cartel, the Organization of Petroleum Exporting Countries, since 1973. Since then, everyone accepts dollars because dollars can buy oil, and every economy needs oil. Dollar hegemony separates the trade value of every currency from direct connection to the productivity of the issuing economy to link it directly to the size of dollar reserves held by the issuing central bank.
These dollar reserves held by foreign central banks by definition must be reinvested in dollar assets. Dollar hegemony enables the US to own, indirectly but essentially, the entire global economy by requiring its wealth to be denominated in fiat dollars that the US can print at will with little monetary penalty. Much of the world is suffering from a shortage of capital while non-dollar economies are prevented from financing their domestic development with sovereign credit and have to rely excessively on exports for dollars. There is no savings glut, only a dollar glut released by a wayward US central bank addicted to monetary laxative.
World trade is now a game in which the US produces at will fiat dollars of uncertain exchange value and zero intrinsic value, and the rest of the world produces goods and services that fiat dollars can buy at "market prices" quoted in dollars.
Blaming the victims for the crime
President Bush continued with his self-absolving explanation of the global financial crisis:
The massive inflow of foreign capital, combined with low interest rates, produced a period of easy credit. And that easy credit especially affected the housing market. Flush with cash, many lenders issued mortgages and many borrowers could not afford them. Financial institutions then purchased these loans, packaged them together, and converted them into complex securities designed to yield large returns. These securities were then purchased by investors and financial institutions in the United States and Europe and elsewhere - often with little analysis of their true underlying value.
The financial crisis was ignited when booming housing markets began to decline. As home values dropped, many borrowers defaulted on their mortgages, and institutions holding securities backed by those mortgages suffered serious losses. Because of outdated regulatory structures and poor risk management practices, many financial institutions in America and Europe were too highly leveraged. When capital ran short, many faced severe financial jeopardy. This led to high-profile failures of financial institutions in America and Europe, led to contractions and widespread anxiety - all of which contributed to sharp declines in the equity markets.
These developments have placed a heavy burden on hardworking people around the world. Stock market drops have eroded the value of retirement accounts and pension funds. The tightening of credit has made it harder for families to borrow money for cars or home improvements or education of the children. Businesses have found it harder to get loans to expand their operations and create jobs. Many nations have suffered job losses, and have serious concerns about the worsening economy. Developing nations have been hit hard as nervous investors have withdrawn their capital.
Notwithstanding Bush's attempt to blame the victims for the crime, the easy credit was not caused by massive inflow of foreign capital. It was the other way around.
The massive inflow of foreign-owned capital denominated in dollars was caused by easy credit that grew out of monetary indulgence on the part of the US central bank, which alone can issue dollars. This monetary indulgence enabled the US to sustain a current account deficit with a capital account surplus of recycled dollars.
The US has been consuming more that it produces through recurring trade and fiscal deficits made possible by dollar hegemony, sucking up wealth form its trade partners who are not in any position to increase domestic consumption because real wealth has been exported to the US in return for fiat dollars that cannot be used in the domestic economy without causing inflation.
The reason homeowners defaulted on their mortgages en mass was not merely because home prices dropped, but because these mortgages were made on inflated home prices pushed up by the debt bubble to levels way above what could reasonably be supported by owner income. This is known generally as subprime lending. This was the problem of income disparity created by neoliberal free trade, which depressed wages in all economies around the world through cross-border wage arbitrage. Sublime lending also permitted no-down-payment mortgages, which gave borrowers an incentive to default when home prices fell below the value of the outstanding mortgage.
President Bush said with a straight face about his ideological surrender:
We are faced with the prospect of a global meltdown. And so we've responded with bold measures. I'm a market-oriented guy, but not when I'm faced with the prospect of a global meltdown. At Saturday's [November 15] summit, we're going to review the effectiveness of our actions.
Here in the United States, we have taken unprecedented steps to boost liquidity, recapitalize financial institutions, guarantee most new debt issued by insured banks, and prevent the disorderly collapse of large, interconnected enterprises. These were historic actions taken necessary to make - necessary so that the economy would not melt down and affect millions of our fellow citizens.
The "market-oriented guy" is forced to temporarily change his orientation toward massive government intervention in the market until the prospect of a global meltdown is averted. Since August 2007, the "unprecedented steps" the US has taken have so far failed to stabilize market seizure, price volatility and loss of confidence. Equity market value has fallen over 50%. Major financial institutions had to be nationalized or allowed to go bankrupt. Financial sectors in all market economies are moving closer toward total collapse by the day.
