Commodity financialization is economic terrorism

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Shift towards hard assets: Financialisation of commodities

Published: May 30, 2011

Many investors strongly feel that if interest rates rise, gold will automatically fall.

Many investors strongly feel that if interest rates rise, gold will automatically fall. But is that going to be true?

There’s a great deal more involved in this story than just interest rates. I think that all commodities are set to rise further this year with prices peaking in 2012 or 2013 when the dollar crisis is likely to hit. The dollar has lost 50% of its value in the last 27 years against major currencies globally.

Precious Metals

Gold and silver is the best hedge against financial chaos in the market. If investors want to get insurance of their wealth, buying gold and silver is the best option since these are real assets. You can’t devalue or multiply gold/silver out of thin air. Gold and silver have got intrinsic value which can protect investors.

Investors should be bullish on silver since its industrial utilisation is very high. Silver has already touched $49 an ounce and it still has room to reach further highs.

Agricultural commodities

Agricultural commodities have been neglected over the past 25 to 30 years, but that is likely to change. In Japan, it is now hard to find farmers. The agriculture sector continues to witness rising prices amid growing demand from emerging economies with increased purchasing power and improved disposable income. Jim Rogers said “Fund managers would be acting like farm managers.” Farmers would be driving Lamborghinis and Mercedes with increased income at their disposal. Sugar is trading 37% below its spot price. With increasing utilisation of biofuel and ethanol, the prices of sugar, corn and soya bean are ready for another record high in the coming months and years. With changing weather patterns which is the main driver for rise in soft commodities, the outbreak of a real, live global famine looks increasingly possible with each passing year. So are investors prepared if a global famine does strike?

Already, there are huge warning signs on the horizon. Just check out what agricultural commodities have been doing. They have been absolutely soaring with the World Bank warning of food crisis this year.

Base metals commodities

All base metals would rise in two to three years as demand outsmarts supply, putting pressure on commodities like aluminum, steel, iron ore, tin, copper, lead, lithium, zinc to rise further as investors get jittery and global markets chaotic moving forward.

Energy Commodities

Oil, natural gas, shale gas, coal and ethanol would keep on rising due to growing demand and supply constraint in the future. Energy billionaire Boone Pickens is bullish on natural gas and advocates solution to the growing energy requirement of the US economy. The Cambridge energy group organised a conference in Houston, Texas in March-2010 and top executives from Exxon Mobile, BP, Chevron, Shell were all deliberating upon the possibility of an upsurge in natural gas, shale gas and its benefit for the global energy requirement since these commodities were more environment-friendly.

New commodities

Water is also commodity now and I don’t rule out the possibility of water becoming a luxury. In Pakistan clean bottled water already is. Water prices have gone up by 37% in China. Clean and drinkable water are a great source investment not only in the South East Asia but also in the North East Asia and Africa as well. Water is fast becoming a scarce commodity and prices would continue to rise going forward. Lithium is perhaps the most sought after commodity for batteries as it is environmental friendly and has improved efficiency. Rare earth for which China holds a market share of 97% will be another area whereby investors would strongly compete for. Happy investingI

The writer is an economist and graduate of the University of Chicago’s Booth School of Business

Strategic factors leading to rise in commodities globally include:

Accommodative monetary policy

Negative effective interest rate [adjusted for inflation from nominal interest rate]

Demand-Supply Gap

Under-investment in few commodities

Geo-political and geo-strategic landscape

Volatile financial markets for the next two years

Sovereign debt risk

Positive price growth

I am bullish on rice, sugar, wheat, corn and soya bean in 2011 and 2012 as well. Here’s what’s happened to some key farm commodities’ prices in 2010:

Corn               63%

Cotton           57%

Wheat             84%

Soya bean     27%

Sugar             55%

Sources: Forbes and Financial Times, Economist

Published in The Express Tribune, May 30th, 2011.

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Economic Crisis, Financialization, and a New Model of Governance

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The economic crisis is nearly two years old. I like to call it the Second Great Contraction, to borrow a term from a mainstream economist, to distinguish it from other postwar economic downturns.

Notwithstanding the “good” reports on GDP, employment and personal consumption growth, there is plenty of reason to be uneasy about the economy.

Investment is sluggish, trillions of dollars in real and fictitious capital have disappeared and will not return, and exploitation increases and wages fall. The housing crisis has eased a bit, but the foreclosure rate and the number of houses underwater are still enormous. Consumer spending remains low as households begin to work off their debt. State and local government spending is declining, even though it should be increasing to counter downward economic pressures. Income inequality is worsening, debt levels remain enormous, manufacturing is limping along; export growth is weak and poverty is ratcheting up, particularly in the racially oppressed communities and among single moms.

And no one should expect China to become a buyer of last resort in global markets.

The one indicator that shows some rebound is – you guessed it – corporate profits, especially in the financial sector. With no shame, management committees at the biggest financial institutions are awarding themselves a huge payout in salary and bonuses. Just when you thought the criminals on Wall Street might lie low, they come out in the open and flaunt their new wealth with supreme arrogance.

By most standards, the recovery falls somewhere between modest and stalled. To say the economy is getting back on its feet is to look at the economic indicators selectively.

Many mainstream economists fail to appreciate that the Second Great Contraction is different in its origins, magnitude and resistance to quick fixes, compared to earlier crises.

If history is any guide, the return to normality following a crisis of this kind will be slow. And still within the realm of possibility is not only a new downturn – a double dip, as it is called.

Furthermore, because of the hyper-connectivity of global markets, the power of bondholders/finance capital, the socialization by taxpayers of losses of “too big to fail financial institutions,” and the buildup of external and internal debt in most countries prior to and after the crisis, one can’t rule out a financial crisis breaking out in one or a few countries and potentially spreading worldwide.

Capitalism, says David Harvey, doesn’t resolve crises so much as it moves them around.

So far the financial crisis has been contained here, but no one should sleep soundly. The notion that it “can’t happen here” has been pulverized by events.

Even if it is contained, the mushrooming of debt is becoming the new instrument to bludgeon working people worldwide, as is evident in Greece. “Tighten your belt and rein in your expectations” are the new clarion calls of deficit hawks worldwide. As if it didn’t get enough, the investor/finance class wants more surplus value from the working class and people in the form of lower living standards and fewer social benefits.

Here there is talk of social security and Medicare reform. And the current budget gives the green light to discretionary spending cuts. What is missing in the dialogue is any talk of a deep going change in the tax structure, reductions in the military budget, and a debt moratorium for ordinary Americans and state and local government.

As long as this out of the conversation, the solution to indebtedness will fall on working people and the poor.

To make matters worse, the endless talk of fiscal responsibility conceals the underlying causes of the crisis: income inequality, the rise of finance and financial liberalization, the hollowing-out of the manufacturing sector, the undermining of working-class power, the entry of new competitors in the global economy, and chronic overproduction in world commodity markets.

No solution to the nation’s economic and financial woes that doesn’t address these fundamental causes of the dire economic situation stands “a snowball’s chance in hell” of succeeding.

Financialization

From the standpoint of the top layers of financial institutions – Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo – the current legislative struggle over financial regulation is but one battle, albeit a crucial one, in an ongoing struggle to fully restore themselves to the preeminent position they occupied in the global economy for the past three decades.

After sitting at the pinnacle of power, seeing their wealth multiply exponentially, and shaping the dynamics and contours of the world economy, they are not about to easily yield – or even slightly diminish – their power and privileged position.

Call the financial czars here and elsewhere whatever you like, but they are well aware of their class interests. What is more, they are mindful that the New Deal hemmed them in for roughly four decades. Admittedly none of them starved, but neither did they enjoy the nearly unchallenged political and economic sway as they have in recent decades.

If finance capital is able to reconstitute its power, the prospects of working people here and elsewhere are bleak. If, on the other hand, its power is progressively curbed, as it can be in the course of successive and contentious struggles, the future of the multiracial working class and its allies is far brighter.

Tough regulation and reduction in bank size are critical, but not enough.

