Chinese Check Us

For a while now it has been obvious that China is the dominant global power, and that it has accumulated, by a combination of skilful strategem and sheer hard work, the power to pull the plug on the US economy at any moment. It is almost exactly a year since Hilary Clinton's humiliating visit to Washington, when she almost begged the Chinese not to do this. When we hear that China is now offering to also buy the Greek debt – for which we might read by the Greek economy, given the way things stand in that country just now – it raises intriguing questions about why China became a 'state capitalist' country in the first place.

The use of that phrase implies that China is following the rules of the same economic game, perhaps with different motives. It is clear that China has understood the money-work nexus that lies at the heart of the capitalist game but there seems no reason to assume that they have any respect for the game itself. They have responded to its rules by keeping a rigid control over their own currency (a fact much bemoaned in Washington and the pages of The Economist alike), and working extraordinarily hard to displace the need for most of the other labour in the global marketplace.

Meanwhile the the shift in the designation of the Chinese currency away from the yuan (as it was traditionally called) to the renminbi (or people's currency) implies a shift from a domestic to a global currency. In much the same way that China accumulated pieces of eight that the Spanish had minted in their new world colonies, it is now accumulating hoards of US paper. Although the renminbi is surely the most powerful currency in the world today, it is not held as reserves by foreign governments. So long as China is prepared to buy US debt and use it as a trading currency then the dollar is secure. Once it decides its economy can grow on the basis of domestic consumption alone it could easily just walk away, leaving the dollar to crash.

In conclusion we can see that China is winning the work game and is also winning the money game. So far China has used this power to gain access to the world's rapidly diminishing resources, especially by striking deals in Africa that are far more favourable than those that Western nations have offered. Compared to our primitive and short-term economic thinking, the Chinese appear to be demonstrating a master play: as they have adopted our industrial methods and excelled us in their use, so they are playing the economic game we invented better than we are.

On a more conspiratorial note, what are we to make of the inscrutable Mr Li who, according to John Lanchester's book Whoops! was instrumental in creating the algorithm that lies behind explosion of collateralised debt obligations that led US traders to destroy the global financial system:

'Li had been sent to North America on a government scholarship in the late 1990s to learn about capitalism. . . In 2000, while working at J.P.Morgan, Li managed to apply a piece of mathematics called a Gaussian copula function to the creation of CDOs' (p. 97) His paper, published in the Journal of Fixed Income, was attractively titled 'On Default Correlation: A Copula Function Approach'. It offered a way to model how different types of stocks move up or down in value together. This enabled the financiers to reduce the risks associated with mortgage-backed CDOs to a single number and the trade took off.

To imagine Mr Li on a mission for the Chinese government is too appealing to be true, but one way or the other it seems that the 'state capitalist' power has out-manoeuvred the 'market capitalist' power and we are all just waiting to see when they will assert their authority. Tweet

One Day All Money Will be Created this Way

In an earlier post I questioned what might be the limitation on the policy agreement between the Bank of England and the UK Debt Management Agency that one can create money from thin air which is then used to buy UK national debt. For a while I have been calling for a transparent process to reduce the the level of this debt from the unpayable quantities announced in the Budget. I now realise that there is a very murky version of such a policy already in operation.

So what prevents the UK government from eliminating the whole of our national debt in this way, by creating money from thin air, or what Mary Mellor calls 'fresh air money'? The traditional response would have been 'Inflation' - because 'once the economy picks up again' there will be too much money in the system. The created money is buying debt that was generated to pay the debts of the banks. So the fact that the Bank of England is countenancing this suggests that nobody expects the 'assets' that we have bought from those banks to ever be worth anything. They are not a future inflation risk because they are as worthless as we always expected - debt and definitely not assets.

Such a policy of creating money to repay our own debt cannot possibly make the UK less solvent, since it is removing the quantity of debt and thus improving out balance-sheet. So why is Standard & Poors threating to downgrade our credit-worthiness as a nation from three stars to two? Leaving aside the question of how much weight we should attach to the views of these agencies that were quite happy with the banks' utterly worthless assets, why should they be making this announcement now?

It seems that there is a struggle going on at the heart of capitalism and this is a shot across the bows of governments that are reneging on the deal they made with corporate investors and the sovereign wealth funds controlled by national governments - the two groups who buy UK national debt.

How does it affect the corporate bond-holders if much of our national debt is simply eliminated by sleight-of-hand? One would have thought that it would have increased their ability to extract work from the labourers of Britain to pay the interest on their gilts, since they are now competing with fewer holders of gilts for their share of this value.