Once the floodgate of government intervention is open, the ailing US auto sector, in steady decline for several decades, takes advantage of the financial crisis to clamor for government bailout, demanded to be treated on par with distressed financial institutions in their access to more easy money from the government, on the basis of "too big to fail". Besides the auto sector, every other sector of the economy is waiting in line for federal government help, as are state and local governments.
Market capitalism continues to fail
Market capitalism is failing in every respect and in every corner of the economy even after the US pumped trillions of liquidity into the financial system, both by creating more fiat money and taking on more sovereign debt. Unemployment in the US has reached above 10 million and still rising; with large firms announcing plans to each lay off ten of thousands more.
The Federal government is reportedly prepared to provide more than $7.76 trillion, about half of current US annual GDP, which US taxpayers must repay in the future, to keep badly managed institutions form failing. The latest measure announced was to guarantee $306 billion of Citigroup debt.
Total US debt, defined as the sum of all recognized debt of federal, state and local governments, international, private households, business and domestic financial sectors, including federal debt to trust funds - but excluding the huge contingent liabilities of social security, government pensions, Medicare and other government off-budget items - stands at $53 trillion in November 30, 2008.
According to the Bank of International Settlement, the total outstanding notional amount of over-the-counter derivative contracts was $683.7 trillion as of June 2008, with gross market value of $20.4 trillion. Of this total notional amount, 66% are interest rate contracts, 10% are credit default swaps (CDS), 9% are foreign exchange contracts, 2% are commodity contracts, 1% are equity contracts, and 12% are other.
OTC derivatives are largely subject to counterparty risk, as the validity of a contract depends on the counterparty solvency and operational ability to honor its obligations. Against this volume of exposure, $7 trillion is additional obligation if interest rates were to shift 1% on a notional value of $700 trillion.
As of November 26, 2008, the US has committed or expended, without the benefit of an overall strategy, lurching from emergency to emergency, the following public funds to rescue with little success the collapsing finance sector:
From the Federal Reserve: (TAF) Term Auction Credit - $900 billion allocated; $415.3 billion expended.
Discount Window Lending - $140 billion
Banks (other loans primary credit) - $93 billion
Investment Banks (other loans primary dealer and other broker-dealer credit) - $47 billion
Loans to buy ABCP (other loans asset-backed commercial paper money market mutual fund liquidity facility) - $66 billion
AIG (allocated minus Treasury's $40 billion) - $112.5 billion; $87.4 billion expended
Bear Stearns (initial loan to support JPMorgan takeover) - $29.5 billion; $27 billion expended
(TSLF) Term Securities Lending Facility - $225 billion; $200.5 billion expended
Swap Lines (dollars provided by Federal Reserve to foreign central banks) - $602 billion (MMIFF) Money Market Investor Funding Facility - $540 billion
(CPFF) Commercial Paper Funding Facility *upper limit from Reuters - $1.8 trillion; $271 billion expended(TALF) Term Asset-Backed Securities Loan Facility - $200 billion
(GSE) Government Sponsored Enterprises and (MBS) mortgage-backed securities Program - $600 billion
From the Treasury:
(TARP) Treasury Asset Relief Program - $700 billion; $330 billion expended
Exchange Stabilization Fund to guarantee principal in money market mutual funds - $50 billion
Treasury direct purchases of MBS since September - $26.5 billion
Citigroup (Treasury+FDIC guarantees) - $238.5 billion
From the FDIC:
Guarantees for Banks - $1.9 trillion From Other Sources:
Automakers - $25 billion; $25 billion more pending
Consumer credit - $50 billion (out of TARP)
(FHA) Federal Housing Administration - $300 billion
Fannie Mae/Freddie Mac Nationalization - $350 billion
Grand Total: $7.362 trillion
A government plan to sop up hundreds of billions of mortgage securities spurred a bond rally that yanked 30-year home loan rates down half a percentage point to about 5.5% in the final week of November. The supply of unsold homes is near record highs. Buyers fearing job loss, or betting on even greater bargains, are unlikely to commit now to one of their biggest investments. Private sector employers cut 250,000 jobs in November, the most in seven years and the latest sign of recession fallout. US unemployment rate is expected to rise to 6.8% in November after setting a 14-year high of 6.5% the prior month.
After committing over $7 trillion into the finance sector, the market continued to fail and the economy heading downward. If just $2 trillion of the $7 trillion the government has so far committed for the financial sector were to be channeled directly to the unemployed, each worker would receive $200,000 (the equivalent of four years at average wages) to tie them over their jobless phase to kick-start the economy.