In a larger sense the struggle is to change the whole social structure of governance and process of accumulation. For more than three decades, the main contours, dynamics and interrelations of the U.S. economy were shaped by finance capital and an exploding and nearly autonomous financial sector.

In previous periods of capitalist development, financial bubbles occurred at the peak of the business cycle. Today, however, financial bubbles are better seen “as manifestations of a longer-term process of financialization, feeding on stagnation rather than prosperity.”

In contrast to conventional wisdom, the severe erosion of the manufacturing sector was not a product of financialization, but the other way around in the early going. New conditions and contradictions – intense price competition, entry of new producers in the global marketplace, high unit labor costs in American manufacturing relative to their counterparts elsewhere, and the consequent difficulty of maintaining adequate levels of profitability in the 1970s – combined with de-regulation and a recession (engineered by the Reagan administration) to stimulate the flight of capital out of the manufacturing and other sectors of the real economy.

Most of it ended up in speculative channels, while some went to plant relocation in countries abroad where costs were cheaper. The center of economic gravity shifted from industry to finance and over time the wheels of financialization, greased by both parties, brought the country to ruin, the likes of which we haven’t seen since the Great Depression.

Much of what is now taking place in the political arena is driven by the battle to reconstitute the economy and along what lines – labor or capital. Or said another way, the corporations or the people.

Labor is prior to, and independent of, capital; that, in fact, capital is the fruit of labor, and could never have existed if labor had not first existed; that labor can exist without capital, but that capital could never have existed without labor! (Abraham Lincoln)

A New New Deal

The Obama administration’s immediate challenge will be to revive the economy. The question is how? Where will economic dynamism come from in the near term? What change in political and economic structures and property relations are necessary?

Part of the answer is massive fiscal expansion, that is, large injections of money from the federal government into the is no answer to growing joblessness.

According to conventional wisdom and mainstream economists, near-full employment and healthy profit rates are the normal condition of a capitalist economy. Perhaps that was the case at an earlier stage of capitalism’s development, but not now. Indeed, one has to wonder what the long-run prospects of U.S. and world capitalism are.

The collapse of Lehman Brothers and the near meltdown of the financial system announced the death knell of capitalism, as we know it. What the future holds no one knows for sure, but it does look dim for working people if the economy is allowed to run its course.

It is hard to draw any other conclusion, given the fragility of the world economy, the incredible debt that has built up worldwide, overcrowded and hypercompetitive world markets, the emergence of the Asian tigers and now the BRIC countries – Brazil, Russia, India and particularly China, the entry of hundreds of millions of people into the workforce, and the resistance of many sections of the capitalist class to structural economic change.

New model of economic governance

What is needed is a new model of political-economic governance at the state and corporate level that favors working people, the racially and nationally oppressed, women, youth, seniors, small business people and other social groupings.

This new model of governance won’t be socialist, but like the New Deal, it would make substantial inroads into corporate power, profits and prerogatives; democratize state and quasi-state structures like the Federal Reserve; give communities, workers and small businesspeople a say in corporate decision-making, encourage small and medium size businesses and new forms of social property such as cooperatives; place energy, finance and transportation in the public domain; demilitarize and green the economy; deepen and extend equality, and reconfigure our government and nation’s role in world affairs.

Furthermore, militarism and militarization of the economy are incompatible to a peaceful world and a people friendly economy.

Yes terrorism is a problem, but projecting U.S. military power overseas and frightening the American people is no solution; its solution requires police action, intelligence sharing, and a more just world.

In any event, class and democratic struggles over the direction of the economy will intensify and will be resolved ultimately in the political arena. These struggles and capitalism’s growing incompatibility with human aspirations and the future of the planet will reveal the new necessity of socialism, to which I now briefly turn

Photo by AFL-CIO, courtesy Flickr

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The IMF has a report out supporting the predictability of my food riot/revolution index. It seems the rocket scientists there equate a 10% increase in global food prices to a 100% increase in anti-government protests. That makes sense. They add an important consideration concerning the U.S. and other developed countries that addresses the large and growing poor population within those countries. In this case, the bottom quartile spends 35% of their income on food. With 45 million people in the U.S. on food stamps, I’d say that data is now understated and dated.

Source: Bank of Japan

If we look at the increase on foodstuff commodities since last November of 25%, up 45% since last year, there is little wonder that increasing parts of the planet are unstable and troubled. Per IMF, this would equate to a tripling of the increase in protests, riots, revolutions and civil wars. In spirit, that seems to be precisely what has happened. With the index nearly breaking out once again to new highs, we may be soon looking to add another 50-100% factor (from another 5-10% food price increase) to the already sky high riot and revolution indicator. In effect, we could go from a 8 magnitude earthquake up to a 9, and set the stage for a long, hot summer.

The Bank of Japan is out with a report examining the financialization of commodities. The amounts involved go far beyond normal economic demand considerations, and that is a key distinction to make here. I thought 2008 was bad enough, but today, the open interest in futures markets in the U.S. exceeds the 2008 CUB (crack up boom). In global markets, exposure far exceeds that of 2008. The net position of commodity index investors/speculators far exceeds that of 2008. With endless commodity account commercials and talking head commentary on busimerical TV and radio, the whole world looks all in and rather fearless on this central bank-hyped and crowded get-rich-quick trade. You can’t turn on one of these networks without some “expert” droning on about materials and commodities.

Source: Bank of Japan

Perhaps showing a bit of concern about the monster it helped create, the Fed rolled out so called moderates Lackerand Kocherlakota last Thursday with more “talk” about the need to review the QE2 fuel being thrown on the fire, and perhaps take it off the table early or defer it. The market, and especially the commodity sector, totally ignored this in the last half hour of trading and in overnight trading. After the news broke, CNBC ran another (“I am going to trade the world.”) commodity trading account commercial .

This illustrates the problem with this feeble “talk loudly and wield a soft stick” or Pinocchio grow-your-nose gambit by the Fed. There is a universal belief that they don’t have any inflation-fighting credibility and use incredulous dog-ate-the-homework excuses like “global demand” and “weather” to explain the carnage. Then when they fail to follow up with real decisive action; this just adds to the relentless crack up bid. In fact given this psychology, should the central banks now act to counter this, especially given the historical volatility of commodities? A large pool of investor and financial institutions could face a large scale liquidation and resulting turmoil from their large exposures.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

This article is tagged with: Macro View, Commodities, United States
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An Empire of Indifference: American War and the Financial Logic of Risk Management

  • Author: Jesse Goldstein

Randy Martin, An Empire of Indifference: American War and the Financial Logic of Risk Management (Durham and London: Duke University Press, 2007).

For all of the unknowns that this current economic crisis presents, one thing has become increasingly certain: the world has become fully engulfed by the volatility of finance. Randy Martin has been arguing as much since well before this most recent implosion. His previous book, The Financialization of Daily Life (2002), is a creative attempt to see financialization as an everyday practice, updating the western Marxist interrogation of commodity fetishism as a lived experience. In An Empire of Indifference, Martin subjects US imperialism and warfare to a similar analysis, arguing that American military aggression in the war on terror has taken on a logic akin to that of financial management. What is new, according to Martin, is less the functions that war plays within and for the capitalist imperium, than the form that these wars take, their inner logic and tactical organization. What distinguishes financialization from other forms of accumulation is the focus upon wealth extraction through risk management. Hence, the “imperial unconscious” (125) has shifted its focus from victory – defined in terms of sovereign control or development – to an active indifference, or the management of permanent war.

The Empire of Indifference is largely an argument made by metaphor, with the keywords of finance, securitization, derivatives, leverage, etc., each coming to describe dimensions of US militarism and the war on terror. The book is divided into an introduction followed by four chapters. The first of these chapters (Chapter 2) establishes a framework for understanding the financialized state, in terms of both domestic and military affairs. Martin begins with a survey of the rise of financialization, focusing on the history of capitalist monetary regimes leading up to the dissolution of Bretton Woods in 1971. With dollars no longer convertible to gold, the Federal Reserve initiated a period of monetarist policies centrally concerned with preempting inflation through the careful management of interest rates. This emphasis on the risk of potential inflation finds its correlate in financialized warfare, where the risk of potential terrorist acts could – like inflation – disrupt the regular operations of business and the free flows of capital. Hence, the war on terror represents a shift away from the cold war’s focus on deterrence, to a newly asserted focus on preemption as a strategy of risk management. There is a shift from enemies with weapons of mass destruction to enemies that ‘seek’ them, enemies that are potential, but not-yet, risks. American war (by which Martin means US militarism) manages the racialized others of its terror war as if they were all potential terrorists.

