Monday, November 26, 2012

Capitalism, Creditism and a New Global Depression?

New Left Review 77, Sep-Oct 2012
Interview with RICHARD DUNCAN

You were one of the very few analysts to predict the full enormity of the financial crisis, writing as early as 2003 of a coming credit crunch that would have ramifications throughout the asset-backed securities sector, necessitating giant bail-outs for Fannie Mae, Freddie Mac and financial-insurance companies, and a possible meltdown in the multi-trillion-dollar derivatives market. This prescience was in stark contrast to the complacency of most mainstream economists. Could you describe how you came to write The Dollar Crisis—what was the course of your intellectual development and what did you learn from your experience as a Far East securities analyst?

I grew up in Kentucky and went to Vanderbilt University. My plan was to go to law school, but I didn’t get in. Plan B was to go to France for a year, picking grapes. I got a job as a chauffeur in Paris, driving rich Americans, and made enough money to backpack around the world for a year, in 1983 and 84. So I was lucky enough to see the world when I was very young. I spent a couple of months in Thailand, Malaysia and Singapore—and even a couple of months there was long enough to realize: go east, young man.

Go east, because?

Economic opportunity. It was obviously booming—there were big skyscrapers going up, and people couldn’t read maps of their own street. So I went back to business school in Boston, at a time when there was of course very little economic growth in the United States. When I finished business school, going to Asia seemed the obvious thing to do. I found a job in Hong Kong, as a securities analyst with a local, Hong Kong–Chinese stock-broking company. This was 1986. In the first twelve months I was there, the Hong Kong stock market doubled—then I woke up one morning and learned that Wall Street had fallen 23 per cent overnight, and Hong Kong immediately fell back to where it had started. By 1990 I had joined James Capel, the oldest and largest UK stock-broking company at that time, and they sent me to Thailand to manage their research department there. We had ten analysts watching all the companies on the Bangkok stock market. At first, there really was something of a Thai miracle—the growth was solid and fundamental. But very quickly, by 1994, it was obviously a bubble and I started being bearish on the market. I wasn’t saying it was going to collapse, but the growth was going to slow down. But it just kept accelerating, and the bubble turned into a balloon. When it did finally pop, in 1997, Thailand’s GDP contracted by 10 per cent and the stock market fell 95 per cent in dollar terms, top to bottom.

So I witnessed at close quarters a very big boom-and-bust cycle, over a very short period of time. And while I was wrong for several years, I had plenty of time to think about why I was wrong. I started reading a lot of macro-economics: Keynes, Schumpeter, Milton Friedman’s monetary history of the US, the classic works. There was also a sort of lightning-flash moment, around 1994. Five years earlier I had taken a group of fund managers on a trip around the Pearl River Delta, from Hong Kong up to Canton, and back down the other side to Macao. What we saw, all along this vast delta, were miles and miles of factories, as far as the eye could see, full of nineteen-year-old girls earning $3 a day. It was in 1994 that the meaning of this really became clear to me: globalization was not going to work. The US would have a bigger and bigger trade deficit, and the American economy would continue to be hollowed out. It was unsustainable—the demographics made it impossible for this system to work. The Dollar Crisis, which came out in 2003, examined the way those global imbalances were blowing bubbles in the trade-surplus economies, and how the money boomeranged back into the US. I came to see that the unlimited credit expansion enabled by the post-gold, post-Bretton Woods international monetary system was where it all began.


What’s been the impact of quantitative easing on the economy as a whole?

The most important short-term effect has been to allow government spending to support the economy while keeping interest rates low. Another aspect, with QE1 in particular, was that the government bought up toxic assets, like the debt issued by Fannie Mae and Freddie Mac. That allowed the financial sector to deleverage by $1.75 trillion, as it swapped mortgage-backed securities for cash. It didn’t work that way in Britain, because the Bank of England didn’t buy assets like that from the banking system, it only bought government bonds. So the British financial sector is still very highly leveraged, whereas in the US it is much less leveraged than it was. Thirdly, every round of quantitative easing drives up the stock market and commodity prices (Figure 12). To some extent higher stock prices create a positive wealth effect, which supports the economy; some sectors will benefit from higher food prices—Mid-West agribusiness, for example—but it’s bad for American consumers; the same goes for the rising price of oil.

Since around 2011, I’d say the costs of QE have been starting to overtake its benefits, which are subject to diminishing returns. Quantitative easing has created food-price inflation that is very harmful for the two billion people who live on less than $2 a day. I’ve read that global food prices went up 60 per cent during QE2, and this was one of the factors that sparked off the Arab Spring. The oil-price spike has been very negative for the US economy; the 2011 slowdown in US consumption was due to higher food and oil prices. It comes back to the old quantity theory of money: if you increase the quantity of money, prices go up. So far, this has barely affected manufactured goods because of the huge deflationary impact of globalization and the 95 per cent drop in the marginal cost of labour that it’s brought. So we don’t see any CPI inflation, because of this offsetting deflationary force. But food prices have gone up everywhere. If the dollar price of food goes up—if rice prices go up in dollars—then rice prices go up everywhere in the world, because otherwise they’d just sell into the dollar market. So if US rice prices go up, Thai rice prices go up. And when the Fed prints dollars, food prices go up. That’s the main drawback, the one real big problem of QE—otherwise it’d be a great thing: print money, make the stock market go up, everybody’s rich and happy. But it has this impact of creating food-price inflation.