The same amount would support for one whole year 40 million middle-income families with an annual income of $50,000. If government funds were directed towards people rather than institutions, consumer demand will revive immediately and companies will sell again to make profits. The recession will end within 18 months.
But alas, the measures taken by the US government thus far were all designed to save the financial system and its institutions from the penalty of excessive risk rather than to help the economy and its people from the pains of recession. The net result of this top-down approach will be to punish the economy with a lost decade while feeding the cancer of a dysfunction financial system held together by unsustainable debt.
Still, the market-oriented US leader felt the need to adhere ideologically only to a top-down solution. The priority must be to save the dysfunctional financial system and its wayward institutions, while the public must wait for the presumed trickling down benefits, if any. A decade-long depression will be the result.
The leaders of the G20 have a collective responsibility to face the reality of the crisis to save the world economy from total collapse instead of meekly following misguided US rescue measures of adding more liquidity to a crisis created by excess liquidity.
The Farce of International Coordination
President Bush then reported the "good news" of international coordination:
In Europe, governments are also purchasing equity in banks and providing government guarantees for loans. In Asia, nations like China and Japan and South Korea have lowered interest rates and have launched significant economic stimulus plans. In the Middle East, nations like Kuwait and the UAE have guaranteed deposits and opened up new government lending to banks.
In addition, nations around the world have taken unprecedented joint measures. Last month, a number of central banks carried out a coordinated interest rate cut. The Federal Reserve is extending needed liquidity to central banks around the world. The IMF and World Bank are working to ensure that developing nations can weather this crisis.
None of these lip-service measures by other governments can be expected to have any significant impact on rescuing the US big domino if the US continues to follow a strategy of adding more liquidity to a crisis of liquidity trap which occurs when the nominal interest rate approaches zero, and the central bank is unable to stimulate the economy with conventional monetary measures. In a liquidity trap, market participants forego higher returns on physical or financial investments to flee to short-term cash accounts, exacerbating an economic downturn and leading to deflation.
Helicopter money
Fed chairman Ben Bernanke subscribes to Milton Friedman's prescription for a liquidity trap by bypassing financial intermediaries to give money directly to consumers or businesses, invoking the imagery of dropping money from helicopters. In essence, it is form of inflation targeting to reverse deflation. Helicopter money can only be dropped covertly to avoid ideological conflict and only to institutions deemed too big to fail. To inject liquidity into a distressed financial system, central banks during a financial crisis sometimes buy gold at above market prices or buying preferred shares and convertible bonds as hidden money to distressed firms.
Bernanke in a speech to business leaders in Austin, Texas on December 1, hinted at the possibility of further central bank relief for a stubbornly sagging economy with the purchase of Treasury notes and bonds to bring down long-term rates. Bernanke's comments immediately stirred further buying of longer-term Treasury bonds, pushing the yield of benchmark 10-year Treasury notes, already at a 31-year-low, to 2.719%.
The National Bureau of Economic Research announced on the same day that the US has been in a recession since December 2007, a year ago, already longer than all recessions since World War II. A long downturn is projected by many forecasters. The Dow Jones Industrial Average dropped 680 points, or 7.7%, to 8,149.09, the 12th biggest one-day percentage drop and fourth-sharpest point loss since the DJIA was launched in 1869.
The fall interrupted a five-day rally of 1,277 points, or 17%, caused previously by the announcement of a new $200 billion program to buy consumer debt and small business loans by Treasury and the Fed. Treasury Secretary Paulson announced that the Treasury has committed all but $20 billion of the first $350 billion Congress has authorized for Troubled Asset Relief Program (TARP).
Inflation targeting does not work if economic turmoil is caused by the bursting of a debt bubble created by monetary inflation, which could only be cured by allowing the bubble burst to liquidate the misallocated investment made during the bubble boom. The debt bubble burst has left the US with a national insolvency problem of insufficient income to support bloated asset price levels. US ideology of market fixation normally limits the solution to come only from market corrections. However, when market correction causes systemic market failure, market ideology is cast aside to make room for practical emergency measures to revive a market system hit by cardiac arrest.
Still, under this market ideology, government assistance is not allowed to be applied directly to distressed individuals who are innocent victims of a dysfunctional debt regime to help them increase their income to transition to a new viable financial regime in a new economic system. It can only be applied to distressed institutions deemed too big to fail. Yet nationalization of insolvent private institutions facing weak demand so that they can continue to survive massive losses in a market economy will only bankrupt the entire nation, bringing down all citizens with it.
What the US economy needs in this crisis is not inflation targeting but income targeting. Let's hope the new Obama administration has the sense to implement immediately a massive income policy when it hits the ground running on January 20, 2009.