The strength of Martin’s approach is to always trace a topography of capital where apparently disparate social relations or institutional forms can be seen to display parallel logics. And so for instance, securitization – now infamous as the central pillar of the subprime crisis – need not be left to the financial pages, but can be seen more broadly as the de-localization of risk through its conglomeration and then abstract segmentation and management. Similarly, the war on terror links its disparate targets through their imperial securitization – in other words, the war homogenizes its enemy as terror, and then manages this de-localized risk through ‘leveraged’ interventions. The securitized state, both domestically and militarily, is Martin’s attempt to financialize Foucault’s concept of biopolitical rule, the injunction ‘to make live and let die.’ He draws connections between the current terror war and the domestic policy wars against crime, AIDS, drugs or poverty of the ‘80s and ‘90s. These are not, as with Lyndon Johnson’s war against poverty, efforts to rehabilitate, but are instead efforts to police, punish and criminalize. The culture of poverty meets its correlate with a culture of terrorism, and the key binarization underlying this financialized logic is a division between those who are able to avail themselves of risk as opportunity, and those who are at risk; the self-managed and the unmanageable.

The next two chapters outline the financialized, post-Fordist management of military intervention. Led by the Office of Net Assessment, the military has adopted a systems analysis where models no longer attempt to predict the future, but instead attempt to thoroughly understand the present, providing a ‘leveraged’ advantage on the battlefield. This systems analysis provides a technological cover for the downsizing and privatization of the military, as it shifts into a post-Fordist model: a militarized version of just-in-time production where technological innovation and investment creates a small set of highly productive (or destructive, as the case may be) commandos, supported by a vast army – literally – of support staff. The ‘products’ of this post-Fordist military are derivative wars, which are small, quick and leveraged affairs – directed attacks less concerned with holding territory than with managing risk.

Martin is not arguing that there is something new about the small war – but that these small wars are no longer about positioning in relation to a larger skirmish. They are now themselves the core of strategic positioning. These interventions are primarily concerned with the ability to circulate, as opposed to the ability to claim sovereignty. For Martin, this is analogous to a shift from shareholders, who own shares of equities, to leveraged derivatives traders, who instead generate wealth via the management of risk. The unintended consequence of this risk management, both in the world of finance and in the case of US empire, is to exacerbate the very volatility that was to have been contained. Hence, there results a vicious cycle of destabilization and derivative wars, which, in the final chapter, Martin terms the “empire of indifference.” This is empire whose stated objective is no longer progress or development but which now only promises the management of a perpetual present of risk-opportunities.

In the final chapter, Martin also discusses the financialization of anti-imperialist struggle, framing it with a critique and reformulation of Hardt and Negri’s work in Multitude: War and Democracy in the Age of Empire (2004). The multitude, grounded in networks of immaterial labor, is replaced with the idea of socialization, grounded in the immaterialty of financial circulation. Martin understands socialization as “the connection between participation, the spread of social production, and the constitution of a social economy” (146). His argument, roughly, is that financialization, and in particular securitization, entails a further socialization of capital and of labor – an intensification of interdependence on a global scale – that is both exploitative and generative; not necessarily of progress, but certainly of social wealth. But who has access to that social wealth, and in what forms? Similar to Multitude, any analysis of the production of value (as Marx outlines in volume I of Capital) is set aside, in favor of a triumphant conception of resistance grounded by people who are in direct control of their own productive lives.1 Martin is absolutely correct that surplus populations create new forms of social wealth, but to presume that these social economies, plagued as they are by a scramble for survival within a militarized, capitalist environment, will automatically result in a form that is less exploitative than capitalism, seems rather naïve. Patriarchy and domination can take many alternative forms; the Taliban may be a case in point.

Nonetheless, this leads Martin to embrace, as do Hardt and Negri, heterogeneous protest movements that “avoid divisive calls for unity” and “challenge the privatizing mandates of the terror war and the discretionary aspects of the derivative war while adopting certain properties of leveraging and securitizing of their own” (157). Such “movement of movements” or “dispersed demonstrations” are the assemblage of small bundles of opposition into a larger effort, a securitized demonstration that renders people “mutually interdependent.” Financialized protesters are at once united in opposition to war and yet at the same time represent a multiplicity of alternatives for organizing the social surplus. Here it is sufficient to say that those already inclined toward this post-Marxist paradigm of political philosophy will welcome Martin’s contribution, and those less convinced will be re-confirmed in their suspicions that such work has divorced itself from any analysis of class struggle.

One gets the sense, reading The Empire of Indifference, that Martin is exploring the financialization of US imperialism and its popular opposition as a cultural moment without sufficiently contextualizing either imperialism or anti-imperialist social movements within their long and bloody history, and without sufficiently accounting for the role of financialization in relation to the crisis tendencies of capitalism. Against the perceived functionalism of Marxist critiques of political economy, Martin raises the possibility of unintended consequences, or the idea that “interest tends to betray itself” (162). However, Martin does not link this to a tendency toward crisis, but only to a tendency toward increasing, yet manageable, volatility.

That said, Martin’s argument could only be made stronger by linking the rise in financialization to contradictions immanent to capitalism – not only the contradiction embedded in the wage relation, which results in a crisis in profitability, but as well O’Connor’s second contradiction, between the non-human conditions of accumulation and their unsustainable exhaustion by capitalist production processes. In fact, in 2004 the Pentagon issued a confidential report that warned of global warming-induced resource depletion creating the conditions of permanent war as soon as 2020.2 Recognizing financialization’s relationship to a value system in crisis, some of the most interesting questions remain to be asked: Will there come a point when the US military has leveraged its position past a point of solvency? Is US imperialism increasingly becoming a speculative bubble, a fictitious power waiting to burst? If so, what will the bailout attempts looks like? And who will pay… with their lives?

The style of the book presents its own problems, reading like an impassioned stream of consciousness, a non-linear ride through the US imperium and its logic of risk management. One is tempted to turn Martin’s own critique of financialization upon his text, and to ask whether he has himself become consumed by a ‘derivative prose’, a rapid succession of short bursts of analysis, each leveraged for maximum impact and hedged against the risk that the reader might somehow lose interest. Yet here, as with the world of derivatives, the attempt at risk management may in fact exacerbate the problem that it seeks to contain. Frustrating as the text can sometimes be, I am nonetheless left with a creative and exciting new analytic for understanding current forms of US imperialism. Martin succeeds in creating a generative text – one that opens up lines of inquiry and re-evaluation of pre-conceived truths regarding the war on terror – and for these reasons, I recommend the book to all those interested in expanding their conceptualization of US imperialism beyond the well trodden paths of current Marxist debate.

Jesse Goldstein
PhD Student in sociology
City University of New York
jesse@space1026.com

Notes

1. Cf. David Camfield, “The Multitude and the Kangaroo: A Critique of Hardt and Negri’s Theory of Immaterial Labour,” Historical Materialism 15.2 (2007).

2. Mark Townsend and Paul Harris, “Now the Pentagon Tells Bush: Climate Change Will Destroy Us,” Observer/UK 22 Feb. 2004.

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The financial meltdown: Roots of the economic crisis in overaccumulation, financialisation and ‘global apartheid’

By Patrick Bond
October 3, 2008 — The global economy’s vast financial sector expansion – in the context of productive sector stagnation tendencies – has increased the leading powerbrokers’ capacity to devalue large parts of the Third World (including major emerging market sites), as well as to write down selected financially volatile and vulnerable markets in the North (e.g. dot.com and real estate bubbles). In contrast to the 1930s, this set of partial write-downs of overaccumulated financial capital has not yet created such generalised panic and crisis contagion as to threaten the entire system’s integrity. Shifting and stalling the necessary devalorisation of overaccumulated capital, particularly as it bubbles up via financial sectors into speculative markets, entailed spatial and temporal fixes.