What effect has it had on profits and investment? US business profits have been hitting 15 per cent this year, according to the Economist, but corporations seem to be sitting on cash mountains that aren’t being used.

Yes, profits are very high, first of all because labour is getting a lower and lower share. Also, as a percentage of GDP, US corporate tax last year was the lowest it has been since the 1950s. In total, the tax revenue for the country as a whole was under 15 per cent of GDP, which is, again, the lowest since the 1950s. So, yes, corporate profits have been exceptionally good, although this quarter, suddenly everyone’s concerned that they may be dropping. But there’s a fundamental problem: there are no viable investment opportunities. So much credit has been expended and so much capacity built that we already have too much of everything relative to the amount of income, as it’s currently distributed, to absorb it. If you invest more, you’re going to lose your money; if you take your corporate cash-flow every year and buy government bonds, you can preserve your money for a better day—but that helps push down bond yields to these historic low levels. That’s why, even in Japan, after two decades of massive fiscal deficits, the ten-year government bond yield is only 0.8 per cent; in Germany, it’s 1.2 per cent; US, 1.5 per cent; UK, around 1.6 per cent. They’ve never been lower, and this is part of the reason. When bubbles pop, there’s no place to invest the money profitably, so it’s better to put it in government bonds.

What are the options, over the longer term?

I think there are three ways forward for the US economy—three paths policy makers could take. Option one is what the libertarians and Tea Party people want: balance the budget. That would result in immediate depression and collapse, the worst possible scenario. The second option is what I call the Japan model. When Japan’s great economic bubble popped twenty-two years ago, the Japanese government started running very large budget deficits, and have done that now for twenty-two years. The total amount of government debt to GDP has increased from 60 per cent to 240 per cent of GDP. That’s effectively what the US and British governments are doing now: running massive budget deficits to keep the economy from collapsing. They can carry on doing this for another five years with very little difficulty, and maybe even for ten years. The US government debt is only 100 per cent of GDP, so they could carry on for another five years and still not hit 150 per cent. But though it’s not clear how high it can go, it can’t go on forever. Sooner or later—say, ten or fifteen years from now—the US government will be just as bankrupt as Greece, and the American economy will collapse into a new Great Depression. So, that’s option two. It’s better than option one, because it’s better to die ten years from now than to die now; but it’s not ideal.

Option number three is for the US government to keep borrowing and spending aggressively, as they’re doing now, but to change the way they spend. Rather than spending it on too much consumption, and on war, for instance—the US government has so far spent $1.4 trillion invading Iraq and Afghanistan—they should invest it; not just in patching up the roads and the bridges, but invest it very aggressively in transformative 21st-century technologies like renewable energy, genetic engineering, biotechnology and nanotechnology, on a huge scale. The US government could put a trillion dollars into each of these industries over the next ten years—have a plan to develop these new sectors. A trillion dollars, let’s say, in solar energy over the next ten years: I’m not talking about building solar panels for sale in the market; I’m talking about carpeting the Nevada desert with solar panels, building a grid coast-to-coast to transmit it; converting the automobile industry to electricity, replacing all the gas stations with electric charging stations, and developing new technology to make electric cars run at 70 miles an hour. Then, ten years from now, the US will have free, limitless energy. Trade will come back into balance, because we won’t have to import any foreign oil, and the US will be able to spend $100 billion less a year on the military, because it won’t have to defend Gulf oil. The US government could tax the domestically generated electricity, and help bring down the budget deficit; and the cost of energy to the private sector would probably fall by 75 per cent—that in itself could set off a wave of private-sector innovation that would generate new prosperity.

If the US government invested a trillion dollars in genetic engineering, it’s probable they could create medical miracles: a cancer cure, or ways to slow the metabolic processes of ageing. We need to think in terms of peace-time Manhattan Projects: bring together all the best brains, the best technology, set them targets; use ‘creditism’ to produce results. We can all now see the flaws in creditism—they’re obvious. But as a society, I think the US is overlooking the opportunities that exist within this new economic system—the opportunity for the government to borrow massive amounts of money at 1.5 per cent interest and invest it aggressively in transformative technologies that restructure the US economy, so that it can get off its debilitating dependence on the financial sector, which has developed into a giant Ponzi scheme, before it all collapses. If not, then the US economy is likely to go down sooner or later into a lethal debt–deflation spiral.

Presumably this ‘creditist’ strategy could only apply to the US economy, though?

Not necessarily. For example, the Bank of England has printed so much money to buy up government bonds that it now owns more than a third of Britain’s entire debt. Now, it didn’t cost the Bank a single penny to buy all those bonds—it didn’t even have to buy any paper or ink to print the money; it’s all electronic now. So why not just cancel them? It wouldn’t cost anybody a thing; even if somehow it bankrupted the Bank of England, it could just print more money to recapitalize itself. Overnight, Britain would have a third less outstanding government debt and its credit rating would improve enormously. The government would announce that it was going to take advantage of this historic opportunity to increase government spending and invest it in new industries, so that Britain can finally wean itself off its debilitating dependence on Ponzi finance and develop manufacturing industries again. For example: throw $100 billion at Cambridge to invest in genetic engineering over the next three years, to become the dominant genetic-technology force on earth. Meanwhile create jobs and fix the infrastructure, at the same time.


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