Next: China the road to recovery
Henry C K Liu is chairman of a New York-based private investment group. His website is at .
Denial as the storm gathered
By Henry C K Liu
China's response to the current global financial crisis is predicated on the reality of the international situation and the separate responses of other major economies around the world.
It took more than a year for US President George W Bush, in whose country the decades-long credit joyride finally imploded in August 2007, to belatedly acknowledge that the financial crisis resulting from decades of US monetary indulgence and fiscal irresponsibility is not merely a passing shower needed to deflate the latest debt bubble in the housing sector of the US economy.
The credit turmoil turned out to be a catastrophic, global, financial
perfect storm of unprecedented dimension that will cause serious structural damage to all market economies around the world. It may even spell the end of the cowboy finance capitalism of the past two decades in which risks are socialized and gains privatized, with debt manipulated to act as phantom capital and high returns on pension funds of workers paid for with permanent loss of employment and regressively low wages for those still working.
Snake-oil theory of big market, small government
For decades, aggressive globalization and wholesale deregulation of finance have been propagated by the flawed US ideology of faith-based, capitalistic, free-market fundamentalism and of the alleged merits of government nonintervention in markets.
The snake-oil slogan of "big market and small government" has been promoted around the world as a win-win, neo-liberal miracle, good for all trade-participating economies and regurgitated tirelessly by neo-comprador economies such as that of Hong Kong. Ironically, free-market Hong Kong finds it necessary to turn to socialist China for government bailouts whenever its free market slows, while it continues to mindlessly boast the superiority of its free-market regime.
Hong Kong's infatuation with US propaganda notwithstanding, the fact is that US ideological imperialism on free-market fundamentalism allowed the financial crisis that began in the US in August 2007 to quickly lead to interconnected market failure in advanced, emerging and developing economies alike the world over.
Predatory dollar hegemony
The exporting economies have been lured into shipping real wealth to the US in exchange for US debt denominated in fiat dollars, which cannot be spent in their own domestic economy without monetary penalty and which must be returned to the US as capital to finance US sovereign debt. The adverse effects of this predatory monetary regime, known as dollar hegemony, differ on economies at different stages of development. But one common effect can be observed clearly: the helpless working poor in all trading economies around the world, who had no voice in economic, trade and monetary policymaking, did not benefit throughout the phantom boom phase from trade globalization and are now suffering the most in these days of reckoning when the boom bust.
US neoliberal trade globalization, having promised a primrose garden of economic growth, has instead led the global economy into a jungle of poison reed, resulting in the worst financial disaster in a century, setting the whole world ablaze with a financial firestorm. This unhappy fate was finally acknowledged as having been policy-induced by Alan Greenspan, the former chairman of the US Federal Reserve who was largely responsible for the monetary indulgence that had caused this hundred-year financial perfect storm. Greenspan confessed before Congress that his trust on transnational finance institutions for self-regulation as a survival instinct had been misplaced, leading him to a flawed policy in support of anarchical financial deregulation and permissive risk management.
Still, Greenspan left unmentioned his equally misplaced faith in central bank ability to mitigate the adverse effect of burst bubbles by creating larger sequential bubbles with more liquidity. The Federal Reserve under Greenspan repeatedly created money faster than the global economy could profitably absorb, creating serial bubbles denominated in fiat dollars. Greenspan insisted that it was not possible, nor desirable to identify an economic bubble in the making as he was inflating it with easy money lest economic growth should be prematurely cut short. It was a perfect example of the rule that intoxication begins when a drinker becomes unable to know its time to stop drinking.
On a more fundamental level, politically independent central banking under Greenspan, instead of being a market-stabilizing force, has become part of the destabilizing causes of recurring economic bubbles. The Hong Kong Monetary Authority (HKMA), the self-styled central bank notwithstanding the peg of the Hong Kong dollar to the US dollar at a fixed rate of 7.8 to 1, thus rendered itself to the status of a monetary policy subsidiary of the US Federal Reserve. When the US Fed eases monetary stance, HKMA must also ease to sustain the currency peg. Thus Hong Kong has been exposed to a contagious bubble from the US bubble.
HKMA chief executive Joseph Yam has for decades held up Greenspan as his policy guru, tirelessly declaring himself publicly without shame as a faithful disciple of the Wizard of Bubbleland. Greenspan has confessed publicly his policy blunder. The people of Hong Kong, now suffering the pains of the Greenspan virus, have yet to hear from the self-important Mr Yam to whom the people of Hong Kong pay an obscenely high salary, several times that of Greenspan as chairman of the Fed.
