Sunday, 24 May 2009

An Analysis of International Monetary Relations – Part 3: Where We Are Going

Hegel famously said that history repeats itself. Marx equally famously said that Hegel should have added: first time as a tragedy, the second time as a farce. Marx should have been more precise. History does not repeat itself only twice. It constantly “repeats” itself, each time at a qualitatively higher plane, corresponding to a progressively more developed stage of the society’s productive forces. Tragedy and farce are always present, farce being a tragedy brought on by the ignorance of self-assured men. That is why Hegel characterized the “invincible faith in oneself” as the chief quality of a comic character. As the societies advance, farce becomes more pronounced because the contradictions become more intensified.

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This is an important point which I will take up in detail in Vol. 5 of Speculative Capital. Here, let me try to explain it with an example.

Take Holbein’s oil painting, The Ambassadors, which is a signature art work of the dawn of Capitalism.


What makes this 1533 work so contemporary is the pose and confident gaze of the two characters “at the camera”. The men stand next to the various artifacts – the “stuff”, in modern language – that represent wealth. But this is not the fixed wealth of old social orders. It is a dynamic wealth associated with international commerce – look at the globe and navigation equipment – and ultimately, the power of money. We are way past the barter trader here.

Except for the “distorted” skull in the foreground that was a common code then for the life’s transitory nature, there is no hint of irony in this painting. It is a serious work, as indicated by its title.

Now, look at the 1999 cover of Time Magazine in which Rubin, Greenspan and Summers are introduced as the saviors of the world.



This, too, is a serious picture; it could not be otherwise, portraying the three most eminent men of finance in the U.S. government on the cover of a prestigious weekly.

Yet, there is a teasing of sorts going on here. The caption – three men saving the world – is the deliberately exaggerated language of advertisers, like saying that BMW is the ultimate driving machine. It is an ad blurb that a modern reader is expected to recognize. The picture’s background, unlike in The Ambassadors, is austere. In fact, there is no background to speak of. The close-up shot merely makes Greenspan look like a three-headed hydra, albeit a smiling and friendly one. Heads contain brains, intelligence and ideas. All three men are closely associated with the globalization. And all three are at the pinnacle of power and prestige. That is what the picture is selling: the idea of the finance capital as the all-powerful savior of the world.

Of course, the reader does not quite buy that suggestion, in the same way that he does not believe a BMW is the ultimate driving machine even when he owns one. Neither do our “saviors”. Yet, the idea is pushed in earnest. That is a setup for farce. Rubin and Greenspan signal it by their grin; the celebrated genius Summers, by his discomfort and embarrassment at taking part in it.

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The instigators a social farce are not harmless clowns. Charlie Chaplin understood this important point. His clowns make you laugh but he never allows you to forget that the buffoon who is amusing you is perfectly capable of doing serious harm. The word farce has a social connotation.

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As a result of what has transpired in economic and financial relations between the countries in the past 30 odd years, Chinese are holding just under $2 trillion of USD-denominated assets, with half of that invested in the U.S. treasuries and agencies. These are the liabilities of the U.S. government, and the ability of the U.S. to extinguish them in such a way that Chinese and other creditors would not suffer is now the central issue of international finance.

On the surface, this circumstance appears similar to the late 1960s, when the European and Japanese central banks with large dollar reserves were expressing concern about the dollar’s convertibility to gold.

But setting aside the changed landscape of global politics and economics, there is a critical difference between now and then. The Bretton Woods crisis was about the ability of the U.S. to convert dollars to gold. The current issue is about the ability of the U.S. to “handle” its unsecured debt. Gold is out of the picture.

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This is probably the closest I will come in this blog to giving trading and investment advice. But if you are concerned about the rise of inflation and would like to put your money into something “tangible”, stay away from gold. Gold is on its way to shedding its status as the universal money, as the universal depository of value. In coming years, if the price of gold increases, it will do so in its capacity as a metal, the way the price of iron or aluminum might increase.

Lenin said that after the world-wide establishment of Communism, gold would be used for furnishing public lavatories. He had this demonetization of gold in mind, a spectacularly theoretical notion that speculative capital brought to the realm of possible in a little over 30 years. This point is important. Gold is demonetized not because of the decision of this or that authority but as a result of a historical process that gave rise to speculative capital and “globalization”, and, at the same time, set the financial system on a path towards a systemic collapse.

The financial system could somehow be “repaired”, but there is no going back to gold. History does not repeat itself, in the sense of returning to where it was previously.

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To prevent a complete meltdown, the U.S. government has pledged about $13 trillion in guarantees and actual payments to various entities, mostly financial institutions.

Then, there are the other, more persistent financial holes the U.S. government also has to plug. The Treasury must finance a $1.8 trillion budget deficit and a $1 trillion trade deficit through issuing bonds.

