The Global Economic Tsunami - Its Roots & Solutions - By Vasantha Raja
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The global economic tsunami: Its roots & solutions

Vasantha Raja - 29 October 2008

Queen Elizabeth recently raised an important point vis-a-vis the deepening global financial and economic crisis when she visited the London School of Economics. Putting the economic pundits on the spot she asked: "Why did nobody see it coming?"

As one who predicted accurately what was about to happen, what form it would take, and what solutions are required to overcome it, I wish to reiterate here what I've been saying earlier - my Sinhala booklet that analyses Sri Lankan economy's fate in the context of the onrushing global economic crisis was published in 2004.

Even after the event many mainstream economists totally underestimated the impact the financial collapse would have on the global economy. Only now some sensible economists are beginning to see that a huge portion of the post-war economic expansion - particularly the zigzag growth of the global economy during the past three decades - is on the whole based on "funny money", or arbitrarily created paper money not in tune with global earnings, output etc. [In a highly globalized economy, creation of credit and money has to be harmonized with the global earnings, output, prices etc. Obviously, this task is beyond the capacity of an anarchic network of nation-states.]

During the first stage in the post-war economic expansion - i.e. prior to the globalization project - the driving force was the capitalist state. Pumping colosal amounts of paper money to create and maintain the welfare state was forced upon the governments by the new militant mood of the post-war mass movement in the west. Taxes alone were not sufficient. Keynesian economics provided the ideological cover for the states to inject massive doses of paper money to do the job.

By late 60s, however, this method of development was running out of steam; hyperinflation, falling rate of profit, rising unemployment and trade union struggles had arrived on the stage. It was the inexorable deterioration of this situation that forced the west to turn towards globalization. Obviously, the nation-state could not shoulder the task. The role of funding this project had to be passed on to private bankers.

Dumping of Keynesianism, scrapping of the gold-standard, free-floating of currencies in the world market and deregulating the banking system did the groundwork for the new episode of capitalist expansion known as the globalization. A new era of highly chaotic ways of credit creation had emerged; the result was a relentlessly swelling credit bubble that fostered the illusion of growth as never before.

The 'regional bubbles' that burst along the way only forced the global credit bubble to expand even faster. It is the collapse of the 'Big Bubble' that has now begun to gobble up all that was built on mountains of debt. This is why pumping in more credit by the state to save capitalism will be of no avail. It will only aggravate the crisis - unless accompanied by radical changes necessary on a global scale.

The efforts to persuade China to change its export-oriented policy and use its substantial foreign exchange reserves to facilitate a Chinese domestic market for the benefit of crisis-ridden western exporters are also unlikely to work in the absence of a new world order.

The Times editorial of 29 Dec, after warning China of possible social unrest due to "deceleration in growth and investment", wrote: "China's strategy of accumulating foreign exchange reserves through expansion of the trade surplus needs to be modified. China is a huge potential market for Western exporters. Its policy makers should now aim to stimulate domestic demand and implement structural reforms. These steps would help to stabilise the global economy, and could also provide the Chinese people with a better quality of life".

Remember how the US took on the baton when the British-dominated world economy was in ruins after the war. Now that the US-dominated global economy is in a meltdown, the effort seems to be to pass the buck to China. With its Stalinist prejudices of "socialism in one country", China could even swallow this proposal having high hopes of future nationalist glory.

But, with all major western currencies heading for zero interest rates, the ground is being prepared for intense trade wars to which China will inevitably drawn in. Thus, "wars and more wars" until the entire post-war developments are in ruins for a new cycle of growth to commence from square one; this could well be the scenario this time round too if the world economy fails to take the leap into a qualititatively new global order.

The alternative, I think, is this: China should support a global conference dedicated to build new international institutions and structures that are indispensable for a new world order. Many Chinese economists, I believe, can enlighten the world in this respect. Using China's foreign exchange reserves to develop its ordinary people's living standards should only be part of such a global project. [I shall be discussing this later. For the time being let's return to the roots of the present crisis.]

Mounting property prices all over the world became a cover to defend reckless lending during the latest episode of the post-war economic boom. The US housing bubble was the cornerstone of the global property bubble; and, this became inseparably intertwined with the credit bubble. Thus, the housing bubbles inevitable collapse has brought down the credit bubble with it. And, all its tangible creations have now reached the vanishing-point.