Fiat dollar liquidity destroys wealth
This US-induced global financial disaster that now threatens to keep the world in deep economic depression for another decade and more is essentially the product of US ideologically based policy and practices. While substantial damage has already been irreversibly done to the world economy by the collapse of economic bubbles caused by a liquidity flood, particularly to confidence in the market system, the US rescue strategy has been to keep the debt bubble from bursting with indiscriminate injections of liquidity.
Until the US monetary policymakers realize that excess liquidity denominated in fiat dollars cannot create wealth, but rather it destroys wealth, the debt-infested US economy will not begin to recover.
Further damage to the global economy cannot be averted without a fundamental change in US policy that has been exploiting its predatory monetary hegemony. This dollar hegemony grows out of a fiat dollar that has allowed the US to finance its decades-long current account deficit with a compulsory compensatory capital account surplus. This sucks wealth from the exporting emerging economies to the US to keep it as the world's richest economy, consistently consuming more than it produces with the help of debt denominated in fiat dollars that the US could print at will.
Now, in the face of a global firestorm of debt that the US has single-handedly created with its flawed ideology and dysfunctional monetary and trade policies, the international community is being asked to coordinate and follow still misguided US ideologically-constrained bailout measures to help the US deal with a global problem of its own making. Yet the solution lies only in fundamental reform of US policy.
The venue for this audacity was the White House Summit on Financial Markets and the World Economy of November 15, 2008, called by a lame-duck president whose office would last only five weeks beyond the summit. He invited the attendance of leaders of the Group of Twenty countries along with representatives of the United Nations, the World Bank, the International Monetary Fund, the Financial Stability Forum and other international agencies.
[The G-20 members are: Argentina, Australia, Brazil, Britain, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United States, and the European Union.]
The G-20 members combined produce 90% of global gross domestic product (GDP), account for 80% of world trade, and are home to two-thirds of the world's population. The summit was billed as the first of a series of follow-up summits to deal with the urgent and complex crisis.
The summit agenda, set by the US, was for world leaders to exchange views on three "important" issues: (1) to assess the progress made by the international community in response to the current financial crisis; (2) to discuss the causes of the financial crisis; (3) to discuss issues such as the regulatory norms and institutional reform in international finance and try to reach consensus on some principles.
The key issue of the basic flaw in neoliberal market fundamentalism was not on the agenda. World leaders were not asked to deliberate on new alternative economic orders to save the world from US-created impending financial disaster, but to "coordinate" with US efforts to validate flawed US ideology and to save predatory finance market capitalism based on it.
To drive home the point, President George W Bush gave a speech on "The Financial Markets and World Economy" at the Manhattan Institute in New York City on November 13, two days before the White House Summit, in which he claimed:
The leaders attending this weekend's meeting agree on a clear purpose - to address the current crisis, and to lay the foundation for reforms that will help prevent a similar crisis in the future. We also agree that this undertaking is too large to be accomplished in a single session. The issues are too complex, the problem is too significant to try to solve, or to come up with reasonable recommendations in just one meeting. So this summit will be the first of a series of meetings.
It will focus on five key objectives: understanding the causes of the global crisis, reviewing the effectiveness of our responses thus far, developing principles for reforming our financial and regulatory systems, launching a specific action plan to implement those principles, and reaffirming our conviction that free market principles offer the surest path to lasting prosperity.
First, we're working toward a common understanding of the causes behind the global crisis. Different countries will naturally bring different perspectives, but there are some points on which we can all agree: Over the past decade, the world experienced a period of strong economic growth. Nations accumulated huge amounts of savings, and looked for safe places to invest them. Because of our attractive political, legal, and entrepreneurial climates, the United States and other developed nations received a large share of that money.
It is a gigantic stretch of self deception to claim that the leadersattending the summit agreed on anything besides agreeing to meet. Attendance cannot be misrepresented as supportive of biased US views. The fact is that many in the world think that the idea of a global savings glut is a myth. The US is receiving a large capital account surplus only because of dollar hegemony, a geopolitically constructed peculiarity through which critical commodities, the most notable being oil, are denominated in fiat dollars, not backed by gold or other species since president Richard Nixon took the dollar off gold in 1971. This financial crisis is US-sourced and has spread to the rest of the world.
The recycling of petro-dollars into other dollar assets is the price
the US has extracted from oil-producing countries for US tolerance for the oil-exporting cartel, the Organization of Petroleum Exporting Countries, since 1973. Since then, everyone accepts dollars because dollars can buy oil, and every economy needs oil. Dollar hegemony separates the trade value of every currency from direct connection to the productivity of the issuing economy to link it directly to the size of dollar reserves held by the issuing central bank.