The tremendous demand for borrowing pushes the interest rates higher. To bring them lower, the Federal Reserve does “quantitative easing”, i.e., it buys the Treasuries. To pay for the purchase, the Fed creates money from thin air through an accounting entry; poof, and there is a trillion dollars.

No currency could withstand such persistent debasing and not lose its value. Hence, the Chinese's lingering unease about the weakness of the dollar.

But it is not the Chinese only. The recent G20 Conference in London this past March was the first economic/financial conference in the past century in which the U.S. not only did not set the agenda and dominate, but it was visibly relegated to the periphery. That more focus was placed on Michelle Obama’s fashion sense than her husband’s conference agenda said all there was to be said about the shape of the future to come.

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Macro developments in economics and finance have a long horizon. They certainly do not happen overnight. The eddies of international finance, furthermore, produce transient effects; a weak dollar could temporarily appreciate against one, two or even all currencies. But the writing is on the wall: the dollar is on its way towards a structural depreciation against all major currencies, including yen. From there, the loss of its status as the main reserve currency will necessarily follow.

If this were the only bad news, it would be good news. But this is not your father’s monetary crisis.

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The dollar became the world's money through its linkage to gold, which historically had that role. What made the linkage possible was the industrial might of the U.S. Without it, the U.S. could not have been in possession of the sufficient amount of gold – it would not have been in a position, period – to orchestrate the Bretton Woods system. Financial maneuvering and one-upmanship, even of the aggressive kind that Harry Dexter While pulled off at the Bretton Woods Conference, could not by themselves create a new world monetary order.

The linkage to gold provided a built-in frame of reference for the value of the dollar and its quantity in circulation; if the amount of dollars in circulation relative to the supply of gold increased, the dollar would be “weak”.

The breakdown of the Bretton Woods system did away with that frame of reference and, in doing so, set the stage for the expansion and subsequent ascent of finance capital.

The “ascent” meant that finance capital could claim a historically larger share of the country's newly produced value. That could only come at the expense of the industrial capital. So the ascent of finance capital was the beginning of the systematic weakening of industrial capital, that is to say, the systematic attack on the industrial base of the U.S. The destruction we are seeing in all spheres of economic activity is the result of this conceptual and yet very real conflict. The “system” in systemic collapse goes far beyond financial markets and institutions.

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A complete analysis of the the relation between finance and industrial capital must await Vol. 4 of Speculative Capital. (That would be the “relation between Wall Street and ‘real economy’”, as it is commonly put because those who put it have no other way of putting it.) For now, an example should suffice.

Take any industrial corporation with a “finance arm”. Take, for example, GM and GM Acceptance Corporation, as the U.S. car companies have been on the news for the past 20 or so years.

The raison d'etre of a car company's finance arm in providing financing to car buyers is so they would not wait weeks for bank financing. Gradually, as this means towards selling cars becomes profitable, it become an end in itself, with the inevitable mission creep that follows. The following story captures this fateful reorientation.
The world’s biggest car company said Tuesday that it earned record second quarter earnings of $1.8 billion US on revenue of $48.7 billion ... General Motors Acceptance Corp., (GMAC), the car maker's financial services arm, contributed $395 million to its income.

The GMAC financial arm pulled in more profit in the second quarter, despite higher interest rates than in 1999 ... GMAC provides a variety of lending and insurance products. It recently became involved in commercial finance, full-service leasing and international mortgages.

We learn that: i) despite a difficult economic environment, the contribution of GMAC to GM's bottom line increased; and ii) GMAC is expanding to new areas, including mortgages.

Here is the result:
GMAC LLC, which provides loans to buyers of General Motors Corp vehicles, said its first-quarter loss grew 15 percent, reflecting an increase in soured mortgage and auto loans as the economy weakens.

But by far, the most pernicious impact of GMAC was in influencing the production cycle of the parent company. GMAC and other sister financing arms created the concept of “leasing” which implicitly assumed that the GM car buyers would get a new car every three years. The production cycle and car design was adjusted around that assumption. This is the ultimate example of production dog wagging the finance arm, with the results plain for everyone to see.

Car companies need not perennially be on verge of bankruptcy. Car companies could be, and the vast majority of them are, profitable.

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The most pernicious damage of finance capital is the destruction of the “business model”. It initially creates a binge of easy profits and, in doing so, changes the organization of the enterprise in line with the “new”, finance-oriented model . Over time, the new model proves the instrument of undoing of the enterprise.

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The U.S. industrial base remains formidable by any measure. But so is the scale of the destruction of the value. It is astounding how little effect almost $13 trillion in commitments and guarantees have had on the markets.

Meanwhile, the farce continues with clowns calling for the creation of a New American Century, as if bombast could be a substitute for economic might. In this way, they provide the surest evidence to date that the 21st Century is the American Century no more.