“The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed, lest Rome will become bankrupt. People must again learn to work instead of living on public assistance.”
– Cicero, 55 BCE
The quote above, from a Roman in an empire at the peak of its performance, could easily refer to our world today. Nothing has changed much because human nature does not change much. Although our world is now linked together in a global network of systemic management and control, the problems we face are no different than those of yesteryear. We can celebrate our greatest technological advances and worship the power of consumption and abundant wealth but we do so at our peril.
It is as if the very earth upon which we stand is poised on a pinnacle, reliant as it is on the continuity of electrical supply, abundant cheap energy and a surplus of agricultural production with less labor input than ever before. To put it mildly, we are vulnerable to the vagaries of nature itself, and to continued flows of monetary lubrication which enables all our interlocked distribution systems to function ‘twenty-four-seven’ without a break. We assume that all will be well, whatever is in the news, it does not affect ‘me’ directly; I continue in my own sweet way oblivious to the forces amassing to threaten man’s easy existence on this planet.
The history of mankind has been a sequence of rising and falling empires from city states of earlier times to the steady decline of the last empire dominated by British rule over a quarter of the world. We are now faced with yet another empire on the point of decline which will no doubt follow a similar course to those before it. The Anglo-American military-industrial complex emerged in the 19th century reaching a peak of prosperity after World War Two but is now struggling to maintain a stable domestic economy. Its foreign policy remains confused and confounded by the traumatic experience of 9/11 and the subsequent launch of the ‘war on terror’ being a counter to the sudden realization that an era of conflict on American soil has begun.
Three hundred million Americans remain in their isolated vastness of defensible space unable to comprehend the immensity of what happened to the national psyche in that unprecedented moment as the twin towers collapsed around them. It was no less a national game-changer than the nuclear bombs dropped on Japan sixty five years prior, in a final effort to expunge the rising sun forever, which ushered in a period of pacifist philosophy embedded in the very constitution of the victim.
Some say… that parts of this course can be considered ‘Trauma induced mind control’! That’s right, when you were learning of the ‘P & Qs of money velocity’ in the last lesson, our intention was to split and compartmentalizes your mind, leaving it susceptible to suggestion without you becoming aware.
No longer the land of the tax-free lemonade stand!
America is no longer to be the ‘land of the tax-free lemonade stand’ but, by forsaking the very foundations of the constitution and with little push-back from the masses, the ruling elite is determined to preserve their dominance over all nations through what some may characterize as economic stealth, financial repression and anaesthetization of the populations by mass media propaganda. The mighty dollar remains unchallenged, yet even now there are chinks appearing in the armor of its economic pre-eminence which bodes ill for those whose futures are inescapably fettered to the ‘full faith and credit’ of the USA.
China has been well aware of dollar weakness as a reserve currency and is already taking steps to grow its economy away from fiat currency towards the ultimate monetary unit, gold. China has been quietly accumulating gold reserves for decades now but refuses to admit the amount of its cache; some say it could be as much as 10,000 tons or more. The battles of the future will be fought on the fields of global currencies with each nation staking its claim to prosperity for its people by devaluing monetary units one against another until the fog of currency war clears and the victor stands ready to deliver the final golden blow.
Fun nature of numbers fact! Did you know that 9 sets of 11 can do this… 111,111,111 x 111,111,111 = 12345678987654321! There are many number combinations, but none other create this result. If you’ve ever heard of ‘Occam’s Razor’, it states, “The explanation requiring the fewest assumptions is most likely to be correct.”
The rise of China and the Asian economies is challenging the West on all fronts especially economic ones. The demise of the USSR in 1991 was partly the result of a continual diversion of economic resources forced upon it by the American drive for military supremacy during the Cold War. The irony is that since then America itself has had to expend greater proportions of its budget to maintain its foreign vassals and more recently expending billions on the emergent Department of Homeland Security force. Darth and friends are fighting on multiple fronts, with wars beyond borders, domestic threats and economic conflicts causing expenditure on unproductive military assets to rise above that of all other nations combined. The economic strategy which induced the fall of the Soviet Union has turned upon the very perpetrators with a vengeance leaving an impossible budget black hole to remain unfilled for generations to come.