These dollar reserves held by foreign central banks by definition must be reinvested in dollar assets. Dollar hegemony enables the US to own, indirectly but essentially, the entire global economy by requiring its wealth to be denominated in fiat dollars that the US can print at will with little monetary penalty. Much of the world is suffering from a shortage of capital while non-dollar economies are prevented from financing their domestic development with sovereign credit and have to rely excessively on exports for dollars. There is no savings glut, only a dollar glut released by a wayward US central bank addicted to monetary laxative.
World trade is now a game in which the US produces at will fiat dollars of uncertain exchange value and zero intrinsic value, and the rest of the world produces goods and services that fiat dollars can buy at "market prices" quoted in dollars.
Blaming the victims for the crime
President Bush continued with his self-absolving explanation of the global financial crisis:
The massive inflow of foreign capital, combined with low interest rates, produced a period of easy credit. And that easy credit especially affected the housing market. Flush with cash, many lenders issued mortgages and many borrowers could not afford them. Financial institutions then purchased these loans, packaged them together, and converted them into complex securities designed to yield large returns. These securities were then purchased by investors and financial institutions in the United States and Europe and elsewhere - often with little analysis of their true underlying value.
The financial crisis was ignited when booming housing markets began to decline. As home values dropped, many borrowers defaulted on their mortgages, and institutions holding securities backed by those mortgages suffered serious losses. Because of outdated regulatory structures and poor risk management practices, many financial institutions in America and Europe were too highly leveraged. When capital ran short, many faced severe financial jeopardy. This led to high-profile failures of financial institutions in America and Europe, led to contractions and widespread anxiety - all of which contributed to sharp declines in the equity markets.
These developments have placed a heavy burden on hardworking people around the world. Stock market drops have eroded the value of retirement accounts and pension funds. The tightening of credit has made it harder for families to borrow money for cars or home improvements or education of the children. Businesses have found it harder to get loans to expand their operations and create jobs. Many nations have suffered job losses, and have serious concerns about the worsening economy. Developing nations have been hit hard as nervous investors have withdrawn their capital.
Notwithstanding Bush's attempt to blame the victims for the crime, the easy credit was not caused by massive inflow of foreign capital. It was the other way around.
The massive inflow of foreign-owned capital denominated in dollars was caused by easy credit that grew out of monetary indulgence on the part of the US central bank, which alone can issue dollars. This monetary indulgence enabled the US to sustain a current account deficit with a capital account surplus of recycled dollars.
The US has been consuming more that it produces through recurring trade and fiscal deficits made possible by dollar hegemony, sucking up wealth form its trade partners who are not in any position to increase domestic consumption because real wealth has been exported to the US in return for fiat dollars that cannot be used in the domestic economy without causing inflation.
The reason homeowners defaulted on their mortgages en mass was not merely because home prices dropped, but because these mortgages were made on inflated home prices pushed up by the debt bubble to levels way above what could reasonably be supported by owner income. This is known generally as subprime lending. This was the problem of income disparity created by neoliberal free trade, which depressed wages in all economies around the world through cross-border wage arbitrage. Sublime lending also permitted no-down-payment mortgages, which gave borrowers an incentive to default when home prices fell below the value of the outstanding mortgage.
President Bush said with a straight face about his ideological surrender:
We are faced with the prospect of a global meltdown. And so we've responded with bold measures. I'm a market-oriented guy, but not when I'm faced with the prospect of a global meltdown. At Saturday's [November 15] summit, we're going to review the effectiveness of our actions.
Here in the United States, we have taken unprecedented steps to boost liquidity, recapitalize financial institutions, guarantee most new debt issued by insured banks, and prevent the disorderly collapse of large, interconnected enterprises. These were historic actions taken necessary to make - necessary so that the economy would not melt down and affect millions of our fellow citizens.
The "market-oriented guy" is forced to temporarily change his orientation toward massive government intervention in the market until the prospect of a global meltdown is averted. Since August 2007, the "unprecedented steps" the US has taken have so far failed to stabilize market seizure, price volatility and loss of confidence. Equity market value has fallen over 50%. Major financial institutions had to be nationalized or allowed to go bankrupt. Financial sectors in all market economies are moving closer toward total collapse by the day.
Once the floodgate of government intervention is open, the ailing US auto sector, in steady decline for several decades, takes advantage of the financial crisis to clamor for government bailout, demanded to be treated on par with distressed financial institutions in their access to more easy money from the government, on the basis of "too big to fail". Besides the auto sector, every other sector of the economy is waiting in line for federal government help, as are state and local governments.