Does this mean humanity is doomed? I don't think so. On the contrary, I think, a historic opportunity to bring about a new world-order is here - about which I shall discuss later. First, let me sketch the rough outline of the post-war economic history and show what went wrong.

Rebuilding of Capitalism on the ruins of the Second World War was based on the inauguration of the US dollar as the global monetary system's linchpin with a guaranteed value of one ounce of gold for $35. The post-war socio-political realities such as the cold-war and the rising demands of war-weary masses in the west, however, forced the United States - which was the backbone of the post-war economic expansion - to inject colossal amounts of money into global circulation causing immense pressure on the gold-standard. There simply wasn't enough gold at Fort Knox to match the swelling 'paper money' quantities.

The way out was to free the dollar from gold-obligations. And, that's exactly what happened in 1971 during Nixon's administration. The anchor was removed enabling the dollar to be printed at will. And major currencies were floated freely for their exchange rates to be determined by the global market.

Amid rising inflation, oil prices leaped four fold by mid-70s making the situation worse. "Stag-flation", currency instability, trade-union struggles and falling rate of profit began to haunt capitalism. The spectre of economic and social chaos was on the cards.

The way out was to force the former-colonies in the 'third world' to open up their economies for foreign capital, goods and services. This marked the beginning of capitalism's 'globalization project'.

The United States - as the chief defender of global capitalism- had no choice but to prepare the grounds to print dollars at will. The 'petrodollar deal' with the OPEC - whereby the dollar was ordained as the sole currency of oil trade - was an ingenious move; for, this move forced the central banks all over the world to amass US Dollars as never before in order to pay for the "Mother of all Commodities", Oil. This, in turn, paved the way for the US to print dollars at will as never before.

Credit had to be pumped into poor countries - in the form of massive loans - enabling them to accommodate the new western requirements. Newly emerged (essentially corrupt) political and business elites in the third world eagerly came to terms with their western counterparts to share the mutual fortunes.

Paying the interest on spiraling debt mountains, however, caused the rich-poor gap in the third world to widen inexorably. Ruthless exploitation of poor masses and large-scale disruption of communities for profits' sake became the social reality in many poor countries. This resulted in a phenomenon of social unrest, civil wars, revolutions and dictatorships that was threatening the very foundation of Capitalism's globalization project. Something had to be done.

The west was compelled to write off some debts and take steps to reduce the economic burden. Global financial sector had to be systematically deregulated to allow the bankers to find their own ways of providing more and more credit all over the world.

Thus, the entire global financial system was turned into a relentlessly swelling 'debt pyramid' standing upside down. The scientific breakthroughs in computer and communication technology, and rising fictitious values of economic bubbles immensely helped the global bankers to invent ingenious ways of dodging the nominally nagging regulations and injecting more and more credit into the contagiously snowballing global 'bubble'.

Soon enough a skilled (and cheap) labour force was ready at hand in the third world for the western capital to utilize in alliance with the indigenous entrepreneurs. At a time when the high cost of production in the west making western industries uncompetitive, the new developments in the third world provided a golden opportunity for the western multinationals; and, a rush for cheap labour began. [China and India emerged as the biggest beneficiaries of this process.]

Problems, however, began to crop up from unexpected corners: The rise of the Euro as a major global currency on a par with the dollar was one of them. Hardening anti-US forces in the Middle-East led by Iraq's Saddham Hussein at the time realized that the best way to harm American interests was to break the 'petrodollar deal' by demanding payments for Iraqi oil in Euros. And, that is exactly what he did by setting a provocative anti-American trend in motion. Some analysts see this move as the immediate cause that pushed the US establishment to carry out a regime change in Iraq that swiftly restored the 'petrodollar arrangement'. They see the US' general need to secure reliable oil-supply merely as a background cause. However, the 'pro-euro trend' did not end there. Two other major oil-producers - Iran and Venezuela - also took steps to do their oil trade in euros. Some analysts cite this dollar-euro change over as a major cause behind the CIA's hitherto failed efforts to assassinate Venezuela's socialist president Hugo Chavez and the US administration's relentless effort to invade Iran.

Another unexpected problem came from the unstoppably expanding US housing bubble that eventually burst. The housing bubble was a deliberate creation of the US administration under desperate circumstances. Let me explain:

The United States' consumers provided the biggest market for the fast expanding global production of commodities. Without them the 'global growth' as a whole would have been in trouble much earlier. Thus their buying power had to be kept lubricated no matter what.