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Click HERE to view the accompanying PowerPoint slideshow

[Read more on the capitalist economic crisis HERE.]

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In addition, extra-economic coercion has intensified, including gendered and environmental stresses. The result is a world economy that concentrates wealth and poverty in more extreme ways, geographically, and brings markets and the non-market spheres of society and nature together in a manner adverse to the latter. Reform of the system is long overdue, and the post-Keynesian political economist Jane D’Arista’s ideas for revitalised multilateral financial institutions, following Keynes’ International Clearing Union proposal, are worth revisiting. However, the context remains one of top-down inability to reform: severe bias in multilateral financial and development agencies amounting to a neoliberal-neoconservative fusion.

Moreover, there is constrained space and political will at national level in most states. These factors compel us to consider – in a future paper – the exercise of social power from below, against the worst depredations of oppression, which are often experienced through the financial circuit of capital.

Introduction

The crash of a variety of US financial institutions – at this writing on 3 October, the five main investments banks, the two main home mortgage guarantors, the largest insurance company, the largest-ever bank to collapse and the Dow Jones itself (which on 29 September had the biggest-ever fall in share prices) – is being superficially explained by mainstream commentators. Many mention deregulation, corruption, greed, feckless borrowing by debt-addicted consumers, or a combination. Joseph Stiglitz adds ‘ideology, special-interest pressure, populist politics, and sheer incompetence’. Here isUSpolitical commentator Thomas Edsall describing the banal mainstream discourse:

The Huffington Post, October 2, 2008
Conservatives Seek To Shift Blame For Crisis Onto Minority Housing Law
by Thomas B. Edsall
Blame for the current economic crisis has been laid on many doorsteps, including the Gramm-Leach-Bliley Financial Services Modernisation Act of 1999; credit default swaps; hedge funds; the Commodity Futures Modernisation Act of 2000; Alan Greenspan; and Phil and Wendy Gramm. But it has fallen to right-wing pundit Ann Coulter to blaze a truly simple path through the maze of credit derivatives, collateralised loan obligations, tranches, securitisation transactions, and Thomson Financial League Tables. This gentle lady spells out the source and origin of the current economic crisis: “THEY GAVE YOUR MORTGAGE TO A LESS QUALIFIED MINORITY!”

Amidst the cacophony, we really need to consider structural roots and shoots of this crisis now – especially in a South African economy that suffers many of the same features ofUS financial capitalism (the subject of the next paper in this series). After all, there is no doubt that financial volatility remains central to the way global markets are developing, and that such volatility constrains economic, social, political and environmental progress in theThird World. The grounding of volatility as a symptom of deeper economic tensions also requires setting the stage politically. These are the main objectives of the second section.

Having done so, the third section allows us to consider two half-hearted and one visionary approach to global financial reform, from above. Time constraints do not permit me to dissect the various reform proposals for the immediate symptoms of the crisis, in the USfinancial institution collapses. Instead, let us retrace several global financial reform proposals to give global context. First, the status quo processes of the Monterrey Financing for Development agenda in 2002 led in 2005 to G7 finance ministers offering sufficient debt relief as to keep borrowers – especially inAfrica – paying both large downpayments and high rates of export earnings. However, the experience of such extreme Northern domination through the International Monetary Fund was the main reason for Latin American countries (and a few others) repaying the IMF early, threatening its own revenue streams. With these divergent forces at work, there was very little on offer in multilateral reform. Second, at least one country,Norway, made some tentative steps forward (e.g. to defunding the World Bank due to its water privatisation fetish, and to canceling earlier corrupt shipping loans), but these were half-hearted and contradictory. Third, we can turn to a much clearer agenda for reform, by post-Keynesian financial economist Jane D’Arista in 1999. But no constituency for this project was built during the crucial early 2000s, as the Jubilee movement’s weak Northern base and militant but strong Southern group found themselves marginalised, and as the rest of the global justice movement addressed issues not immediately concerned with finance – the topic of the third paper in this series.

So, with nothing breaking the deadlock and no enlightened capitalists ready to address the root causes, as witnessed by the limits of financial architecture debates, it is crucial to nurture an approach more respectful of deep-seated popular challenges to commodification and corporate globalisation. Cases to be explored in a later paper include the challenge to multinational corporate power in the sphere of AIDS medicines patents and reparations for past ‘Odious Debts’ to regimes like apartheid. In the sphere of consumer finance, we will turn to experiences as diverse yet interrelated as the SA township ‘bond boycott’ andMexico’s ‘El Barzon’ movements. Finally, aiming again at global financial governance, activists’ World Bank Bonds Boycott strategy, especially powerful during the early 2000s, is another way to disempower some of the most dysfunctional aspects of global finance (the Bretton Woods Institutions), and instead empowering investors to do something more useful with their resources.

Before setting out the case for enhanced, and more radical, internationalist civil society activism, the roots of the crisis should be explained.

2. The crisis: roots and shoots, and stalls and shifts

About a dozen key moments mark the onset of systemic global financial volatility and its policy companion, namely the imposition of neoliberalism across the world:

• in 1973, the Bretton Woods agreement on Western countries’ fixed exchange rates – by which from 1944-71, an ounce of gold was valued at US$35 and served to anchor other major currencies – disintegrated when the US unilaterally ended its payment obligations, representing a default of approximately $80 billion, leading the price of gold to rise to $850/ounce within a decade, and at the same time, several Arab countries led the formation of the Oil Producing Exporting Countries (OPEC) cartel, which raised the price of petroleum dramatically and in the process transferred and centralised inflows from world oil consumers to their New York bank accounts (‘petrodollars’);

• from 1973, ‘los Chicago Boys’ of Milton Friedman – the young Chilean bureaucrats with doctorates in economics from the University of Chicago – began to reshape Chile in the wake of Augusto Pinochet’s coup against the democratically-elected Salvador Allende, representing the birth pangs of neoliberalism;

• in 1976, the International Monetary Fund signalled its growing power by forcing austerity on Britain at a point where the ruling labour Party was desperate for a loan, even prior to Margaret Thatcher’s ascent to power in 1979;

• in 1979 the US Federal Reserve addressed the dollar’s decline and US inflation by dramatically raising interest rates, in turn catalyzing a severe recession and the Third World debt crisis, especially in Mexico and Poland in 1982, Argentina in 1984, South Africa in 1985 and Brazil in 1987 (in the latter case leading to a default that lasted only six months due to intense pressure on the Sarnoy government to repay);

• at the same time, the World Bank shifted from project funding to the imposition of structural adjustment and sectoral adjustment (supported by the IMF and the ‘Paris Club’ cartel of donors), in order to assure surpluses would be drawn for the purpose of debt repayment, and in the name of making countries more competitive and efficient;

• the overvaluation of the US dollar associated with the Fed’s high real interest rates was addressed by formal agreements between five leading governments that devalued the dollar in 1985 (Louvre Accord), but with a 51 percent fall against the yen, required a revaluation in 1987 (Plaza Accord);

• once the Japanese economy overheated during the late 1980s, a stock market crash of 40 percent and a serious real estate downturn followed from 1990, and indeed not even negative real interest rates could shake Japan from a long-term series of recessions;

• during the late 1980s and early 1990s, Washington adopted a series of financial crisis-management techniques – such as the US Treasury’s Baker and Brady Plans – so as to write off (with tax breaks) part of the $1.3 trillion in potentially dangerous Third World debt due to the New York, London, Frankfurt, Zurich and Tokyo banks which were exposed in Latin America, Asia, Africa and Eastern Europe (although notwithstanding the socialisation of the banks’ losses, debt relief was denied the borrowers);