As for national governments holding sterling as reserves, they may become uneasy (queasy?) about the value of these assets, since the QE buy-back policy suggests an inability to support the levels of debt that have been taken on by the UK government. But again, the reality is that as the level of debt is managed down, the ability of UK plc to make good on what remains is increased.

The real issue is a political one. Money is being created from thin air to enable banks that extracted huge amounts of value during the asset bubble to carry on functioning - to maintain themselves as ongoing concerns that can thus continue to hold these 'assets'. What must really frighten the board of Global Capital Inc. is the thought that we, the revolting peasants of these islands, might demand that money is created in a similar way to pay for schools, hospitals and the others services that are so under-financed.

So the downgrading of national debt is a shot across the bows of a government that has increased investment in the public sector in recent years - the lastest move by the privateers to establish their power over our national economic life following a time when the government was forced to introduce a de facto socialist regime. It reinforces that massive transfer of value to the rich that the bank bailout represents, and reinforces the rules of the capitalist game that those who earn must work for their living, while those who own need not. Creating money directly is a head-on challenge to these rules and this is why it must be undermined. Tweet

International Monetary Farce

Where do you turn as national chancellor when your country is bankrupt? If you don't have a reserve currency to protect you this is a situation you are pretty likely to face in the coming months. Your only option is to hope that you get in while the IMF still has some funds.

The International Monetary Fund is the part of the global financial system that is supposed to support the occasional accident that results from over-exuberant capitalist enterprise. It is not in a position to support the whole global banking system. Its pot apparently only extends to $200bn, which, given the size of money flows we've seen recently, appears extremely modest.

So, it could be that the Fund will be coming to national governments, asking them, on our behalf, to put our hands in our pockets again. Now we will be expected to bail out not only our own banking system, but whole economies across the world. The countries themselves will be required to take on more debt - the last thing they actually need. Surely it would be better to cancel all these debts in one almighty jubilee and negotiate the whole system again from scratch?

Imagine yourself as that national chancellor. You have only done what you were advised by economic theory. You have no control over global capital flows, and is isn't really your fault that your rely heavily on oil, or steel, or that you are a country which financial speculators don't like the look of.

The IMF tends to make offers to people who are in no position to refuse, and the offers are usually in the neoliberal mode, requiring restraint on public spending, a contracting state, and more market liberalisation. Exactly the sorts of policies that got those countries into the mess in the first place.

Interestingly, in the past few years many of the poorer countries who have been the recipients (victims?) of IMF loans have wised up and chosen to repay (see stories on Argentina and a story of recent IMF politics). In the insane world of banking, without anybody to lend to, the IMF would have gone bankrupt. It does seem a strange coincidence that exactly at this point a whole new range of countries are being forced into bankruptcy and into crippling loans that will keep the IMF afloat for another few decades. Tweet

So Long, and Thanks for all the Fish

I feel tempted to begin in the immortal words of E. J. Thribb, 'so farewell then Iceland'. The country has overreached itself and been forced to learn the lessons of hubris. I had a conversation with my son in which I said 'Iceland is bankrupt' and he asked, 'What? The supermarket?'. That is the nature of the global economy - it is quite simply beyond belief.

What is the difference between Iceland and the UK or US? For once, in economics, there is a simple answer to that question: we have reserve currencies; Iceland does not. The viking raiders who bestrode the globe arranging impossible deals failed to grasp this fact about the global economy. Only those who are part of the charmed circle can get away with this sort of behaviour.

In a world of global finance, who is really backing up anybody's savings? If your bank is owned by a country with international clout it will be defended by others when the crunch comes. Iceland found itself left exposed - and rather smartly turned to Russia for help. This leverage appears to have resulted in 'support' from the IMF: the terms of this remain to be clarified.

Iceland is an object lesson in what is wrong with capitalism. Like all capitalist economies it grew exponentially and using debt rather than saved value. It ignored the fact that, with few resources other than hot water and fish, and with a population barely larger than the size of Bristol, it was always on borrowed time in its competition with the big boys of global capitalism.

But let us not be deceived by the 'one bad apple' mantra that is used to explain away capitalist disasters. Iceland was not an economic basket-case - it was just a country that played by the rules of the system without knowing its place and ignoring the crucial rule - if you are not at the top table you have nowhere to go when the creditors come to call in their debts. Tweet

Banking on each other

No wonder that Venezuelan president Chavez is public enemy no. 1 for the Bush administration. Not only is he smart enough to have figured out how the international financial system repeatedly stymies the poorer countries' attempts at economic progress, but he has the resources to do something about it. As news agencies and media outlets are increasingly coming under the power of corporations some reading between the lines is necessary, but the stories about the Latin American regional development bank are fairly clear to discern.