In other words, the US housing bubble was the linchpin for the irrevocably expanding global economy. It not only enabled the consumers to get more credit but also the bankers to evade regulations in creating dodgy credit 'instruments'. For, the spiralling house prices kept reinforcing the consumers' ability to burrow and the creditors' ability to give - until this vicious circle reached the point of collapse.

Now that the bedrock of the global economy is gone any hope of saving world capitalism via pumping more 'paper money' is also gone. If the governments want to put 'real public money' and resuscitate the system, the implications would be suicidal. For, that would mean the wipeout of public welfare and developments to save global bankers and multinationals.

One important lesson from the past three decades since the scrapping of the gold-standard in 1971 is this: the global banking sector in the profit-hungry private hands - with limited selfish visions - is incapable of financing the real economy in a rational way with long-term global visions focused on global productivity and humanity's general welfare.

On the positive side, however, the bankers have unwittingly prepared the ground for the eventual formation of a humane 'One World'. Today the global economy is tightly intertwined where parts are interdependent as never before. Therefore, understanding the crisis as well as solving it require a global approach. There are no national or regional solutions. The potential for a democratically regulated global financial sector that can guide the anarchic market [the adjective 'free' is a misnomer] within a rational global vision has emerged.

The time is here for a truly global outlook that transcends all nationalist perspectives - an outlook that should mark a paradigm-shift in economic thinking. The profit-centred capitalist values of competition, nationalism and economic anarchism should be replaced with new values of cooperation, internationalism and scientific planning.

Thank Goodness, the credibility of free-market philosophy [the so-called "trickle down economics"] is finally in jeopardy; and, the interest in alternative economic visions is on the rise.

The task confronting the present Labour government in Britain is historic. The globally unfolding events at present pose both dangers and opportunities for the humankind as a whole. The Labour Party that was created over a century ago by the British labour movement to challenge the establishment should grasp the meaning of the new opportunities and lead the world in a new direction. For, both the main problems and their possible solutions cannot be understood within national boundaries; they are global in a direct and practical sense. The time is up for Labour leaders to go beyond the nationalist mind-set and present themselves as global visionaries. Any failure in this historic task would signal the necessity to replace the Labour Party with a new socialist leadership.

Democratic & transparent global institutions are needed to transform the existing mode of globalization into a genuinely humanist globalization. This would involve, among other things, nationalization of the banking system, regulation of the world market, mobilization of "Marshall-Plan" type projects to eradicate world poverty, designing & coordinating world-infrastructure ventures crucial to global productivity, providing leadership in the search for green energy and the harmonization of economic growth with environmental protection & global welfare.

The finance sector and the planning & development of economic infrastructure should be directly under the guidance of reformed global institutions such as the UN, the World Bank and the IMF. Long-term global planning with scientific expertise should be the foundation of public investment. Planning and investment on national & regional infrastructure should be part of the planned global growth of productivity & common welfare. [Remember, common welfare is not just a moral issue; it's an economic issue, for, health, education, housing etc. are inseparably linked to productivity.]

Up until now, the creation of credit was the result of self-centred 'visions' of private bankers hell-bent on reaping profit. What we are painfully learning at present is: The creation of credit should be in the hands of democratically controlled public institutions with global visions to plan worldwide human development in a balanced way.

will succeed in moving away from the already failed New Labour economics and rediscovering the value of socialist economics remains to be seen.

None of this is conceivable without a paradigm-shift that cleanses globalization from all its hereditary imperialist traits. What is needed is to campaign for a new Bretton Woods type conference aimed at re-structuring and strengthening the post-war global institutions - the UN, World Bank, IMF & International judicial institutions - with fresh mandates appropriate for a new world-order, and turn them into authentic global institutions. The long-term logic of this line of thinking could well be the eventual creation of a global parliament & a single global currency.

I hope the above-mentioned perspectives make it clear that reviving a Bretton Woods type conference does not mean returning to the past. There should be no restoration of the gold-standard [for, that will unnecessarily limit the state's ability to plan long-term infrastructure projects.] and there should be no place for 'the nation-state mindset' in designing the new world order - as opposed to the nationalist outlook that dominated the post-war global deal.

Let's closely watch if the global leaders are capable of discarding the discredited laissez-faire ideology and building the much needed cooperation of the world towards designing the global economy on socialist principles.

Editor: www.lankaeye.com [v.raja@btinternet.com]