Signs of the Economic Apocalypse 7-25-05
The dollar closed at 0.8293 on Friday, down 0.2% from last Friday’s close of 0.8308. That put a euro at 1.2058 dollars, compared to 1.2036 dollars a week earlier. Oil closed at 58.65 dollars a barrel, up a percent from $58.09 the previous Friday. In euros, oil would be 48.64 a barrel, up 0.8% from last week’s 48.26 close. Gold closed at 425.40 dollars an ounce, up 0.9% from $421.70 a week earlier. In terms of euros, that put an ounce of gold at 352.79 euros, up 0.7% from last week’s 350.37. The gold/oil ratio closed at 7.25 barrels of oil to an ounce of gold, down 0.14% compared to 7.26 on the previous Friday. In the U.S. stock market, the Dow Jones Industrial Average closed at 10,651.18, up 0.1% from 10,640.83 a week earlier. The NASDAQ closed at 2,179.74, up 1% from the previous Friday’s close of 2,156.78. The yield on the ten-year U.S. Treasury bond closed at 4.22 percent, up five basis points from 4.17 a week earlier.
The big news economically last week was the announcement by the Chinese government that they will remove the dollar peg from their currency and peg it instead to a basket of currencies. While it is too early to say what the consequences of this universally anticipated move will be, most observers think that it will lead to a weakening in the dollar and a rise in U.S. interest rates and inflation. The question is when and how bad. Here’s Paul Krugman:
Politically the week also saw the visit of the Indian prime minister to Washington, leading to the announcement of a deal for the United States to help India develop peaceful nuclear energy capabilities, a move widely seen as a move by the United States to increase the prominence of India in the world, to strengthen the new alliance between the United States and India and to promote India as a counterweight to China in the world. Here’s Keith Jones:
By Paul Krugman
Thursday's statement from the People's Bank of China, announcing that the yuan is no longer pegged to the dollar, was terse and uninformative - you might say inscrutable. There's a good chance that this is simply a piece of theater designed to buy a few months' respite from protectionist pressures in the U.S. Congress.
Nonetheless, it could be the start of a process that will turn the world economy upside down - or, more accurately, right side up. That is, the free ride China has been giving America, in which the world's richest economy has been getting cheap loans from a country that is dynamic but still quite poor, may be coming to an end. It's all about which way the capital is flowing. Capital usually flows from mature, developed economies to less-developed economies on their way up. For example, a lot of America's growth in the 19th century was financed by investors from Britain, which was already industrialized. A decade ago, before the world financial crisis of 1997-1998, capital movements seemed to fit the historic pattern, as funds flowed from Japan and Western nations to "emerging markets" in Asia and Latin America. But these days things are running in reverse: capital is flowing out of emerging markets, especially China, and into the United States. This uphill flow isn't the result of private-sector decisions; it's the result of official policy. To keep China's currency from rising, the Chinese government has been buying up huge quantities of dollars and investing the proceeds in U.S. bonds. One way to grasp how weird this policy is would be to think about what a comparable policy would look like in the United States, scaled up to match the size of our economy. It's as if last year the U.S. government invested $1 trillion of taxpayers' money in low-interest Japanese bonds, and this year looks set to invest an additional $1.5 trillion the same way.
…The question is what happens to us if the Chinese finally decide to stop acting so strangely. An end to China's dollar-buying spree would lead to a sharp rise in the value of the yuan. It would probably also lead to a sharp fall in the value of the dollar relative to other major currencies, like the yen and the euro, which the Chinese haven't been buying on the same scale. This would help U.S. manufacturers by raising their competitors' costs. But if the Chinese stopped buying all those U.S. bonds, interest rates would rise. This would be bad news for housing - maybe very bad news, if the interest rate rise burst the bubble. In the long run, the economic effects of an end to China's dollar buying would even out. America would have more industrial workers and fewer real estate agents, more jobs in Michigan and fewer in Florida, leaving the overall level of employment pretty much unaffected. But as John Maynard Keynes pointed out, in the long run we are all dead. In the short run, some people would win, but others would lose. And I suspect that the losers would greatly outnumber the winners. And what about the strategic effects? Right now America is a superpower living on credit - something I don't think has happened since Philip II ruled Spain. What will happen to our stature if and when China takes away our credit card?