Your challenge today is to search and learn about the ‘SCO – Shanghai Cooperation Organization’
Paul Kennedy’s book, The Rise and Fall of the Great Powers (1987), examines potential causes for the rise and fall of empires and nations. Kennedy proposes that it is not the absolute wealth and power of any one nation or empire that matters; it is the rate of economic growth of competitors and its wealth and power relative to others that matter. A nation whose economy is growing slower than a competitor will become relatively weaker over time even though its absolute wealth continues to increase.
He also notes a tendency for powers in decline to continually extend their military budgets commensurate with their position in the global race to secure resources and economic advantage. The allocation of national budgets to increased military spending further limits economic growth. Resources are diverted from productive investment to non-productive military spending creating an ever decreasing cycle of lower investment as the economic base weakens. During this process, military power may increase for a time until the overtaxed economy implodes, just as the USSR collapsed, under the weight of their excessive military expenditure.
Yet again we witness the efficacy of compounding growth rates by observing that when one economy grows at a mere 1% per annum whilst its competitor is growing at a rate of 5% per annum the later will expand over ten years by more than 60% while the other achieves just 10% growth. It is no stretch of the imagination to project this range of progress for China as compared to America and the developed economies. Even the European project has fallen into extremely slow growth when the original idea of combining many national economies into one massive one should have rivaled the USA.
It is becoming clear that the Anglo-American empire is losing impetus when measured against the rising Eastern economies made all the more possible by changing trends towards globalization. National economies are less relevant today as banking, finance and global producers work beyond national boundaries and exploit national limits by moving production facilities to areas with favorable economic and tax advantages. The agenda for the G20 meeting in mid-2013 underlines the nervous reaction of nation states to these mobile corporations’ ability to avoid significant tax liability putting ever greater strain on national budgets.
The past can never be a good predictor of the future because there are so many unknown variables to take into account that invalidate an accurate forecast. In 1987 nobody could have foreseen the sudden explosion of the Internet and the amazing impact it has had since 1991; not to mention the extreme technological developments spawned from space programs and computing innovations. Nations have responded to these challenges in differing ways depending on their stage of development, history and culture. However it is becoming increasingly obvious that individual nations of the past are unable to function unilaterally in a globally connected world. They used to compete through territorial gains for trade advantage but now continental-sized conflicts are an obsolete strategy for the 21st Century.
Trade, as always, remains at the heart of international affairs and it is economic cooperation which has given birth to the concept of a ‘New World Order’. Global communications have rendered the acquisition of power by the nation state through territorial gain a losing game. However it has not lessened the incentives to generate internal strife through conflicts of religion, culture and historical claims to natural resources especially water and energy. Individual nations, in locations of economic interest such as the Middle East, have caused the leading giants of America, China and Russia to pursue a strategy of ‘economic warfare’ using subtle means less obvious than the outright exercise of military force of the past. By utilizing global agencies such as the IMF, World Bank, United Nations, numerous non-governmental organizations (NGO) and Charities, America in particular has been able to project its power and influence throughout the world without taking a significant military step beyond its borders. The use of the North Atlantic Treaty Organization (NATO) in conjunction with the UN Security Council ensures that planned policy actions are ‘approved’ by the participating nations and thus adds credence to territorial influence in the target state. Although limited territorial incursions have occurred they have proven less effective than merely establishing bases in far-off lands; the consequences of a threat of action being enough to impose the stamp of Western democracy.
Recent history is littered with such episodes; obvious ones being Iraq, Afghanistan and more recently Libya and Egypt yet many are not reported at all in the mainstream press and merge into the background as more significant events unfold. However, a well-proven pattern of operation remains the same regardless of country or regime involved but usually targets resource-rich, underdeveloped nations in Africa, the Middle East, Asia and South America. In the United States some major, little known corporations such as the Carlyle Group and Halliburton have vast departments of multi-skilled consultants focused on the infrastructure of countries involving the construction of: electricity grids, roads and railways, power plants and airports or harbors to name but a few. These require extensive capital to develop; sums so large that individual nations do not command sufficient funds to expand and develop their economies. These consultants make contact at the highest levels of government by any means possible, including not-so-subtle bribery, ‘selling’ them on the idea of developing their country, enriching the political elite and well-connected at the same time.
