[A-List] The Fed: Consequences

["Anyutka" <annewilliamson@xxxxxxx>]

Sanders Research Associates


The Imperishable Primacy of Interest

March 15, 2004



>From these two, art and nature, it is fitting,

if you recall how Genesis begins,

for men to make their way, to gain their living;

and since the usurer prefers another

pathway, he scorns both nature in herself

and art, her follower; his hope is elsewhere

Allen Mandelbaum, tranls. (1995), The Divine Comedy of Dante Alighieri,
Canto XI. London, Everyman Publishers, p.105





Taking a breather

The expansion in world manufacturing output is beginning to look like taking
a breather. Regional manufacturing surveys in the US and Europe are sending
signals of a relaxation in the brisk rate of output growth. Industrial
output growth in Scandinavia, the UK, Spain and Italy is looking somewhat
weak. And almost everywhere the current cycle upswing has disappointed
analysts looking for a big pickup in hiring, never mind those workers who
are not being hired.

Having said this, world trade is booming. The Baltic Freight Index has
climbed another 11% since the beginning of the year and it was already off
the charts. Dry bulk shipping rates are through the roof, as are tanker
rates. Those in the business of moving things have never had it so good.

The focus of most of this activity is the Far East, where ports are humming.
Hong Kong and Singapore re moving more than 19 million TEU and 17 million
TEU[i] of cargo respectively. To put these volumes in perspective, each of
them is shipping some three times the volumes of Los Angeles. Shanghai alone
moves more than 33% more than Los Angeles. This is the sharp edge of
globalisation. Nor is it all one-way traffic, with China consuming ever
greater volumes of imported oil, having already outstripped Japan as the
world's second biggest c onsumer of petroleum. And all of this is being
financed with record low interest rates and abundant liquidity provided
thanks to the recycling of Asian export profits back into US debt
securities.



Deindustrial blues

It all looks too good to be true, and it is. The reason why is essentially
encapsulated by the American trade deficit, which last Wednesday hit a
stupefying monthly level of more than $43 billion, representing an annual
rate of more than $500 billion or some 4.7% of GDP. US domestic demand is
strong, fuelled by a 1% Fed Funds rate. Theories purporting to prove why
this does not matter are springing up faster than March daffodils, reminding
us of nothing so much as the sorts of arguments that were deployed in the
late 90s to "prove" that the stock market was fairly valued.

We have written extensively in recent years about the deindustrialisation of
America (and Britain too for that matter); what we are seeing now is the
result. The technology of logistics is also playing a part. Where goods used
to be ordered far in advance of use or sale and stored for the interim in a
warehouse, increasingly, thanks to the just-in-time revolution, the
warehouse is now the container and the ship carrying it. These developments
pose at least two serious risks for the American political economy, the
first financial and the second existential.

The financial problem arises fundamentally from the lack of value-added
product to offer to the world for sale. This is not as silly as it sounds.
In recent years manufacturing as a percentage of GDP has plummeted, while
finance has soared. Finance now represents about a quarter of GDP, while
manufacturing is some 14-15%. There are a number of reasons for this. To
begin with, the national security superstructure of the American economy
co-opts a large and growing proportion of the national wealth. This is not
the generally accepted wisdom in the US where it is believed, based on the
annual Pentagon budget, that the military's share of the national output is
a "modest" 4% or so of GDP.



War as fantasy

This is a complete fantasy. As we pointed out a year ago and many times
since, the national security budget of the United States is more than $800
billion dollars per annum and rising. Over the decades corporate American
has adjusted itself to the facts of life: if you do business with the
Pentagon you get cost-plus deals, subsidised R&D and venture capital
funding. If you don't then you have to bear those costs and risks yourself
in competition with firms that do not have to bear them. The result is
predictable and in fact was predicted with great accuracy and foresight
fifty years ago.[ii] Competitive companies would be driven out of business
or acquired by firms whose profits are geared positively to costs.

America's ability to trade paper for real things, thanks to its reserve
currency monopoly, has meant that it has been able to subsidise the costs to
society of this immensely destructive dynamic by simply printing money. This
in turn has handed finance a strong competitive advantage of its own, and
largely explains the trends in the chart above.