• in late 1987, crashes in the New York and Chicago financial markets (unprecedented since 1929) were immediately averted with a promise of unlimited liquidity by Alan Greenspan’s Federal Reserve, a philosophy which in turn allowed the bailout of the Savings and Loan industry and various large commercial banks (including Citibank) in the late 1980s notwithstanding a recession and serious real estate crash during the early 1990s;

• likewise in 1998, when a New York hedge fund – Long Term Capital Management (founded by Nobel Prize-winning financial economists) – was losing billions in bad investments in Russia, the New York Fed arranged a bailout, on grounds the world’s financial system was potentially at high risk;

• starting with Mexico in late 1994, the US Treasury’s management of the mid- and late 1990s ‘emerging markets’ crises again imposed austerity on the Third World while offering further bailouts for investment bankers exposed in various regions and countries – Eastern Europe (1996), Thailand (1997), Indonesia (1997), Malaysia (1997), Korea (1998), Russia (1998), South Africa (1998, 2001), Brazil (1999), Turkey (2001) and Argentina (2001) – whose hard currency reserves were suddenly emptied by runs; and

• in addition to a vastly overinflated US economy (with record trade, capital and budget deficits) whose various excesses have occasionally unraveled – as with the dot.com stock market (2000) and real estate (2007) bubbles – the two largest Asian societies, China and India, picked up the slack in global materials and consumer demand during the 2000s, but not without extreme stresses and contradictions that in coming years threaten world finances, geopolitical arrangements and environmental sustainability.

This is merely a list of major events that reflect tensions and occasional eruptions. Crucial to this story line is that treatment of the problems never amounted to genuine resolutions to the overall volatility. One reason for this is the adverse balance of forces that emerged from several political processes in train during the same period. A catalogue of geopolitical changes since the 1970s would emphasize at least four major developments:

• the 1975 US defeat by the Vietnamese guerrilla army, which reduced theUSpublic’s willingness to use its own troops to maintain overseas interests;

• the demise of the Soviet bloc in the early 1990s, as a result of economic paralysis, foreign debt, bureaucratic illegitimacy and burgeoning democracy movements;

•Middle Eastwars throughout the period, withIsraelgenerally dominant as a regional power from the 1973 war withEgypt(notwithstanding its 2006 defeat inLebanon); and

• the rise ofChinaas a potent competitor to the West (in political as well as economic terms) during the 1990s-2000s.

These were merely the highest-profile of crucial geopolitical developments, leaving a sole superpower in their wake, yet one with much lower levels of legitimacy, dubious military and cultural dominance, slower economic growth, higher poverty and inequality, and vastly reduced financial stability over the past third of a century. One critical aspect of the struggle between classes associated with these developments was the waning of theThird World nationalist project and a dramatic shift in class power, away from working-class movements that had peaked during the late 1960s, towards capital and the upper classes.

Chronologically, other crucial moments that helped define the splintered, polarised political sphere since the 1970s included the following:

• formal democratisation arrived in large parts of the world – Southern Europe during the mid-1970s, the Cone of Latin America during the 1980s and the rest of Latin America during the 1990s, and many areas of Eastern Europe, East Asia and Africa during the early 1990s – partly through human/civil rights and mass democratic struggles and partly through top-down reform – yet because this occurred against a backdrop of economic crisis in Latin America, Africa, Eastern Europe, the Philippines and Indonesia, the subsequent period was often characterised by instability, in which ‘dictators passed debt to democrats’ (as the Jubilee South movement termed the problem) who were compelled to impose austerity on their subjects, leading to persistent unrest;

• the ebbing of Third World revolutionary movements – in the wake of transformations in Nicaragua, Iran and Zimbabwe in 1979-80 – was hastened by the US government’s explicit attacks during the 1980s on Granada, Nicaragua, Angola and Mozambique (sometimes directly but often by proxy), as well as on liberation movements in El Salvador, Palestine (via Israel) and Colombia, as well as former CIA client regimes in Panama and Iraq, hence sending signals to Third World governments and their citizenries not to stray from Washington’s mandates;

• after Vietnam, the US’s subsequent ground force losses in Lebanon during the early 1980s and in Somalia during the early 1990s (followed by Afghanistan and Iraq in the mid-late 2000s) shifted the tactical emphasis of the Pentagon and NATO to high-altitude bombing, which proved momentarily effective in situations such as the 1991 Gulf War (decisively won by the US in the wake of Iraq’s invasion of Kuwait), the Balkans during the late 1990s, the overthrow of Afganistan’s Taliban regime in 2001 and the initial ouster of Saddam Hussein in Iraq in 2003;

• the 1989-90 demise of the Soviet Union had major consequences for global power relations and North-South processes, as Western aid payments to Africa, for example, quickly dropped by 40 percent given the evaporation of formerly Cold War patronage competition (until the resurgence of Chinese interest in Latin America and Africa during the 2000s);

• the consolidation of European political unity followed corporate centralisation within the European Economic Community, as the 1992 Maastricht treaty ensured a common currency (excepting the British pound which was battered by speculators prior to joining the euro zone), and as subsequent agreements established stronger political interrelationships, at a time most European social democratic parties turned neoliberal in orientation and voters swung between conservative and centre-right rule, in the context of slow growth, high unemployment and rising reflections of citizen dissatisfaction;

• persistent 1990s conflicts in ‘Fourth World’ failed states gave rise to Western ‘humanitarian interventions’ with varying degrees of success, in Somalia (early 1990s), the Balkans (1990s), Haiti (1994), Sierra Leone (2000), Cote d’Ivoire (2002) and Liberia (2003), although other sites in central Africa – Rwanda in 1994 and since then Burundi, northern Uganda, the eastern part of the Democratic Republic of the Congo, Somalia and Sudan’s Darfur region – have witnessed several million deaths, with only (rather ineffectual) regional not Western interventions;

• the 2001 attack on the World Trade Center in New York City and the Pentagon near Washington (followed by attacks in Indonesia, Madrid and London) signaled an increase in conflict between Western powers and Islamic extremists, and followed earlier bombings of US targets in Kenya, Tanzania and Yemen which in turn received US reprisals against Islamic targets in Sudan (actually, a medicines factory) and Afghanistan in 1998 and Yemen in 2002; and

• the early-mid 2000s rise of left political parties in Latin America included major swings in Venezuela (1999), Bolivia (2004) and Ecuador (2006), as well as turns away from pure neoliberal economic policies in Brazil, Argentina, Uruguay and Chile, and were joined during the mid-2000s in Europe by left coalitions in Norway and Italy.

This list of seminal political moments should not obscure other important trends that seem to have accompanied them:

  • social and cultural change, including postmodernism, the ‘network society’, demographic polarisations and family restructurings;
  • new technologies brought about by the transport, communication and computing revolutions;
  • major environmental stresses including climate change, natural disasters, depletion of fisheries and worsening water scarcity; and
  • health epidemics, such as AIDS, Bovine Spongiform Encephalopathy, anthrax, drug-resistant tuberculosis and malaria, severe acute respiratory syndrome and avian flu.

In the realm of ideology the importance of these polarising events and processes cannot be overstated. Moreover, given the rise of neoliberal and neoconservative philosophies (formerly ‘modernisation’ and colonialism), there have been sometimes spectacular counterreactions ranging from Islamic fundamentalism and resurgent Third World Nationalism, to Post-Washington Consensus and ‘global governance’ reform proposals, to global justice movement protests.

If we accept this catalogue of moments and power relations associated with the unfolding of economic crises and political realignments, as spelled out above, then we might consider a further step in contextual work, namely mapping an ‘array of forces’ configured in a snapshot matrix of contending ideologies in the Appendix, highlighting positionalities, internal contradictions, key institutions and exemplary personalities. That then allows us to ask whether the most reasonable of D’Arista’s visions, namely the evolution of the current chaos in global political economy and geopolitics back to a more stable, predictable, prosperous and evenly-distributed set of political-economic relations, such as existed during the immediate post-War quarter-century (1945-70). It is with the hope of restoring such balance that D’Arista has provided three proposals for restructuring, in a 1999FinancialMarketsCenterarticle.