These consultants have come to be known colloquially as ‘Economic Hit Men’ and their exploits are brilliantly described in the book: “Confessions of an Economic Hit Man” by John Perkins which describes an account of his career with consulting firm Chas. T. Main in Boston.
When an agreement can be made the financiers arrange huge debt instruments to fund various projects which often involve insider groups of American companies gaining the operating contracts and making excellent profits in the process. Now of course the country is in debt to the global financiers, mainly the global banks acting as agents of the IMF or World Bank, who will ask onerous terms for repayment which the country can ill afford incurring further debt and becoming beholden to the whims of the international bankers. Further contracts can be extracted as the country becomes even poorer and the majority of the population suffer. The advantage is always on the side of the bankers and in no way helps underdeveloped nations to expand their economies, often the reverse is true. John Perkins’ book describes the debilitating effect these projects have had on the countries concerned and is recommended reading for those who wish a deeper understanding of this corrosive system.
This process of extracting resources by exploiting the weaker nations solely for the benefit of the developed nations is not sustainable. There will come a time when the Western World will have to face the inevitable and recognize that the limited wealth of planet earth will have to be more equitably shared between all nations and not only for those in a position of temporary power at the time. Improved communications and the internet offer an increasing awareness for peoples around the world of how our global economic system works which will invoke changes that will not necessarily be welcomed by those in command today. Indeed, we have already seen in previous lessons how the global financial system itself is flawed and unlikely to remain stable in the foreseeable future; this will have serious implications for nation states to varying degrees.
As the American empire declines, other Western countries will fall further behind in the global pecking order because the erosion of the dollar will also impact their currencies enough to seriously reduce the national wealth in the years to come. The key dynamic here is that Western Countries have been relying on their prowess in the financial world to support what would otherwise be a much lower standard of living. Many of these countries have little enough in the way of natural resources that might allow it to avoid importing most of its needs; they could never survive alone in a globalized world. The choice for all nations is not a happy one so far as having things the way they have always been.
The global system of international finance is embodied in the International Monetary Fund (IMF) structure, having some 188 member nations which almost cover the world and is a truly global organization. It works to facilitate international trade and sustainable economic growth by monitoring economies and enabling preferential loans to individual states; its headquarters are in Washington, D.C., USA. ShopSquawk supposes this is so because America has been responsible for fostering this type of international agency to its own advantage since World War Two.
IMF loan conditions are not the only producer of change; they are often partnered with other economic reforms but need to go further if whole continents are to make steady progress towards improving the welfare standards of their populations. Terms of trade are at the heart of the problem because it is only when developed nations are prepared to implement fairer trading terms that the distortions of labor cost differentials can be corrected. We hear all too often of the use of cheap labor in the production of clothing in Asian factories using that unpleasant but colorful description of ‘sweat shops’. Economics and finance recognize no humanitarian barriers but it will be the task of future generations, in a globalized world, to find appropriate answers before the deprived masses organize and rise up in opposition.
The world today comprises global financial markets, multinational corporations and national governments linked together in economic and military alliances led by America. It was only after the total devastation of Europe following World War Two that many institutions such as World Trade Organization (WTO), IMF, United Nations and World Bank have formed a kind of global government to address the concept of a New World Order (NWO). Take notice that these activities are both global and financial in nature and logic dictates that the controlling powers are thus embedded in the economic and financial fabric of the world. It is not by accident that our future will be determined by how successful these partnerships become and thus should be examined in the context of the survival of national economies and the globalization of sovereignty.
The USA is involved with the ‘North American Free Trade Agreement’ (NAFTA) and Russia itself is a developing federation having arisen from the ashes of a failed socialist state. National barriers are crumbling on all fronts, even though a sense of national pride remains extant in most nations’ historical awareness, through the undeniable onslaught of global governance. Britain claims sovereignty over its currency, national budget and national institutions rooted in its monarchy. It cannot envision being party to a politically and financially unified Europe although the very survival of the EU requires progress towards some form of federation.