This story is still in its early days. On the first day of the new policy, the yuan rose only 2 percent, not enough to make any noticeable difference. But one of these days Chinese dollar purchases will trail off, and we'll find ourselves living in interesting times.
In a joint statement Monday, Indian Prime Minister Manmohan Singh and US President George W. Bush proclaimed “their resolve to transform the relationship between their countries” into a “global partnership.” For several years now, Indian and US officials have been speaking of an Indo-US “strategic partnership,” including increased economic, scientific, technical and military ties. That this partnership has suddenly taken on global dimensions, with Bush and Singh touting it as a means to “promote stability, democracy, prosperity and peace throughout the world,” points to the rapidly shifting world geo-political and economic landscape.
The Bush administration is anxious to court India, hoping that through increased Indo-US economic, geo-political and military linkages, India can be transformed into a viable counterweight to China and one malleable to US objectives and pressure. Buoyed by India’s emergence as a major center for outsourced business processing, research and manufacturing operations and the country’s growing military prowess, India’s economic and political elite is eager, meanwhile, to lay claim to world-power status, including a permanent seat on the UN Security Council.
One can imagine the discussions in Washington: “Let’s have an alliance of Christians, Jews and Hindus against the Moslems!” This begs the question: Which way will the Confucians turn? To complicate matters in Asia, India has also been repairing relations with China, relations which used to be cool, to say the least. During the Cold War, U.S.-India relations were also cool, but that has been changing since the 1990s. Keith Jones again:
With the end of the Cold War and the growing crisis in India’s economy created by its relative isolation from the resources of world economy, the Indian bourgeoisie has since 1991 pursued a radically different strategy, aimed at soliciting foreign investment so as to make India a cheap-labor haven for world capital. The dismantling of the traditional nationally regulated economy and accompanying assault on the limited concessions made to the working class and oppressed masses in the first decades after independence has been accompanied by a major shift in India’s foreign policy. The US has emerged as India’s single largest trading partner and foreign investor and increasingly New Delhi and Washington have developed a gamut of ties, including joint military exercises.
The US for its part has increasingly embraced India as an ally. Already under the Clinton administration there was a major change in the US attitude towards South Asia, with Washington tilting away from Pakistan and toward India. Because of its apprehensions about the growing power of China, the Bush administration from the time it came to office in 2001 sought to place relations with India on a new plane. The US decision to invade Afghanistan and subsequent revival of Washington’s close relations with Pakistan, especially the Pakistani military, complicated the Bush administration efforts to draw India into a “strategic partnership.” But leading figures in the administration have indicated—as exemplified by Rice’s offer of help in making India a “world power”—that the pursuit of a partnership with India is central to its world geo-political strategy. In May, the number three man in the State Department hierarchy, Nicholas Burns, the Undersecretary for Political Affairs, said of US-Indian relations, “I think you’ll see this as a major focus of our president and our secretary of state, and it will be the area of greatest dynamic change in American foreign policy.”
India’s economy has been developing exremely fast since it’s decision to align with the United States. Economically what does the United States get from India? Cheap engineering labor for its corporations which strengthens U.S. corporate competitiveness and weakens U.S. labor power. But that can’t go too far without provoking a backlash as well as too much domestic economic weakness (the corporate elite seem to want the “just right” amount of domestic economic weakness for the time being). What India can do for the United States labor market (and for its strategic interests as well) is purchase advanced weaponry (whose manufacturing plants cannot be off-shored, for obvious reasons).
However, the most important feature of this week’s joint statement was an agreement between Washington and New Delhi that has as its aim the removal of the international ban on sales of civilian nuclear technology and fuel to India that has been imposed since 1974, when India first exploded a nuclear device.