Before addressing these, I would only add a story line about the underlying cause of the financial crises currently afflicting the world economy, which I take to be associated with worsening conditions of overaccumulation. The main reason a neoliberal-neoconservative fusion has continued, even as tensions in economic relations have worsened, is the success of bailouts, as we are seeing at present in the wake of the subprime mortgage market’s contagion. Crisis displacement techniques became much more sophisticated since the 1930s freeze of financial markets, crash of trade, Great Depression and by 1939 interimperial turn to armed aggression. By 1936, these conditions had compelled John Maynard Keynes to write his General Theory, which advocated much greater state intervention so as to boost purchasing power. The difference today is that such drastic problems have been averted, largely through moving devaluation – what Joseph Schumpeter called ‘creative destruction’ – across both time (via the credit system) and space, and also through ‘accumulation by dispossession’. Of course, new institutions emerged to facilitate this, namely the IMF and World Bank which were able to turn what in earlier times (1830s, 1870s, 1930s) were defaults, into reschedulings (Figure 1).

Figure 1: Sovereign debt defaults, 1820-1999

Source: Barry Eichengren in the World Bank’s Global Finance Tables, Washington DC, 2000.

Thus in relation to Third World debt (one of many financial bubbles since the early 1970s), the key innovation from global capitalist managers is the Bretton Woods Institutions’ capacity to reschedule debt, so as to delay the necessary clearing away of the economic deadwood associated with fictitious capital formation. Hence the disempowerment and financial disruption of the Bretton Woods Institutions will necessarily be one component of the broader strategy of dealing with debt. More generally, beyond the simple illustration of debt default mitigation, we might make four arguments regarding financial volatility and social power, considered ‘from above’.

    1. the durable late 20th century condition of overaccumulation of capital – as witnessed in huge gluts in many markets, declining increases in per capita GDP growth, and falling corporate profit rates – was displaced and mitigated (‘shifted and stalled’ geographically and temporally) at the cost of much more severe tensions and potential market volatility in months and years ahead;
    2. the temporary dampening of crisis conditions through increased credit and financial market activity has resulted in the expansion of ‘fictitious capital’ – especially in real estate but other speculative markets based upon trading paper representations of capital (‘derivatives’) – far beyond the ability of production to meet the paper values;
    3. geographical shifts in production and finance continue to generate economic volatility and regional geopolitical tensions, contributing to unevenness in currencies and markets as well as pressure to ‘combine’ market and non-market spheres of society and nature in search of restored profitability; and
    4. capital uses power associated with the two stalling and shifting (temporal and spatial displacement) tools above to draw additional surpluses from non-market spheres (environmental commons, women’s unpaid labour, indigenous economies), via extra-economic kinds of coercions ranging from biopiracy and privatisation to deepened reliance on unpaid women’s labour for household reproduction in an ever-expanding process of long-distance labour migrancy.

Having set the stage, then, what is to be done? In the next section, three different approaches are considered: those of the existing powerbrokers; those ofNorway(the North’s most leftwing and internationally-activist government in financial reform), and those of Jane D’Arista in her important 1999FinancialMarketsCenterreport.

3. Whose reforms – Monterrey, Norway, D’Arista?

The past decade, since the East Asian crisis, has witnessed renewed elite debate about reforming the world financial system. Naturally, the establishment institutions are contemplating marginal changes largely for the sake of relegitimisation and recapitalisation, rather than for genuine problem-solving. However, one country, Norway, has suggested deeper reforms for North-South financial relations, and begun them on a piece-meal basis. Finally, Jane D’Arista’s own ideas about new institutions that can melded onto the world financial system should be considered.[1]

In the Mexican city of Monterreyin March 2002, the United Nations’ Financing for Development (FFD) Conference was the first major international opportunity to correct global capital markets since the spectacular late 1990s emerging markets crises. South African finance minister Trever Manuel and former International Monetary Fund managing director Michael Camdessus[2] were UN secretary general Kofi Annan’s special envoys at the conference.Mexico’s ex-president Ernesto Zedillo effectively managed the process, even though the Yale-trained neoliberal economist’s five-year term inMexico City was notable for repression, failed economic crisis-management, and the end of his notoriously corrupt party’s 85-year rule. Zedillo appointed as his main advisor (and document author) John Williamson of the Washington-based Institute for International Finance, a think-tank primarily funded by the world’s largest commercial banks.

It was, in short, a site for preaching to the converted, as reflected in Manuel’s endorsement of privatisation during his high-profile address to business elites who had gathered on the conference sidelines: ‘Public-private partnerships are important win-win tools for governments and the private sector, as they provide an innovative way of delivering public services in a cost-effective manner.’[3] Back in South Africa, such PPPs were nearly universally failing, from the standpoint of workers and consumers, and sometimes also businesses, in water, sanitation, electricity, telecommunications, the postal system, forestry, air and road transport, ports and road construction.[4] In August 2001 and October 2002, the main trade union federation, Cosatu, held two-day mass stayaways against private parternships involving essential public services. They targeted Manuel, though atMonterrey he didn’t mention these problems, even as caveats, nor did he concede his government’s repeated failure to reach revenue targets from state asset sales.

While the Monterreyfinal report that Manuel helped steer through the conference contained some pleasing rhetoric, it promotes only orthodox strategies. ODA shortfalls and external debt were considered the main constraints, whereas global financial volatility, while recognised as a problem, was not explicitly linked to development goals. Achieving the Millennium Development Goal targets would cost $54 billion per year, according to IMF and World Bank estimates.[5] The report observed ‘dramatic shortfalls in resources required to achieve the internationally agreed development goals.’[6] But it endorsed the Highly Indebted Poor Countries (HIPC) initiative, as ‘an opportunity to strengthen the economic prospects and poverty reduction efforts of beneficiary countries.’ The New Partnership for Africa’s Development carries a similarly worded endorsement of HIPC.[7] Manuel suggested that, ‘the HIPC Trust Fund be fully funded, and that provision is made for topping-up when exogenous shocks impact on countries’ debt sustainability,’ as if the programme was otherwise satisfactory.[8]

Within a year of Monterrey, the World Bank admitted some of HIPC’s mistakes. The Bank was forced to accept longstanding criticisms that its staff ‘had been too optimistic’ about the ability of countries to repay under HIPC, and that projections of export earnings were extremely inaccurate, leading to failure by half the HIPC countries to reach their completion points.[9] Although HIPC had been endorsed by NGO campaigners such as Jubilee Plus, it was a mirage from the outset. The London lobby group conceded, ‘According to the original HIPC schedule, 21 countries should have fully passed through the HIPC initiative and received total debt cancellation of approximately $34.7 billion in net present value terms. In fact, only eight countries have passed Completion Point, between them receiving debt cancellation of $11.8 billion.’[10]

Add a few other countries’ partial relief via the Paris Club ($14 billion) and the grand total of debt relief thanks to the 1996-2003 exercise was just $26.13 billion. There remained more than $2 trillion of Third Worlddebt that should have been canceled, including not just HIPC countries but also Nigeria, Argentina, Brazil, South Africaand other major debtors not considered highly-indebted or poor in the mainstream discourse. The lack of financial provision for HIPC in western capitals reflects deep resistance to debt relief and, probably, the realisation that there are merits to using debt as a means of maintaining control over Third Worldeconomies. HIPC began in 1996, and in late 1999 was accompanied by a renaming of the structural adjustment philosophy: Poverty Reduction Strategy Papers (PRSPs). More than two years later, at Monterrey, Manuel told fellow finance ministers that PRSPs were ‘an important tool for developing countries to reduce their debt burdens… a thorough and useful PRSP requires time, resources and technical capacity.’ He suggested the Bretton Woods Institutions increase their role, to ‘provide more technical assistance to meet those particular challenges.’[11]

