[R-G] [BillTottenWeblog] Scenes From the Global Class War

[Bill Totten]

Scrawny Geese; No More Golden Egg

by Michael Hudson

www.counterpunch.com (October 27 2008)


On Friday, October 24, the pound sterling dropped to just $1.58 (down
from $1.73 earlier in the week, an enormous plunge by foreign-exchange
standards), and the euro sunk to just $1.26, while Japan's yen soared by
ten per cent. These shifts threatened to disrupt export markets and
hence industrial sales patterns. Global stock markets plunged from five
to nine per cent abroad, and there was talk of closing the New York
market if stocks fell more than 1,000 points. Pre-opening trading saw
the Dow Jones Industrial Average down the maximum limit of 550 points
(largely on foreign selling) before bounding back to lose "only" 312
points as the dollar soared against European currencies.

Friday's currency turmoil and stock market plunge was a case of the
chickens coming home to roost from the class-war policies being waged by
European and Asian industry and banking squeezing their domestic
consumer markets - that is, labor's living standards - in favor of
export production to the United States. The internal contradiction in
this industrial and financial class warfare is now clear: To the extent
that it succeeds in depressing labor's income, it stifles the domestic
consumer-goods market. This disrupts Say's Law - the principle that
"production creates its own demand", based on the assumption that
employees will (or must) be paid enough to buy what they produce.

This has not been true for many years in Europe and Asia. But production
has been able to continue without faltering because of an international
deus ex machina: consumer demand in the United States.

This is not to say that no class warfare is being fought in the United
States. Indeed, living standards for most wage earners today are down
from the "golden age" of the late 1970s. But the US economy had its own
financial deus ex machina to soften the blow: Alan Greenspan's
asset-price inflation that flooded the banks with credit, which was lent
out to homebuyers and stock market raiders. Rising home prices were
applauded as "wealth creation" as if they were a pure asset, much like
dividends suddenly being awarded to one's savings account. Homebuyers
were encouraged to "cash out" on the rising "equity" margin, the
(temporarily) rising market price of their homes over and above their
(permanent) mortgage debt. So while most mortgage money was used to bid
up the price of home ownership, about a quarter of new lending was
reported to be spent on consumption goods. Credit card debt also soared.
In the face of a paycheck squeeze, US consumers were maintaining their
living standards by running further and further into debt.

This could not go on for very long. It never has. Debt-financed bubbles
can't last for more than a few years, even when fueled by a self-feeding
inflation of asset prices in which households and corporate industry
borrow more and more against the rising price of their collateral. But
once the housing bubble burst the game was up.

The game was up was up not only for the US economy, but also for foreign
economies that had geared their industrial production to serve the US
market rather than their own home markets. A global industrial slowdown
is now threatened, and must continue until foreign domestic markets are
nurtured - just the opposite trend from the recent generation of
neoliberal anti-labor policies.

To understand the dynamics at work, one needs to look at the balance of
payments - not so much the balance of trade itself, but the currency
speculation, international lending and arbitrage that has dominated
exchange rates over the past two decades. Exchange rates no longer
reflect relative wage levels, "purchasing power parity" or living costs
as in times past. Today, they reflect the flow of international
borrowing where interest rates are low and lending at a markup where
credit is tight - and then hedging this arbitrage, and jumping on the
bandwagon to speculate on which way currencies will go.

In this way the balance of payments and currency values have been
"post-industrialized" just as domestic economies themselves have been.
Instead of promoting industrial growth based on a thriving home market,
governments throughout the world have pursued a "post-industrial"
financial strategy of "wealth creation".

Japan's yen crisis - payback for the "carry trade"

Nowhere has this been more the case in Japan, whose economy has remained
in the doldrums ever since its bubble burst in 1990. For seventeen years
straight, quarter after quarter, Japanese land prices fell, and so did
stock market prices - and hence, the collateral pledged as backing for
loans. This quickly left Japan's banks with negative equity. The Bank of
Japan's response was to devise a way for them to rebuild their balance
sheets - to "earn their way" out of the bad loans they had made.

The policy was not to revive the faltering domestic market in Japan or
its industrial corporations. From 1945 through 1985, Japanese had a
model industrial banking system. But in 1985, US diplomats asked Japan
to please commit economic suicide. Angered by the striking success of
Japanese industry, US officials asked their compliant Japanese
counterparts to raise the yen's exchange rate so as to make its
industrial exporters less competitive, and in due course to flood its
own economy with credit so as to lower interest rates, thereby enabling
the Federal Reserve to flood the US market with enough cheap credit to
give a patina of prosperity to the Reagan Administration. This policy -
announced in the Plaza Accord of 1985 - led economist David Hale to joke
that the Bank of Japan was acting as the Thirteenth Federal Reserve
District and the Japanese government as the Republican Re-election
Committee.