The Bush administration stopped short of recognizing India, which officially proclaimed itself a nuclear weapons state in 1998, as a state having the legal right to possess nuclear weapons (a violation of the terms of the 1968 Non-Proliferation Treaty). But it has effectively announced that it favors India being accorded a special status in the international treaty and regulatory system governing nuclear technology—what the Bush-Singh statement calls a “responsible state with advanced nuclear technology”—so long as India agrees to certain restrictions and international oversight of its civilian nuclear program and the “other nuclear countries” and the US Congress agree. Indian government officials are proclaiming the statement a major advance. Foreign Secretary Shyam Saran boasted to a media briefing, “What has been achieved is recognition by the US that, for all practical purposes, India should have the same benefits and rights as a nuclear weapons state.”
India, which is heavily dependent on foreign oil, is eager to expand its nuclear power generation capacity and for this needs greater access to foreign nuclear technology and fuel. A second major consideration for both New Delhi and Washington is the fact that the sanctions imposed on India for being outside the international nuclear regulatory regime have included prohibitions on the sale of advanced US military equipment. The US-based intelligence report Stratfor says official Pentagon leaks have said India is poised to make up to $5 billion in purchases from US arms manufactures once the sanctions are lifted, including advanced anti-submarine and anti-missile technology to protect its Indian Ocean fleet.
The Bush administration has a double purpose in seeking to boost arms sales to India. Needless to say, it wants to boost the US arms industry, but it is also extremely anxious to render India dependent on US military technology.
In non-economic news the London Bombings remained the main story. The political push given the war on terrorism by the London bombings may be a plus for Bush’s gang in the short term, but the whole War on Terrorism will only highlight the precarious nature of the United States Empire: the dominant military power and the worlds greatest debtor nation. Here is Marshall Auerback :
For all of the good news emanating from the US recently, it is worth bearing in mind the huge ongoing financial strains the country continues to experience, as it seeks to confront the scourge of global terrorism.
…Much has been made of the improvement sustained in the May trade figures. But let’s keep this in context. As William Greider, national affairs columnist for The Nation, noted: “The United States is heading for yet another record trade deficit in 2005, possibly 25 percent larger than last year's. Our economy's international debt position - accumulated from many years of tolerating larger and larger trade deficits - began compounding ferociously in the last five years. Our net foreign indebtedness is now more than 25 percent of gross domestic product and at the current pace will reach 50 percent in four or five years .”
What about the fiscal position? Last year, talk of rising 'twin deficits' was widespread at the height of dollar pessimism. Markets generally tend to be less tolerant of external deficits when they are seen as being driven by the public sector.
However, in recent months the Federal deficit appears to be showing signs some dramatic improvement (a point that CEA head Ben Bernanke made last Wednesday). In the past three months, the 12 month running deficit has contracted by a $109bn to `just' $D335bn. In 3 month moving average terms, net tax receipts have risen a striking 21% year over year whilst net outlays have risen just a little over 6% year over year.
On the other hand, it is worth considering this “improvement” in the context of the overall 2004 Financial Report of the United States Government (the full document being available as a PDF file at www.fms.treas.gov/fr/04frusg/04frusg.pdf). The table published in the Overall Perspective on page 11 shows an $11.1 trillion annual deterioration in the government's net worth. As an aside, it is worthwhile noting the GAO's auditor's letter as to why they will not certify the statements. Explaining the discrepancy, financial analyst John Williams notes the following:
“The government's GAAP-based accounting generally is as used by Corporate America. It includes accrual accounting for money not yet physically disbursed or received but that otherwise is committed. The largest differences come from the bookkeeping related to Social Security and Medicare, where year-to-year changes in the net present value (discounted for the time value of money) of any unfunded liabilities are counted. In contrast, traditional deficit accounting is on a cash basis. It counts the cash received from payroll taxes (social Security, etc.) as income, but it does not reflect any offsetting obligations to the Social Security system.