There is, obviously, a yawning gap between theory and practice in the US
economy. Theory has it that the market sets interest rates. Practice has it
that the central bank (or more accurately, central banks) set them Theory
has it that the markets determine foreign exchange rates. As the reserve
accumulation by Asian central banks demonstrates, in practice central banks
do. Thus the price and quantity of money is set for all intents and purposes
by fiat. This has nothing to do with the supply and demand curves taught in
most economics textbooks and everything to do with the pursuit of political,
strategic and factional objectives.[iii]


Finance, the leading industry of the New World Order

In abstract terms this has resulted in a vast inflation of liabilities in
the economy at large. More concretely it has led to the phenomenal balance
sheet growth of financial institutions as diverse as America's GSEs and the
International Monetary Fund. Coupled with the increased securitisation of
credit and the growth of the investment management industry, all this has
led to increased risk in the economic and financial sense of the term, not l
ess. Acknowledging this is not the same as doing something about it. Central
banks have understood the problem for years. Their sole response has been to
increase the power of the money monopoly through increased regulatory
oversight and supervision. There are several but possibly the best example
is the Basel Accords on capital adequacy. Nominally intended to ensure the
solvency of financial institutions worldwide, in practice they have greatly
increased the competitive advantage of the largest and politically most
powerful institutions, at the top of which list sit the major American,
European and Japanese banks.

Finance is by its nature unproductive. This is contrary to theory (written
by financial people) that finance increases economic productivity. The
theory is more easily asserted than demonstrated, and the historical record
is littered with concrete examples to the contrary from the Erie Railroad in
the 1870s to the Asian Crisis of 1997. JP Morgan, Jay Gould and E.H.
Harriman could not have operated a railway system if their lives depended on
it. That did not prevent them from controlling and eventually monopolising
railway operations in the United States. They accomplished that thanks to
their ability to manipulate stock prices and control credit. For example,
the Crash of 1907 was in fact a Morgan manipulation from start to finish,
and a very profitable one at that.[iv] Not only did it enable him and his
allies in the railway and energy cartels to destroy the last vestiges of
competition, but he and the cartel ended up with not just control of the
nation's credit de facto, but within five short years had completed its
total takeover de jure with the creation of the Federal Reserve system.



Pump & Dump

More recently the Crash of 1997 in Asia looks to us in retrospect exactly
like a classic Morgan, Harriman or Gould "pump and dump" operation, which
would certainly explain Wall Street's and Washington's hostility to
countries such as Malaysia whose leadership could not be suborned. By
imposing currency controls, refusing to open its financial and productive
sectors to what amounted to a hostile takeover, and jailing his deputy and
Wall Street's darling Anwar Ibrahim, Mahathir Mohammed proved the vacuity of
both Wall Street ideology and the nature of its intent.[v]< /span> In
contrast, more than one Korean in the years since must have rued their
country's openness, as the Carlyle Group, Citigroup[vi] and others have
snapped up Korean assets at rock bottom prices.

This has great relevance to the situation today. Asian exports are
increasingly delivering profits directly to Western companies. This is
particularly important in China, which has opened itself up to foreign
direct investment, and in the process is enjoying a meteoric rise in foreign
sales. But the real significance of this is the shift in interests; there is
now a significant American corporate stake in the maintenance of a solid
production platform in China. And as corporate America is outsourcing
physical production to China, it is outsourcing services and even research
and development to India. Industrial America is "hollowing out" rapidly,
leaving behind a debt superstructure that effectively transfers liability to
the taxpayers, or more accurately workers, while management, which is to say
the cartel, transfers not just jobs but production abroad. The gul f between
the citizens' conception of this and that of their leaders was poignantly
illustrated recently by comments made by the chairman of the president's
Council of Economic Advisers, Greg Mankiw.[vii] Asked about job outsourcing,
Mankiw termed it just anther kind of trade. There may be short term costs
(like your job), but in the long run everyone is better off if there is more
trade.