Japan flooded its economy with credit, lowering interest rates and
fueling the world's largest real estate bubble of the 1980s. The stock
market also soared to reflect the rise in Japanese industrial sales and
earnings. But after the bubble burst on December 31 1989, the mortgage
debts and stock that that Japanese banks held in their capital reserves
fell short of the valuation needed to back their deposit liabilities. To
help bail out the banks, Japan's government urged them to engage in what
has become known as the "carry trade": lending freely created yen
credits to foreign financial institutions at remarkably low rates, for
these borrowers to convert into other currencies to buy bonds or other
assets yielding a higher rate. If the domestic Japanese market lacked
credit-worthy borrowers, let them lend to foreigners. As a new source of
revenue for the banks in place of loans to domestic real estate and
industry, low interest rates enabled them to flood the global economy
with credit. This served global finance by providing speculators and
"financial intermediaries" with an opportunity to get a free arbitrage ride.

Borrowing rates remained high within Japan itself. As veteran Japan
watcher Richard Werner, author of Princes of the Yen (2003) recently
described the situation to me, "while Japanese small firms were killed
by the continued refusal of banks to expand credit (and many a small
firm president was killed by having to sell a kidney to the loan sharks
he was forced to resort to), foreign speculators received ample yen
funds for a pittance". The silver lining to this credit creation was
that Japanese exporters were aided as the conversion of yen into foreign
currencies drove down the exchange rate. (Yen credit was "supplied" to
global currency markets, and was spent to buy and hence bid up the price
of euros, dollars, sterling and other currencies.)

So the yen remained depressed, helping Japanese sales of consumer goods,
while foreign borrowers were enabled to ride their own wave of
asset-price inflation. Speculators could borrow at only a few percentage
points interest in Japan, and convert their debt into foreign currency
and lend to equally desperate countries such as Iceland at up to fifteen
per cent.

Hundreds of billions of dollars, euros and sterling worth of yen were
borrowed and duly converted into foreign currencies to lend out at a
markup. Arbitrageurs made billions by acting as financial intermediaries
making income on the margin between low yen-borrowing costs and high
foreign-currency interest rates. As Ambrose Evans-Pritchard wrote over a
year ago in the Financial Times, "the Bank of Japan held interest rates
at zero for six years until July 2006 to stave off deflation. Even now,
rates are still just 0.5 per cent. It also injected some $12 billion
liquidity every month by printing money to buy bonds. The net effect has
been a massive leakage of money into the global economy. Faced with a
pitiful yield at home, Japan's funds and thrifty grannies shoveled
savings abroad. Banks, hedge funds, and the proverbial Mrs Watanabe,
were all able to borrow for near nothing in Tokyo to snap up assets
across the globe. BNP Paribas estimates this 'carry trade' to be $1,200
billion."

All this was conditional on the ability of lenders to get a continued
free ride. Now that the free lunch is over, Japan's postindustrial mode
of rescuing its banking sector is coming home to roost. It is doing so
in a way that highlights the inherent conflict between finance
capitalism and industrial capitalism. Whereas industrial expansion is
supposed to keep going - and can continue to do so as long as markets
keep pace with production - debt bubbles end, usually abruptly as we are
seeing today. Now that Iceland has gone bust, Hungary looks like it is
following suit.

As global currency markets no longer provide the easy pickings of the
last decade, the yen carry trade is being wound down. This involves
converting Icelandic currency, euros, sterling and other non-Japanese
currencies back into yen to settle the debts owed to Japanese banks.
This repayment - and hence re-conversion into yen - is pushing the yen's
price up. This threatens to make Japanese exports higher-priced in terms
of dollars, euros and sterling. Last week, Sony forecast that its
earnings will fall as a result, and other Japanese companies face a
similar squeeze in sales, not only from rising yen/dollar prices but
from the global slowdown resulting from two decades of pro-financial
anti-labor economic policies.

Evans-Pritchard rightly accused the world's central banks of having
created this mess. "It was they - in effect governments - who intervened
in countless complex ways to push down the price of global credit to
levels that warped behavior, as the Bank for International Settlements
(BIS) has repeatedly noted. By setting the price of money too low, they
encouraged debt and punished savings. The markets have merely responded
with their usual exuberance to this distorted signal. Private equity was
tempted to launch a takeover blitz at a debt-to-cashflow ratio of 5.4
because debt was made so cheap. The US savings rate turned negative
because interest rates were held below inflation." He should better have
said, asset-price inflation. Gains for wealth-holders at the top of the
economic pyramid polarized economies. What was rising for the bottom
ninety per cent was debt, not asset-price gains from easy money.

