Thursday, April 30, 2009

An Analysis of International Monetary Relations – Part 2: Where We Are

These days, references to the Great Depression and the Bretton Woods system abound. Analogy with the past crises is supposed to shed light on the present.

In analogy, we seek to establish sameness between two disparate objects. “Bone to dogs is like meat to cats” highlights the universal need of animals for food. The analogy works because that need is a defining and unchanging attribute of animals.

History is dynamic. The snapshots of historical events – a Great Depression here, a monetary crisis there – might have some surface resemblance to some aspects of the current crisis, but they could offer nothing by way of understanding the problem at hand. The secret of understanding history is knowing the nature of its dynamism, the way the changes take place.


”A major lesson of the crisis is that the remarkable overall performance of the global economy between 2003 and 2007 contained within it the seeds of its own destruction”.
Thus spoke the U.S. Treasury secretary Timothy Geithner the other day in the Economic Club of Washington.

Has the crisis turned him into a dialectician? “The global economy containing the seeds of its own destruction” – Hegel himself could not have said any better.

The answer is No. His absurd time frame betrays his tenuous grasp of the roots of the crisis. (The time frame is absurd in terms of understanding the crisis, but it is not random. Geithner unwittingly ties the rise of mortgage products with the destruction of Fannie Mae and Freddie Mac; 2003 is about the time Fannie and Freddie were neutered.)


The crisis we are witnessing is not the result of any exuberance in any particular period, however much the exuberance might have played a role in it. It is not the doing of rogue traders, unscrupulous speculators, careless lenders or irresponsible borrowers -- even though these elements were all present. Neither is it a Black Swan, a 100-year flood, or a once-in-a-lifetime event. All this by way of saying that it is not an aberration. It is the natural, necessary and inevitable consequence of the working of the so-called Anglo-American model of finance, rightly claimed as the most developed form of finance. This point is critical. The crisis came about because of, not despite, the system’s sophistication and is an inseparable part of it. The moment we approach it as an exception, we are lost.


The point about “natural, necessary and inevitable” outcome must be understood. The adjectives refer to a state of affairs brought about by the internal developmental logic of the system. Only knowing, conscious human action can interrupt or derail such process. Good intentions, grand ideals, great expectations and the like would not do; they are literally immaterial.


In the early days of television, there were grandiose predictions that the new medium would bring culture to masses. Banjos in Alabama were going to play Appassionata, mortgage-ridden farmers around Chicago, Chaconne. We know how that one turned out.

There is nothing preordained about TV turning into a vast wasteland. It could bring culture to masses. But the “business model” sets the direction and limitation of what can be achieved. Trash TV is the natural, necessary and inevitable fate of a medium whose raison d’etre is selling stuff to masses.

The same goes for the notion of the Internet bringing literacy to the masses. Or microloans brining prosperity to Indian peasants. Or casinos solving the housing and employment problem in Atlantic City – remember that one? You get the idea.


Finance capital has a distinct mode of existence which creates the realm of finance. The uncritical eye sees this sphere as something independent, different and separate from the “real economy”. Hence, the nonsense about whether the “real economy” – like pornography, never defined but always assumed to be understood – could be affected by the losses in Wall Street. You recall this was the intellectual question of the last year.

In reality, finance capital is an integral part of the economic system of a country. In its less developed stages, when its size is relatively small compared to the industrial capital and its activities limited to simple lending and borrowing, it has limited sway over the economy. As its size, reach and complexity increases, its influence likewise grows. This real-life development is reflected in the rise of the academic discipline of finance, which, originally a backwater part of economics, has come to dominate the mother science.


In its latest, historically most developed form, finance capital morphs into speculative capital. This is a gradual process, with the size of speculative capital constantly increasing. At this stage, trading, the mode of existence of speculative capital, begins to influence financial markets to the point that even public finance decisions must be made with an eye to accommodating its needs.
The government has taken the first step toward a revival of the 30-year bond, an unexpected shift that could provide an important tool to grapple with the nation’s troublesome budget deficit and its creaky pension system.
This is The New York Times, reporting the Treasury’s decision to reissue the 30-year bond. The paper frames the decision as the creation of a budget management tool, but few paragraphs later in the same article, the Treasury officials flatly refute that spin.
Treasury officials said yesterday that the decision had nothing to do with the budget deficits.
So what prompted the decision? Perhaps the following – again, from the same article:
Wall Street ... has been clamoring for a revival of the bond almost since it was abandoned in 2001 ... The 30-year bond is a longer-term security that is more volatile than shorter-term securities. And Wall Street traders love volatility because it is an opportunity to make money. The committee from Wall Street that advises the Treasury on the sales of government debt recommended this week that the 30-year bond be revived.

Still, where exactly was Wall Street's interest in reviving the long bond? Were there not sufficient amounts of Treasuries to play with?

The answer is No. The daily volume of the repo and tri-party repo market alone in which the U.S. Treasuries exchanged hands had reached and surpassed $6 trillion. That is, the entire public debt of the U.S. government was being turned over once a day. What was driving this feverish activity?

I touched upon this question in several places, including here, in discussion the structure of the financial markets in the U.S, and also here and here. I will return to this subject in detail in Vol. 4 of Speculative Capital. The critical point to note is that an increase in demand increases the price of treasuries and pushes their rates down. Treasuries rates are the frame of reference for all commercial rates in the U.S. and much of the globe. In this way, finance capital encourages borrowing by all parties, large or small, public or private. The U.S. consumer, whose real income has been falling since 1971, sees this as an opportunity. So the consumer debt soars and the reach of finance capital is extended.


I repeat: finance capital is an integral part of a nation's economy. As it develops and expands: i) its reach extends beyond the national borders; and ii) it becomes the catalyst and enabler not only of the monetary relations but the economic relations as well. Globe-spanning operations of large corporations presuppose and rely on “sophisticated” capital markets.


As an example of economic relation, take the case of WalMart. The company produces virtually all its products in China. That is the main reason China has amassed $2 trillion reserves, about $800 billion of which is invested in treasuries.

Meanwhile, cheap imports from China enable WalMart to reduce the cost of living for all workers. That helps keep wages low and profits high for all corporations. At the same time, workers have to borrow the shortfall in their budgets due to their low wages. It is a perfect one-two punch.


The first and foremost order of a system is self-preservation. The “order” is not so much a conscious mandate but a built-in mechanism; a system without such mechanism could not exist and would not last.

Finance capital’s immediate self-interest, expansion through maximizing profit, collides with and contradicts its existence as a going concern. This is most vividly seen in the case of speculative capital – capital engaged in arbitrage. Arbitrage is self-destructive; it eliminates opportunities that give rise to it. The destruction you are seeing in all spheres of the economy, not in businesses anymore but in the business models, is the natural, necessary and inevitable consequence of what transpired in the past 35 years.

That is where we stand now, where money, to the tune of $13 trillion that the U.S. government has committed to every sphere of economic activity, cannot solve an economic crisis. That is what is qualitatively different about this crisis. And that is why it is no use looking back at the past crises for solutions; none will be found.