Lord, make me a good economist, but not just yet

Mankiw is like a bishop who has never had a real religious experience but
knows exactly what plays well with the pope. Free trade is one thing when
conducted with things that can be easily moved. People are stickier; they
need stability as humans, not volatility. Traffic in humans, which is what
outsourcing at bottom is, used to be called slavery, and using free trade as
a justification for the suppression of incomes is not measurably different
(if we can talk about measuring such things) than the justification of the
African slave trade two hundred years ago on the spurious grounds of racial
theory. Both are assertions in the service of profit, neither is proved.

Mankiw understandably did not amplify his answer to discuss risk. The
warehousing of goods in transit, technically feasible thanks to computer
technology, is also exquisitely delicate: one hitch with one component and
the whole edifice comes apart at the seams. He does not discuss one of the
reasons that it makes sense for corporate executives to outsource research
and service jobs, which is the hugely overvalued dollar. And necessarily,
since he does not address the currency issue, he needn't address its causes,
which is government intervention to support it. Since the governments doing
so are those of America's Asian allies, and primarily the Japanese, it is
tempting to think as many undoubtedly do, that it is simply foreigners who
are protecting their export industries.

Perhaps it is, but economics of this idea is not too convincing in the case
of Japan, whose economy is no more trade intensive than the US, and whose
major exporters in any case have moved to distributed production across
Asia. More convincing is the idea that to do differently would threaten the
status quo in Japan, which is to say the power base of the Liberal
Democratic Party. But even this is hard to imagine if the US were really
unhappy about it. For the truth is that the US could do something about it
tomorrow if it wished, and indeed has had it in its power for decades to do
so. That is simply to stop relying on debt expansion for growth.

This too is hard to imagine; there is too much interest vested in the status
quo, and every year that goes by makes the prospect of such an adjustment
harder to contemplate. It is far easier politically to just keep priming the
pump. Of course, pumps do break from time to time.

Which bring us at last to the existential question we raised earlier. There
is no historical precedent that we are aware of to support the idea of a
nation existing on the profits from financial services alone. Some form of
real physical value-added needs to be produced. The histories of Venice,
Holland, Britain and others strongly support this argument. All were
successful industrial, financial and military powers that became
overburdened with debt, which is to say within which the financial sector
became too strong. This is why we think that the US won't make it without
bartering a great deal of its freedom of action for international support.
And which is another reason for thinking that the Bush regime is going to
lose the 2004 elections; it has lost too much international backing. Kerry
is the international community's candidate of choice.

Do not confuse this issue with policy. Policy will not change,[viii] but the
political centre of gravity will. The cartel has no national allegiance,
only interests.



Chris Sanders

csanders@xxxxxxxxxxxxxxxxxxx





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[i]TEU: Twenty foot equivalent unit, referring to shipping container size.
Hence also FEU, forty foot equivalent unit.

[ii]See Melman, www.aftercapitalism.com for extensive research on the
subject.

[iii]It is no accident that we hear little talk these days about central
bank "independence." Twenty years ago when the policy objective was to
disinflate we heard about little else. The reason was simply that after the
experience of the 60s and 70s it was necessary to convince the investing
public that central banks were politically disinterested and above the fray.
The smashing success of this propaganda exercise can be measured by the
equanimity with which the pension management industry has greeted the fiscal
volte face of the Bush administration an d the monetary policy since 1987 of
the Greenspan Fed. Serial market bubbles have not just been endured; bubbles
have entered the day to day give and take of market analysts as though they
are an ordinary feature of economic life instead of the highly destructive
phenomena that they really are. The issue of central bank independence from
narrow political self interest is best left unexamined under these
circumstances.

[iv]Meyers (2002) History of the Great American Fortunes, Volume 3.
Honolulu, University Press of the Pacific, reprint of the 1910 edition.

[v]In the process, he not incidentally proved that it can be resisted.

[vi]See Tim Shorrock, Crony Capitalism Goes Global, the Nation, March 14,
2002

[vii]See www.whitehouse.gov, "Ask the Whitehouse." December 5, 2003.

[viii]See All News is Lies, March 8, John Kerry: Man of the Moment, by John
Laughland.