For nearly four decades, officially sanctioned accounting gimmicks have masked federal deficit reality. Surpluses in trust accounts, such as Social Security, have been used to obscure the true shortfall in government spending. With less than one tenth of the actual deficit being reported each year, a cumulative negative net worth for the U.S. government has built up in stealth to a level that now tops $45 trillion, with total obligations of $47.3 trillion (more than four times annual GDP). The problem has moved beyond crisis to an uncontrollable disaster that threatens the existence of the U.S. dollar and global financial stability.”
If increased revenues come as a consequence of increased debt growth, then this doesn’t really resolve the underlying problem. Indeed, the most frightening thing about this long time build-up in debt is that it has largely occurred during a time of comparative political tranquillity… But, as events over the first part of the new century have demonstrated, this comparatively peaceful interregnum is now over and the tab for the US has mounted accordingly.
During Vietnam, the defence budget reached a peak of $439 billion (in inflation adjusted FY 2005 dollars). This budget supported about 550,000 troops in Vietnam, but it also kept hundreds of thousands of other troops forward deployed in Europe, Korea, Japan, the Philippines, Okinawa, and Guam; it funded a rotation in base in US to support these forward deployments, and funded hundreds of nuclear warheads on alert in missile silos, submarines at sea, and airplanes in the air.
Now compare this commitment to that of Iraq: To support the war in and Afghanistan, the United States will have a larger budget than at the peak Vietnam year, even if one removes the effects of inflation. The FY 2005 budget is in excess of $500 billion (in comparable FY 2005 dollars), once one factors in the $80 billion supplemental recently appropriated for Iraq. But America’s military is only about one-third the size of that fielded during Vietnam.
Weapons are projected to age even faster than during the Clinton Administration as the Bush Administration contemplates more cutbacks in future production (e.g., Joint Strike Fighter). US forces are clearly overstretched by a deployment of only 150,000 troops deployed to Iraq and about 15,000 deployed to Afghanistan as evidenced by the coercive personnel retention policies, such as the now notorious “stop-loss.” Militarily, America's forces are stretched too thin in Iraq, and they are showing signs of getting bogged down in a self-protection mode much like the Turks did in WWI.
That is a startling analogy: the Turks in World War I. That war saw the end of the once powerful Ottoman Empire. In the Paul Krugman column quoted above, he compares the U.S. empire to the Spanish Empire of Philip II. If American elites are starting to make these analogies, the situation must be dire.
And while basic needs of the fighting troops are not being met in a war of choice -- armour plate being the most infamous, the courtiers at the Pentagon are merrily throwing money at all sorts of cold-war inspired weapons (e.g., new attack submarines, ballistic missile defence, the F-22 and Joint Strike Fighters, the V-22 Tilt Rotor, etc.) which cannot possibly alleviate the situation for American troops enmeshed in a real Fourth Generation War.
That fact tells us that the people in charge of the war do not care about the people fighting it. They care only for the financial health of the corporations making money off the slaughter.
…Add to this, the near-guaranteed loss of much of what's left of the none-too-impressive "coalition" in Iraq in the next year -- the Italians have reiterated their intention to begin withdrawing their troops in September, the Poles have made similar noises, the Spanish are already out and even the British are planning a major drawdown relatively soon under the guise of redeploying in Afghanistan, hopefully to be replaced by the Australians. Consequently, the Bush administration is soon likely to find itself, standing very much alone in its mission, with a major domestic and international recruitment crisis on its hands.
According to The Guardian, the US military has stopped battalion commanders from dismissing new recruits for drug abuse, alcohol, poor fitness and pregnancy in an attempt to halt the rising attrition rate in an army under growing strain as a result of the wars in Iraq and Afghanistan. What’s next, emptying the jails?
…Of course, the tragedy of the London bombings may well prove useful to Bush, by recasting him again as a “war President”, even though it is interesting to contrast the respective approaches adopted in London and Washington to their respective terrorist attacks. The former seem far more inclined to treat this as a policing action, as opposed to a war (using the vocabulary of war, and the inflammatory “you’re either with us, or against us”, frankly co-opts tens of millions of Muslims into the camp of the west’s enemies, even though they might loathe some of the more odious leaders who head regimes in the Islamic world).