Market capitalism continues to fail
Market capitalism is failing in every respect and in every corner of the economy even after the US pumped trillions of liquidity into the financial system, both by creating more fiat money and taking on more sovereign debt. Unemployment in the US has reached above 10 million and still rising; with large firms announcing plans to each lay off ten of thousands more.
The Federal government is reportedly prepared to provide more than $7.76 trillion, about half of current US annual GDP, which US taxpayers must repay in the future, to keep badly managed institutions form failing. The latest measure announced was to guarantee $306 billion of Citigroup debt.
Total US debt, defined as the sum of all recognized debt of federal, state and local governments, international, private households, business and domestic financial sectors, including federal debt to trust funds - but excluding the huge contingent liabilities of social security, government pensions, Medicare and other government off-budget items - stands at $53 trillion in November 30, 2008.
According to the Bank of International Settlement, the total outstanding notional amount of over-the-counter derivative contracts was $683.7 trillion as of June 2008, with gross market value of $20.4 trillion. Of this total notional amount, 66% are interest rate contracts, 10% are credit default swaps (CDS), 9% are foreign exchange contracts, 2% are commodity contracts, 1% are equity contracts, and 12% are other.
OTC derivatives are largely subject to counterparty risk, as the validity of a contract depends on the counterparty solvency and operational ability to honor its obligations. Against this volume of exposure, $7 trillion is additional obligation if interest rates were to shift 1% on a notional value of $700 trillion.
As of November 26, 2008, the US has committed or expended, without the benefit of an overall strategy, lurching from emergency to emergency, the following public funds to rescue with little success the collapsing finance sector:
From the Federal Reserve: (TAF) Term Auction Credit - $900 billion allocated; $415.3 billion expended.
Discount Window Lending - $140 billion
Banks (other loans primary credit) - $93 billion
Investment Banks (other loans primary dealer and other broker-dealer credit) - $47 billion
Loans to buy ABCP (other loans asset-backed commercial paper money market mutual fund liquidity facility) - $66 billion
AIG (allocated minus Treasury's $40 billion) - $112.5 billion; $87.4 billion expended
Bear Stearns (initial loan to support JPMorgan takeover) - $29.5 billion; $27 billion expended
(TSLF) Term Securities Lending Facility - $225 billion; $200.5 billion expended
Swap Lines (dollars provided by Federal Reserve to foreign central banks) - $602 billion (MMIFF) Money Market Investor Funding Facility - $540 billion
(CPFF) Commercial Paper Funding Facility *upper limit from Reuters - $1.8 trillion; $271 billion expended(TALF) Term Asset-Backed Securities Loan Facility - $200 billion
(GSE) Government Sponsored Enterprises and (MBS) mortgage-backed securities Program - $600 billion
From the Treasury:
(TARP) Treasury Asset Relief Program - $700 billion; $330 billion expended
Exchange Stabilization Fund to guarantee principal in money market mutual funds - $50 billion
Treasury direct purchases of MBS since September - $26.5 billion
Citigroup (Treasury+FDIC guarantees) - $238.5 billion
From the FDIC:
Guarantees for Banks - $1.9 trillion From Other Sources:
Automakers - $25 billion; $25 billion more pending
Consumer credit - $50 billion (out of TARP)
(FHA) Federal Housing Administration - $300 billion
Fannie Mae/Freddie Mac Nationalization - $350 billion
Grand Total: $7.362 trillion
A government plan to sop up hundreds of billions of mortgage securities spurred a bond rally that yanked 30-year home loan rates down half a percentage point to about 5.5% in the final week of November. The supply of unsold homes is near record highs. Buyers fearing job loss, or betting on even greater bargains, are unlikely to commit now to one of their biggest investments. Private sector employers cut 250,000 jobs in November, the most in seven years and the latest sign of recession fallout. US unemployment rate is expected to rise to 6.8% in November after setting a 14-year high of 6.5% the prior month.
After committing over $7 trillion into the finance sector, the market continued to fail and the economy heading downward. If just $2 trillion of the $7 trillion the government has so far committed for the financial sector were to be channeled directly to the unemployed, each worker would receive $200,000 (the equivalent of four years at average wages) to tie them over their jobless phase to kick-start the economy.
The same amount would support for one whole year 40 million middle-income families with an annual income of $50,000. If government funds were directed towards people rather than institutions, consumer demand will revive immediately and companies will sell again to make profits. The recession will end within 18 months.