The proposed Banco del Sur is being discussed by a group of Latin American countries including Argentina, Brazil, Bolivia, Ecuador and Paraguay as well as Venezuela, a pretty comprehensive list of the countries that lost out most spectacularly as a result of their debts to the IMF. Paying interest to rich bankers in the West swallowed up the huge income they were earning from exports, preventing it from benefiting their own citizens.



The leaders of these countries, the majority now broadly on the left and including the highly colourful characters of Evo Morales of Bolivia (who meets visiting dignatories dressed in an alpaca jumper) and former union leader Lula of Brazil, as well as Chavez himself, have learned the lessons of the 1980s and 1990s. The proposed new bank will hold reserves made up of the currencies of the countries of the region and could make development loans. It could also operate as a clearing-house for regional trade, avoiding the need to use dollars and hence support the US.

The high price of petroleum enables Venezuela to step outside the exploitative international institutions that have kept the South poor since the Bretton Woods agreement. The countries of Latin America can create an internal import-export market based on parity and fair representation, rather than the one-sided system of the WTO.



I wonder if this is the little joke that Chavez was sharing with his friend and inspiration Fidel Castro in those pictures from the Havana hospital! No wonder they laughed so much! Tweet

Bank money: source of debt and destruction

A bank charter is literally a licence to print money. Since the system of requiring a certain proportion of assets to be kept on reserve has gradually been eroded the only control on banks’ ability to produce money as credit is our willingness to borrow, hence the constant stream of junk mail and TV advertising offers of credit. When the banks lend us the money the debt is listed and the money sought and retrieved but at that point it belongs to the bank. They have used our willingness to borrow as an opportunity to create a debt; when we repay the debt the money they have taken from us belongs to them. No wonder we are seeing record bank profits: they are simply creating their profits out of our debts.

No surprise also that we see spiralling levels of personal, business and public debt. Neoclassical economists see no problem with this. On their planet, the creation of money in this way will be balanced out by a corresponding amount of economic growth. Apart from the obvious fact that money supply is growing far more rapidly than economic activity from a green perspective this growth itself is a problem. So the most important first step towards creating the steady state economy that will not put intolerable pressure on the carrying capacity of the planet is to change the system of money creation that generates the need for the growth.

The discussion so far has been in terms of a national currency, but currencies are also exchanged and used to pay for exchanges of goods and services between national economies. This role is now played primarily by the dollar, which has acquired the status of international reserve currency since the agreement establishing the financial structure to dominate global capitalism after World War II. Under the Bretton Woods Agreement, the USA also extracted the right to have its currency—the dollar—considered the equivalent in terms of economic weight of gold reserves. In the post-war exhaustion, low morale and financial desperation of the other world powers the USA pulled off this extraordinary confidence trick which has enabled their dominance for the past fifty years but left us all with a teetering economic system. The coda to the story is that the USA proved itself incapable of maintaining the value of the dollar and, in the face of the need for massive liquidity resulting from the costs of war in Vietnam, Nixon ‘closed the gold window’ on 15 August 1971. This meant that dollars were now themselves no longer linked to the reserves in Fort Knox but floating free, and foreign Central Banks could no longer exchange their dollars for gold.

Global capitalism relies on one country’s currency to provide credibility for the system as a whole. Initially this role was undertaken by gold itself, as a commodity of real value, but the movement towards fiat money which went hand in hand with the capitalist expansion, meant that currencies rather than gold played this role. The reserve currencies—sterling, the dollar, the yen, and the euro—are all used to underwrite economic activity, but just as in banking there is a central bank so in the currency system there is a central currency and this is the currency of the most powerful player in the global economy—the global hegemon.

It is mainly its own credibility and that of its economy and military structure that guarantees the functioning of the international economy, but it needs its own back-up in the form of gold reserves. During its days of empire the UK played the role of preferred currency. At that time US bankers supported the pound, a fact that alienated those outside the charmed circle who could not understand why US gold was being used to support a foreign competitive economy. Similar questions were raised when Chancellor Gordon Brown sold 415 tonnes of the UK’s 715 tonnes of gold reserves in May 1999, reducing the official reserve percentage held in gold from 16.7 to 7 per cent, and substituting currency, a mixture of dollars, euros, and yen. This is a record low level of gold holdings compared with the 2000-2500 tonnes held between 1958 and 1965, most of which were sold during Britain’s financial crises of the late 1960s and early 1970s.

The may seem like technical stuff, but the central point is simple. The nature of money creation via bank debt is undemocratic and unsustainable. Money should be created by ourselves, as citizens, to facilitate necessary economic exchange. Neither we, nor our governments, should be required to borrow it from banks. The debts this create cripple lives and are also fuelling unsustainable economic growth. Tweet