But as Europe begins to seem a more possible epicenter for further terrorist attacks, this may well provide further underpinning to the dollar, even though the war itself is now one of the major sources of imperial overstretch, which will ultimately undermine the greenback.
These are all dollar bear points for the medium to longer term. As we noted last week, the ongoing improvement in the Euroland data might point to a more immediate inflexion point in regard to the euro/dollar cross, as the markets begin to dismiss the notion of an imminent cut in the ECB discount rate. Last week, it was Germany whose data consistently surprised to the upside (and continues to do so to judge from an unexpectedly strong measure of investor confidence in the latest ZEW survey, which rose to a 10-month high of 37 in July from 19.5 in June). This week, it is France, where industrial production rose by 0.3% mom in May, posting the first increase in 4 months. Manufacturing production grew a more robust 0.5% mom; capital and intermediate goods were particularly strong.
The OECD’s composite leading indicator also points to a broadening of global economic activity. Soon to retire European Central Bank Chief Economist Otmar Issing has consistently iterated that the outlook for inflation in the dozen nations sharing the euro has deteriorated in the past month, suggesting the bank sees no scope to lower interest rates: “The outlook for prices has clearly worsened since June,” when the ECB last revised its inflation forecasts, said Issing in a dinner speech in Frankfurt last Thursday. Rates are still “appropriate” and “borrowing costs present no obstacle to growth in the euro region, rather quite the opposite,” said Issing.
So in many respects, the dollar’s current “success” on the foreign exchange markets appears to contain the seeds of its own destruction. Improved revenues appear largely a product of debt financed activity, which in turn are generating revenue gains that are probably unsustainable in the longer run. The strains of military overstretch is likely to exacerbate the problem and appear set to get worse as the “coalition of the willing” gradually becomes the “coalition” of the one. The dollar’s strength, therefore, appears no more than a summer respite. By the autumn, things may well look different to the forex markets again.
What makes the situation even more unstable is the breakdown of U.S. social structure with the polarization of society into extremes of rich and poor (or scared to death of becoming poor). Joseph Kay reflects on the polarization shown by two stories on one page of the Wall Street Journal.
By Joseph Kay
20 July 2005
Sometimes the real character of social relations in the United States manages to find its way into pages of the American press. Such was the case in Tuesday’s edition of the Wall Street Journal. The front page of the newspaper’s Marketplace section featured two articles, which when combined give a sense of the class division that cuts across American society. In “Keeping Up is Hard to Do,” Kris Maher tells the story of Mark and Donna Bellini, a typical working class couple from Pennsylvania. The Bellinis, who have two teenage sons, have a combined income of about $60,000 a year, which is roughly the median annual income for married couples. Indeed, the Bellinis are in many ways a very typical American family. However, this does not by any means guarantee them a stable living, and the Bellinis live under constant financial strains and the burden of debt. Maher notes that over the past several years, Mark Bellini’s pay has stagnated: “Mr. Bellini, a 51-year-old line technician for Comcast Corp., hasn’t received a pay increase in three years, since 2002. His wages have been stuck at $19.10 an hour while overall consumer prices have risen 8%.” The cost of basic necessities, particularly food and gasoline, has risen at a higher rate, and gas prices alone have jumped 55 percent since 2002.
The case of Mr. Bellini highlights an important fact: despite all the talk of an economic recovery and a resumption of growth, the conditions faced by most workers, even those who have not been laid off, have grown progressively worse. “Despite an economy growing at roughly 4%, healthy corporate profits and low unemployment levels, annual wages of workers in nonmanagerial positions—representing about 80% of the US work force—rose 2.7% in June from a year ago,” Maher writes. These increases have been entirely wiped out by inflation. In the most recent period, real wages have actually fallen.