Civil society activists saw things differently. Resistance to structural adjustment increased across the Third World, sometimes in the form of ‘IMF riots.’ Annual reports in the World Development Movement’s States of Unrest series include dozens of countries and hundreds of IMF riots. In Africa, as an example, anti-neoliberal protests were called by students, lecturers and nurses in Angola; public sector workers in Benin; farmers, electricity workers and teachers in Kenya; municipal workers in Morocco; healthworkers in Niger; the main trade union federation, including police and municipal workers, in Nigeria; community groups and organised labour in South Africa; and bank customers and trade unionists in Zambia. As the World Development Movement found, the new version of structural adjustment did not fool the victims: ‘PRSPs have failed to deviate from the IMF’s free market orthodoxy.’ The report covering 2002 showed that:

The protesters in developing countries come from across the social spectrum. They are not always the poorest of the poor …they are also the newly emerging middle-classes: teachers, civil servants, priests, doctors, public-sector workers, trade-union activists and owners of small businesses. This broad based movement clearly indicates how policies promoted by the IMF and World Bank are not only keeping the poor in poverty, but are also impoverishing sectors of society generally relied upon for wealth creation, economic development and civil society leadership. Policies intended to promote economic development and poverty reduction in the emerging and fragile economies of developing countries are not only failing, but are actually leading to economic stagnation, which is felt across the social spectrum.[12]

In the same critical spirit some months earlier, a Jubilee South conference of the main African social movements inKampalaconcluded:

• The PRSPs are not based on real people’s participation and ownership, or decision-making. To the contrary, there is no intention of taking civil society perspectives seriously, but to keep participation to mere public relations legitimisation.

• The lack of genuine commitment to participation is further manifested in the failure to provide full and timeous access to all necessary information, limiting the capacity of civil society to make meaningful contributions.

• The PRSPs have been introduced according to pre-set external schedules which in most countries has resulted in an altogether inadequate time period for an effective participatory process.

• In addition to the constraints placed on governments and civil society organisations in formulating PRSPs, the World Bank and IMF retain the right to veto the final programs. This reflects the ultimate mockery of the threadbare claim that the PRSPs are based on ‘national ownership.’

• An additional serious concern is the way in which PRSPs are being used by the World Bank and IMF, directly and indirectly, to co-opt NGOs to ‘monitor’ their own governments on behalf of these institutions.[13]

The latter gambit had begun to fail by the time the FFD convened in Monterrey. Even the World Bank’s best African case, Uganda, heard its National NGO Forum report: ‘Among CSOs there is growing concern that perhaps their participation in the endeavour has amounted to little more than a way for the World Bank and IMF to co-opt the activist community and civil society in Uganda into supporting the same traditional policies.’[14] Other NGO, funding agency and academic studies of PRSPs were highly critical.[15] The Harare-based debt-cancellation advocacy network, Afrodad, studied the experiences inBurkina Faso,Mauritania,Mozambique,Tanzania andUganda, the first African countries to undergo PRSPs. Afrodad noted that in each of these countries, there were processes with varying degrees of participation that preceded the PRSPs:

The PRSPs, rather than introducing participation into poverty and development concerns, interfered to lesser or greater degrees with existing processes. The relationship is still one of ‘if you want what we have to offer, you must do things our way.’ At the global level, this reflects well entrenched power relations rather than anything that could be called ‘participatory.’[16]

A report by a SussexUniversityacademic found a ‘broad consensus among our civil society sources in Ghana, Malawi, Mozambique, Tanzaniaand Zambiathat their coalitions have been unable to influence macro-economic policy or even engage governments in dialogue about it.’[17]

An underlying objective of those who authored the Monterrey Consensus was to grant more power to the Bank, Fund and WTO. In contrast, the WHO, International labour Organisation, UN Conference on Trade and Development and UN Research Institute for Social Development were too centrist, or even leftist, to be integrated into Monterrey’s neoliberal framework. When Monterreyrequested states to ‘encourage policy and programme coordination of international institutions and coherence at the operational and international levels,’ some institutions were more coherent than others. Coordination would come between the Bretton Woods Institutions and WTO first, and was a dangerous new mode of introducing cross-conditionality. Although opposed by many Third World negotiators at the WTO, such coherence was one of Manuel’s only explicit Monterrey ambitions reported back home: ‘ensuring that international institutions effectively consider the extent of overlapping agendas… [because] conflicting policies serve no one, especially not the poor.’[18]

On the contrary, it should be obvious that the world’s poor would have been served if there had been conflicting policies between the institutions of the embryonic world-state, for example, if the World Bank had taken former chief economist Joseph Stiglitz’s advice seriously, or if conflict simply led to gridlock between the global economic institutions. As critics in the main progressive agriculture think-tanks explained in May 2003, ‘Over the decades, loan conditions of the IMF/World Bank have forced developing countries to lower their trade barriers, cut subsidies for their domestic food producers, and eliminate government programs aimed to enhance rural agriculture. However, no such conditions are imposed on wealthy industrial countries.’ Instead, the WTO explicitly permits the dumping of ‘surplus foods at prices below the cost of production, driving out rural production in developing countries and expanding markets for the large transnational exporting companies. It also prohibits developing countries from introducing new programs that may help their local agriculture producers. As a result the agriculture sectors in developing countries, key for rural poverty reduction, have been devastated.’ Similar NGO complaints were made about the ‘coherence agenda’ on water privatisation, regulation of foreign investors, and governance of the multilateral institutions.[19]

A more ‘coherent’ approach did not mean the Monterrey Consensus would consider even timid suggestions for global governance reforms. The Monterreyfinal report merely recognised ‘the need to broaden and strengthen the participation of developing countries in international economic decision-making and norm-setting… We encourage the following actions [from the International Monetary Fund and World Bank]: to continue to enhance participation of all developing countries and countries with economies in transition in their decision-making.’[20]

In reality, at the Bretton Woods Institutions, nearly fifty Sub‑Saharan African member countries were represented by just two directors, while eight rich countries enjoyed a director each and the US maintained veto power by holding more than 15% of the votes. (There is no transparency as to which board members take what positions on key votes.) The leaders of the Bank and IMF are chosen from, respectively, the USand EU, with the UStreasury secretary holding the power of hiring or firing.[21] Political will to change the system was lacking for another five years, and as Manuel put it at a press conference during the September 2003 IMF/Bank annual meeting in Dubai, when asked why no progress was made on Bretton Woods democratisation, ‘I don’t think that you can ripen this tomato by squeezing it.’[22] It was only in September 2007 thatChina and a few other countries won slightly higher voting share, and this was at the expense of poorer countries.

If democratic reform was off the agenda, financial liberalisation continued. To be sure, the Asian crisis stalled the persistent armtwisting efforts of UStreasury secretary Larry Summers to force through an amendment to the IMF articles of agreement which would end all exchange controls everywhere. Nevertheless, when Ethiopian prime minister Meles Zenawi resisted in 1997, according to both Robert Wade and Joseph Stiglitz, the IMF cut off the cheaper loans it had earlier made available. Cross‑conditionality also made Ethiopiaineligible for other low-interest loans and grants from the World Bank, the European Community, and aid from bilaterals.[23] Stiglitz waged war within the Bank and Clinton regime, finally winning concessions, but he learned a lesson: ‘There was clear evidence the IMF was wrong about financial market liberalisation and Ethiopia’s macroeconomic position, but the IMF had to have its way.’[24] It was not just Ethiopia that would witness a renewed attack on exchange controls. In the immediate wake of the Asian crisis, in 1999, then IMF managing director Camdessus argued, ‘I believe it is time for momentum to be re‑established… Full liberalisation of capital movement should be promoted in a prudent and well‑sequenced fashion.’[25]

What of the potential for prudent work-out of unrepayable debt? This, too, has been under discussion for Bretton Woods reform. As the The Guardian’s Larry Elliott explained,

Gordon Brown and his fellow finance ministers told the IMF to draw up a plan that would give bankruptcy protection to countries. The idea was to give states the same rights as companies if they went belly‑up, avoiding the expensive bail‑outs that have accompanied the big financial crises of the past decade. The IMF was given six months to come up with a blueprint, but when it reported back last month the idea was dead in the water. Billions of dollars from the bail‑outs ended up in the coffers of the big finance houses of New Yorkand George Bush was told not to meddle with welfare for Wall Street. The message was understood: the USused its voting power at the IMF to strangle the bankruptcy code at birth.[26]

It was up to civil society critics, including Canadian financial-democracy activist Robin Round of the Halifax Initiative, to take the critique forward:

After five long years of preparatory work, the UN Financing for Development conference is a diplomatic disaster. This conference was to find new ways to wipe out poverty and narrow the growing gap between rich and poor. IntenseUSpressure, however, gutted the process, reducing the final conference statement to a set of vague principles and generalities. Shamefully,Canadabecame the echo in the room whenever theUSspoke.