Financing the US "trickle-down" economy from below

The soaring yen and plunging foreign currency rates are the result of
unwinding the Japanese "carry trade" strategy to rescue its banks.
Japanese industry will pay the bill. And despite the fall in sterling
and the euro, Europe's policy of emphasizing exports to the American
market rather than to sell to its own domestic labor force looks pretty
bad in view of the imminent economic slowdown in store. US consumer
spending and living standards will have to fall - and it seems, to fall
sharply - in order to finance the "trickle down" economy at the top.
Current Treasury policy is to bail out the creditors, not the debtors.
The banks are being saved, but not US industry, and certainly not the US
wage earner/consumer. Instead of pursuing a Keynesian type of deficit
spending in a manner that will increase employment (government spending
on goods and services, infrastructure spending and transfer payments),
the Treasury and Federal Reserve are providing money to the banks to buy
each other up, consolidating the US financial system into a
European-type system with only a few major banks. The financial system
is to become monopolized and trustified, reversing two centuries of
economic policy aimed at  preventing  financial dominance of the economy.

None of the money being given to the banks really will trickle down, of
course. Instead, the largest upward transfer of property in over seventy
years will occur. The policy of giving money to the wealthiest sectors -
these days the financial sector - turns the trickle-down economy into a
euphemism for the concentration of wealth. The pretense is that
America's economy needs the financial and property overhead in order for
the "real" economy to "take off" again. But a stronger financial sector
selling yet more debt to the economy at large threatens to deter
recovery, not to speak of a new takeoff.

Seeing the imminent shrinkage of the US market, lenders and investors
are dumping their shares, not only those of US firms but also stocks in
European and Asian export sectors. This is the "inner contradiction" of
today's financial rescue operation. Finance itself cannot survive in the
face of a stifled domestic "real" economy.

So the world ought to be at an ideological turning point. But the last
thing that Europe's oligarchy wants to see is higher labor standards.
Nor does the US financial class. Europe and Asia put their faith in a US
consumer-goods market rather than their own. The US financial sector
found this appealing as long as consumption was financed by running into
debt, not by workers earning more money or paying lower taxes.
Industrial and political leaders throughout the world have been so
anti-labor that there is little thought of raising domestic living
standards via higher wage levels and a tax shift off labor and industry
back onto property where progressive tax policies used to be based.

Here's why it is impossible to go back to the past, as if this were some
kind of normal condition that can be recovered. When Alan Greenspan
flooded the mortgage market with credit, homeowners borrowed against
("cashed out" on) the rise in housing prices as if their homes were a
piggy bank. The difference, of course, is that when one draws down a
bank account there is less money in it, but no debt is involved to
absorb future income in repayment schedules. "Equity loans" have left a
debt residue, which now has turned into negative equity with loans still
needing to be repaid. This will leave less for consumption. So US
consumer spending will fall because of (1) no more easy mortgage or
credit-card credit, (2) debt deflation as consumers repay past
borrowing, "crowding out" other forms of spending, and (3) downsizing
and job losses lead to falling wage income.

Lower consumer spending means less sales by US and foreign manufacturers
- especially those in countries whose currency is rising against the
dollar (for example, Japan). Lower sales mean lower earnings, which mean
lower stock prices. And in the stock market itself, price/earnings
ratios are falling as the credit that fueled stock-market speculation by
hedge funds and other arbitrageurs is cut back. So the combination of
falling price/earnings ratios and falling earnings mean less in the
denominator (earnings) to be multiplied into prices (earnings
capitalized at the going interest rate).

Declining stock market prices are reducing the coverage of corporate
pension funds (as well as personal retirement accounts), requiring
higher set-asides to fully fund these accounts. In the face of
tightening bank credit, this will cut back new corporate spending on
plant and equipment, further slowing the economy.

As foreign exporters are rudely awakened the dream of an American
demand, when will the point come at which Europe and Asia seek to build
up their own domestic consumer markets as an alternative? The first
problem is to overcome the ideological bias in which central bankers are
indoctrinated, in a world where politicians have relinquished economic
policy to bankers trained in Chicago School financial warfare against
labor and even against industry. It probably is too much to hope that
today's European central bankers and kindred economic managers will drop
their neoliberal anti-labor ideology and see that without a thriving
domestic market, their own industrial firms will languish. The solution
must come from a revived political sector representing the interests of
labor, and even of industry itself as it sees the need to revive
domestic markets.

_____

Michael Hudson is a former Wall Street economist He was Dennis
Kucinich's chief economic advisor in the recent Democratic primary
presidential campaign, and has advised the US, Canadian, Mexican and
Latvian governments, as well as the United Nations Institute for
Training and Research (UNITAR). A Professor at University of Missouri,
Kansas City Hudson is the author of many books, including Super
Imperialism: The Economic Strategy of American Empire (new edition,
Pluto Press, 2002) He can be reached via his website, mh at michael-hudson.com

http://www.counterpunch.com/hudson10272008.html


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