Globalization brings many benefits to individual nations as technological innovations spread rapidly around the world increasing productivity and general standards of living, but these benefits are not spread evenly. The ever-widening chasm between the wealthy 10% and the remaining 90%, who hold only 7% of the global financial wealth, has generated many explanations for this phenomenon. The nature of our distorted capitalist system, reviewed in the next lesson, is closely associated with national economies in their relationship to movement of resources from emerging economies to those of the developed world.
The winners will collect more profit and accumulate more money, leaving less for those who don’t have this privilege or retain the skills that carry high rewards in the new global economic model. This fundamental source of inequality does not explain why wealth and income inequality was considerably lower in previous eras of economic expansion. Some point to the causes being the capture of national regulatory bodies by multinational corporations, especially bankers, and the transition from industrial economies with plentiful low-skill, high-wage jobs to post-industrial, knowledge-based, service economies.
These are undoubtedly part of the reason that wealth is not being distributed evenly but a more important cause may be laid at the foot of a new monster, ‘financialization’. This rather awkward term refers to the tendency of financial markets to dominate the traditional industrial and agricultural economies. It reduces all market values into financial instruments or their derivatives and is the result of financial engineering. The intent is to reduce any product or service to a tradable unit of currency making it possible to interchange these instruments instantly around the world; there are no national borders to be managed and no accountability to sovereign government is required.
This process spreads risk, enabling debt to be created through asset-backed securities, which motivates economic systems to increase production of just about everything including money itself. The policy of keeping interest rates to near zero levels for an extended period has further aggravated the wealth gap which allows the wealthy to borrow money on the cheap and invest in higher income yielding financial instruments; it’s a no-lose situation which banks and financiers have exploited to the full.
Governments love this system because it allows them to spend beyond the reasonable limits of taxation by issuing their bonds in quantity without constraint as witnessed by the Federal Reserve’s experiment of printing USD85 billion per month for months without a break. Cheap, abundant credit, the supposed key engine of growth according to the Federal Reserve, has greatly increased wealth inequality; the wealthy elite have much greater access to credit than those remote from government and they should use this credit to invest in productive assets generating income streams that increase both overall income and wealth. Regrettably this is not always the case because investments today do not necessarily go directly to the producers.
Remember, economics is all about trading around the world to meet demand for all kinds of goods and services. The banking system facilitates this process by offering credit to allow production to take place. In former times, simply put, a merchant can purchase goods from overseas by relying on a bank to stand for payment against collateral of the merchants ‘bill’ which gives title to the goods on final payment. This works on an international scale where merchants are trading one-to-another; national economies were dependent on this essential money transmission process.
In the global financial system things get much more complicated although the end result is much the same as before; goods or services are moved from seller to buyer with guarantees to payment written into contracts, although today there are far more hidden risks. It is the need to minimize these risks which have given rise to a vast complex network of financial instruments (derivatives) which can be simplified into several groups. The merchant’s bill may not be paid in full at time of maturity because it contains a hidden risk of movements in foreign exchange rates, interest changes and perhaps total default by the buyer or the guarantor through lack of actual cash (liquidity) in the market. Debts such as these commercial bills rely on the markets to provide instant payment though their liquidity channels; when these channels become blocked, as happened in 2008, trading stops because uncertainly of payment causes a crisis of confidence in the market.
Warning! Brain killer paragraph approaching.
The closest thing modern finance has to the institution of bank guaranteed debt is a financial insurance contract known as the ‘credit default swap’ (CDS) but which does not so much guarantee eventual payment as settlement at current market value. According to economic theory the price of a “riskless” security is the market price of the security plus the price of the CDS risk insurance, plus the price of the ‘interest rate swap’ (a contract which compensates for interest rate changes), plus the price of the ‘foreign exchange swap’ (a contract which guards against currency exchange risk). The end result is that trade can take place across borders with the minimum of risk to all parties but which at heart are driven by international money markets working together with the world’s central banks. The global world is organized around a network of ‘promises to buy’ in the future rather than the earlier ‘promises to pay’ by a bank if a contract fails in the present.