But alas, the measures taken by the US government thus far were all designed to save the financial system and its institutions from the penalty of excessive risk rather than to help the economy and its people from the pains of recession. The net result of this top-down approach will be to punish the economy with a lost decade while feeding the cancer of a dysfunction financial system held together by unsustainable debt.
Still, the market-oriented US leader felt the need to adhere ideologically only to a top-down solution. The priority must be to save the dysfunctional financial system and its wayward institutions, while the public must wait for the presumed trickling down benefits, if any. A decade-long depression will be the result.
The leaders of the G20 have a collective responsibility to face the reality of the crisis to save the world economy from total collapse instead of meekly following misguided US rescue measures of adding more liquidity to a crisis created by excess liquidity.
The Farce of International Coordination
President Bush then reported the "good news" of international coordination:
In Europe, governments are also purchasing equity in banks and providing government guarantees for loans. In Asia, nations like China and Japan and South Korea have lowered interest rates and have launched significant economic stimulus plans. In the Middle East, nations like Kuwait and the UAE have guaranteed deposits and opened up new government lending to banks.
In addition, nations around the world have taken unprecedented joint measures. Last month, a number of central banks carried out a coordinated interest rate cut. The Federal Reserve is extending needed liquidity to central banks around the world. The IMF and World Bank are working to ensure that developing nations can weather this crisis.
None of these lip-service measures by other governments can be expected to have any significant impact on rescuing the US big domino if the US continues to follow a strategy of adding more liquidity to a crisis of liquidity trap which occurs when the nominal interest rate approaches zero, and the central bank is unable to stimulate the economy with conventional monetary measures. In a liquidity trap, market participants forego higher returns on physical or financial investments to flee to short-term cash accounts, exacerbating an economic downturn and leading to deflation.
Helicopter money
Fed chairman Ben Bernanke subscribes to Milton Friedman's prescription for a liquidity trap by bypassing financial intermediaries to give money directly to consumers or businesses, invoking the imagery of dropping money from helicopters. In essence, it is form of inflation targeting to reverse deflation. Helicopter money can only be dropped covertly to avoid ideological conflict and only to institutions deemed too big to fail. To inject liquidity into a distressed financial system, central banks during a financial crisis sometimes buy gold at above market prices or buying preferred shares and convertible bonds as hidden money to distressed firms.
Bernanke in a speech to business leaders in Austin, Texas on December 1, hinted at the possibility of further central bank relief for a stubbornly sagging economy with the purchase of Treasury notes and bonds to bring down long-term rates. Bernanke's comments immediately stirred further buying of longer-term Treasury bonds, pushing the yield of benchmark 10-year Treasury notes, already at a 31-year-low, to 2.719%.
The National Bureau of Economic Research announced on the same day that the US has been in a recession since December 2007, a year ago, already longer than all recessions since World War II. A long downturn is projected by many forecasters. The Dow Jones Industrial Average dropped 680 points, or 7.7%, to 8,149.09, the 12th biggest one-day percentage drop and fourth-sharpest point loss since the DJIA was launched in 1869.
The fall interrupted a five-day rally of 1,277 points, or 17%, caused previously by the announcement of a new $200 billion program to buy consumer debt and small business loans by Treasury and the Fed. Treasury Secretary Paulson announced that the Treasury has committed all but $20 billion of the first $350 billion Congress has authorized for Troubled Asset Relief Program (TARP).
Inflation targeting does not work if economic turmoil is caused by the bursting of a debt bubble created by monetary inflation, which could only be cured by allowing the bubble burst to liquidate the misallocated investment made during the bubble boom. The debt bubble burst has left the US with a national insolvency problem of insufficient income to support bloated asset price levels. US ideology of market fixation normally limits the solution to come only from market corrections. However, when market correction causes systemic market failure, market ideology is cast aside to make room for practical emergency measures to revive a market system hit by cardiac arrest.
Still, under this market ideology, government assistance is not allowed to be applied directly to distressed individuals who are innocent victims of a dysfunctional debt regime to help them increase their income to transition to a new viable financial regime in a new economic system. It can only be applied to distressed institutions deemed too big to fail. Yet nationalization of insolvent private institutions facing weak demand so that they can continue to survive massive losses in a market economy will only bankrupt the entire nation, bringing down all citizens with it.
What the US economy needs in this crisis is not inflation targeting but income targeting. Let's hope the new Obama administration has the sense to implement immediately a massive income policy when it hits the ground running on January 20, 2009.
Next: China the road to recovery
Henry C K Liu is chairman of a New York-based private investment group. His website is at .
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