As a consequence, fewer workers are able to amass any significant savings or put money away for retirement. Instead, they have been forced deeper and deeper into debt. For the Bellinis, more worrisome than the different life changes they have had to make to cut back on costs is the fact that “the couple counts almost no savings, and they haven’t, as once planned, been able to start a college fund for their two teenage sons. ‘The sense of security is gone,’ Mrs. Bellini says.” In order to get by, both Donna and Mark work full-time jobs, with Donna recently increasing her weekly hours from 24 to 38, at $10 an hour. After income and payroll taxes, the couple takes home about $3,200 a month, all of which is consumed by various expenses — utilities, a mortgage, property taxes, food and insurance, gasoline, clothing and other costs. Their credit card debts amount to $6,000, or the equivalent of nearly two months of take-home pay. Like so many American families, the couple lives “from paycheck to paycheck.” As Maher writes, Mr. Bellini “admits he doesn’t have a single dollar in his wallet and won’t until he receives his paycheck two days later.”
What will happen if something unexpected happens—a layoff, a health problem or a car accident? When considering the problems faced by the Bellinis, one understands the sudden surge in bankruptcy filings in recent years.
How is it possible to prepare for the future—including college costs and retirement funds—when current pay just barely covers current costs? Like many workers, Mr. Bellini has been forced to take loans against his 401(k) retirement account in order to pay bills. This, combined with a declining stock market, means that the Bellinis have less than $60,000 saved for retirement, the equivalent of only one year of their current income.
On the same page of the newspaper, Carol Hymowitz entitles her column: “To Rein in CEOs’ Pay, Why Not Consider Outsourcing the Post?” She begins by pointing out that while corporations have done everything they can to cut labor costs, including the outsourcing of jobs to countries around the world, pay for American CEOs has continued to rise, reaching levels far in excess of pay for executives anywhere else.
CEO pay—including salaries, bonuses and stock options—at major corporations routinely reaches into the tens of millions of dollars, hundreds of times more than the average worker at these same companies.
These pay packages are often justified on the grounds that they are necessary to retain top-quality executives. “What is galling,” Hymowitz responds, “is how rarely, even in a time of heightened governance sensitivity, compensation is linked to performance. Newly named CEOs are guaranteed a trough of money before they’ve done any work. When they fail and are dismissed, they are handed even more money.”
…Carly Fiorina, who had no trouble with poverty while CEO of Hewlett-Packard, nevertheless really hit the jackpot when she got pushed out earlier this year. Hymowitz notes that her severance package is $14 million, plus a $7 million cash bonus and $23.4 million in stocks and a pension.
Former Morgan Stanley CEO Phil Purcell received a severance and retirement package valued at more than $100 million when he got kicked out. “Former [Morgan Stanley] Co-President Steve Crawford is walking away with two years of severance estimated at $32 million after 3½ months on that job,” Hymowitz writes. Purcell’s package amounts to nearly 2,000 times the amount of money the Bellinis have in their combined retirement accounts.
…While Hymowitz points to these figures, she is at a complete loss to explain why something so irrational—such as the handing out of massive severance packages to failed CEOs—should be so prevalent. Reflecting the general bewilderment of the media establishment and a section of the ruling elite itself, she can only make an appeal at the end of her column for corporate boards that are more responsible.
In fact, the difficult situation of the Bellinis and the extreme wealth of the Purcells and the Fiorinas are inextricably linked. They are two facets of the same underlying process. On the one hand, the ruling elite in the US has responded to the crisis of American capitalism by furiously escalating attacks on workers, driving down wages, downsizing and outsourcing. On the other hand, under conditions in which the position of American manufacturing has plunged and profitable production has become more and more problematic, the corporate elite has increasingly resorted to outright theft.
When most people are struggling financially, when soldiers are sent to far away lands without the proper equipment, when the government is going broke and is rapidly becoming a failed state that cannot provide any of the basic functions to its citizens, what do you call it when failed CEO’s walk away with tens of millions of dollars in severance and moderately successful ones who sell their company to a larger predatory company walk away with hundreds of millions? It can only be described as massive theft, as plunder. The question to ask is why are they stealing so much now? Are they trying to purchase survival from the coming cataclysm? Are they attempting a staged crash followed by a grabbing of all world assets for pennies on the dollar? Or is it just compulsive greed and self-delusion?