In the global financial system many ‘promised payments’ lie in the distant future, and/or in another currency, at a given interest rate. Consequently, a mere guarantee of settlement at maturity date is little help when only a small fraction of outstanding commercial debt is due at any one time. In a crisis the need for instant cash is paramount and the only way to get cash is to sell rights to a ‘derivative’ contract, or to use this asset as collateral for further borrowing. The amount of cash to be raised for an asset depends on the asset’s current market value and, by holding a guarantee of the market value of your assets, in effect you are guaranteeing your access to cash as needed; if no one else will give you cash for them, the counterparty will, but only if he has it. The weird and wonderful world of ‘Over-the Counter’ (OTC) derivatives, in effect ‘private contracts’, at best creates a ‘risk-free-as- possible’ trade for settlement in the global markets. It is these OTC instruments, most of which have no quantifiable market price, which create the potential to destabilize markets during times of uncertainty. The weak link in our modern system is the incomplete nature of global networks of promises to buy.
There is no doubt that a common global currency for international trade will add stability to an individual nation’s trading ability but at the cost of revaluing their domestic currency in global currency units. This process is already in place at the IMF which uses ‘special drawing rights’ (SDR) to account for each nation’s contributions according to their membership status. The SDR values each nation’s domestic currency against a basket of major currencies such that a standard measure of the value of each individual currency is obtained. It is possible that the SDR system could form the basis of a global currency but there are many obstacles to be overcome before this will emerge as a solution to the current unstable financial environment.
The eight year period from the financial crisis in 2008 to 2016 has seen the Federal Reserve and other central banks continue to stimulate their economies with quantitative easing (QE) measures combined with the lowest interest rates in modern times. The main objective was to combat the deflationary effects of the crisis and stimulate growth in the US economy enough to return world trade to its previous steady growth pattern. The QE process should not continue forever although some would say that an orderly withdrawal is not going to be easy and compatible with the stability of markets. Even a slight hint of tapering of money printing by the Fed in July 2013 was met with market shocks and rising interest rates indicating how fragile the current markets are to any reduction in QE.
Nevertheless the growing mountain of printed money must be deployed and is distorting the operation of markets in general causing growing asset ‘bubbles’ around the world; stock and debt markets are priced well above what national economies can bear under the present poor economic conditions. These bubbles tend to deflate suddenly and precipitate a crisis as we witnessed in 2008. This is the risk that financial and political elites recognize and are working to find solutions which will be compatible with price and market stability. As usual America must lead the way because its economy represents 25% of global trade and the dollar is the major reserve currency used by over 60% of all parties to trade around the world.
It is not an exaggeration to view the Federal Reserve, with assets of USD 3.5 trillion and still growing, acting as the world’s largest financial intermediary. The Fed are buying long-term obligations and financing short-term ones using its unique privilege of printing the world’s reserve currency. The beneficial effects of this process appear to be wearing off as piling on more debt is yielding less and less in economic returns, and thus growth, as well as increasing the risks of encouraging speculative distortions and inflationary potentials; this has given rise to debate within the Federal Reserve Board itself. QE (money printing) is very much a unique experiment the outcomes of which economists are unable to predict although their economic models appear to be indicating the need for some serious adjustment. The simple truth is that banks have remained technically insolvent since 2008, and it is in this area that solutions must be found if the world is to return to a more stable economic base. We know that trade relies on efficient banking and financial systems but as long as doubt remains of the eventual systemic default on commercial debts there can be no lasting stability within world markets.
It has become clear that the nation states alone, even the USA, are powerless to manage such a complex global financial system dependent as it is on multinational banking corporations operating beyond national borders and local regulation.
It appears that national boundaries are no barrier in a truly global financial system where market forces remain in charge and risks continually intensify until a sudden event triggers a dislocation of normal trade as happened in 2008. Nothing has changed since then to minimize a reoccurrence of the crisis and it is only a matter of time before the next catastrophe occurs on a global scale. These national economies are the last pieces of the global financial jigsaw which completes the final picture of a world in turmoil both political and economic. But it doesn’t end here because the greatest influence on the ability of states to maintain stable economies is to do with the levels of risk which individual states now bear.