Governments eliminated or weakened commitments that could have delivered real reform to global finance and trade systems that by their very nature keep the poor poor. They left out commitments to review trade policies that block access to markets in rich countries. How can you develop, when you can’t sell your goods abroad?

They overlooked the urgent need to cancel the crippling debt of developing countries. How can you develop, when you must pay the International Monetary Fund before you inoculate children?

They refused to examine how the World Bank and IMF manipulate developing countries’ economic, fiscal, and social policies. How can you develop, when you’re not allowed to govern your own country?[27]

Three years later, it was clear in the run-up to Gleneagles, hence, that the debt payments that African and otherThird Worldcountries continued to make were unjustifiable. Large mobilisations of British citizens – and Blair’s unpopularity because of the Iraq War, during an election year – compelled the British government to offerAfricasome financial concessions so as to appear humanitarian in character. According to Alex Wilks of the European Network on Debt and Development:

British finance minister Gordon Brown said in February 2005 that the G8 meeting in Scotlandon 6-8 July would be known as the ‘100% debt relief summit’. Both Tony Blair and George W Bush used similar language at their White House press conference on 7 June… In actual fact, the official plan may only write off 10% of low-income country debt. Not a penny more… The eighteen-to-thirty-eight beneficiary countries will eventually have their debts canceled, but will also have a corresponding amount cut from the aid flows they were likely to receive… Zambiawill stop paying its debts to three creditors, but will not receive the equivalent amount in aid to spend, likely less than 20% of the amount of debt canceled. In order to get what little extra money they are eligible for, the governments of developing nations will have to accept harsh World Bank and IMF conditions. This typically means privatisation and trade liberalisation, misconceived policy measures which often harm poorer people and benefit international traders.[28]

What difference, then, would the finance ministers’ announcement make? According to GreenLeft Weekly:

The huge figures most often quoted by the press, $50-55 billion, include IMF, World Bank and African Development Bank debts owed by around 20 of the other poorest Third Worldcountries, which may become eligible for debt cancellation in the future; possibly nine more in 12-18 months, and another 10 or so at some undetermined date. While the $1.5 billion a year made available will certainly be of use for the 18 poverty-stricken countries, it will only boost their collective budget by about 6.5% per annum. The modest sum illustrates that the Western media’s backslapping over their governments’ ‘generosity’ is more than a little exaggerated and somewhat premature. Those 18 countries account for only 5% of the population of the Third World, and if all 38 countries become eligible in the future, it will still only affect around 11%.[29]

African and global justice advocates offered harsh condemnations:

    Jubilee South in Manila: ‘The multilateral debt cancellation being proposed is still clearly tied to compliance with conditionalities which exacerbate poverty, open our countries further for exploitation and plunder, and perpetuate the domination of the South… Even if the debt cancellation were without conditionalities, the proposal falls far too short in terms of coverage and amounts to demonstrate a bold step towards justice by any standard.’
    Demba Moussa Dembele, director of Forum for African Alternatives inDakar: ‘At the moment this is nothing but a promise… Therefore we will wait to see how this decision is put into action and with what conditions. Caution is necessary also because the ‘creditor’ countries are long-time masters of the arts of duplicity, manipulation, and concealment.’
    Jayati Ghosh, economics professor at Nehru University, India: ‘[E]ven otherwise well-informed and progressive people in the developing world were fooled into thinking that, for a change, the leaders of the core capitalist countries were actually thinking about doing some good for people desperately in need of it… The G8 debt relief deal is actually a paltry and niggardly reduction… And this pathetic amount is being traded for yet more major concession made by the debtor countries, in terms of sweeping and extensive privatisation of public services and utilities, which is about all that is left for governments to sell in these countries, as well as large increases in indirect taxes which fall disproportionately on the poor.’
  • African Network & Forum on Debt and Development based in Harare: ‘Nothing short of the continuation of the chains of slavery and bondage for the citizens in those countries… The agreement does not address the real global power imbalances but rather reinforces global apartheid.’[30]

A few weeks after the finance ministers’ announcement, at the African heads of state meeting in the African Union inSirte,Libyaissued an unprecedented call for comprehensive debt cancellation for all ofAfrica. Although some African elites more forcefully objected to their debt burdens, most continued to the bidding of the IMF and World Bank. In one crucial case, however, parliament and civil society advocated repudiation:Nigeria. That particular case is worth contemplating, in the wake of its October 2005 agreement with the following Paris Club countries, which were owed $30 billion:Austria,Belgium,Brazil,Denmark,Finland,France,Germany,Italy,Japan, theNetherlands, theRussian Federation,Spain,Switzerland, theUKand US. As the IMF explained,

The agreement envisages a phased approach, in which Nigeriawould clear its arrears in full, receive a debt write-off up to Naplesterms, and buy back the remainder of its debt. The agreement is conditional on a favorable review of its macroeconomic and structural policies supported by the Fund under a nonfinancial arrangement.[31]

The underlying agenda came to fruition on October 20. Nigeria, $6.3 billion in arrears, would first pay $12.4 billion in up-front payments. As Rob Weissman of Multinational Monitor reported,

You can celebrate this deal, as the Paris Club does, if you ignore the fact that creditors generally write down bad debts as a matter of course (not charity), the billions over principle that Nigeria has already sent out of the country, the fact that the deal imposes IMF conditionality on Nigeria (even though the IMF isn’t providing credit to the country), and the reality of the severe poverty in Nigeria.[32]

According to the leader ofNigeria’s Jubilee network, Rev. David Ugolor,

The Paris Club cannot expect Nigeria, freed from over 30 years of military rule, to muster $12.4 billion to pay off interest and penalties incurred by the military. Since the debt, by President Obasanjo’s own admission, is of dubious origin, the issues of the responsibilities of the creditors must be put on the table at the Paris Club. As desirable as an exit from debt peonage is, it is scandalous for a poor debt distressed country, which cannot afford to pay $2 billion in annual debt service payments, to part with $6 billion up front or $12 billion in three months or even one year.[33]

Similarly, remarked the Global AIDS Alliance,

The creditors should be ashamed of themselves if they simply take this money [$12.4 billion]. These creditors often knew that the money would be siphoned off by dictators and deposited in western banks, and the resulting debt is morally illegitimate. They bear a moral obligation to think more creatively about how to use this money. Nigeriahas already paid these creditors $11.6 billion in debt service since 1985.[34]

The next step was for president Obasanjo to agree to a reimposition of neoliberal policies by the IMF, under the rubric of the new ‘Policy Support Instrument’ (PSI). That instrument also deserves further consideration. According to Jubilee Africa’s Soren Ambrose,

The Paris Club requires that countries applying for relief be under an IMF program, but the prospect of agreeing to one is political dynamite in Nigeria. The Paris Club was however under great pressure to complete a landmark deal with Nigeria, where the legislature had threatened to simply repudiate the debts, so the PSI was deemed an acceptable alternative. Nigerian Finance Minister Ngozi Okonjo-Iweala told Reuters on May 18 that ‘the IMF makes sure it is as stringent as an upper credit tranche programme and then monitors it like a regular program, but the difference is that you develop it and you own it’.[35]

Indeed, the core message of the PSI document released by the IMF is its desire to retain effective control of African countries’ macroeconomic policies, on behalf of ‘donor’ countries (i.e., its shareholders):

Around 40% of donors expressed a need for on/off signals, and a majority for multidimensional assessments. According to the survey, the Fund is expected to assess, first and foremost, macroeconomic performance and policies. Like low-income members, donors consider a quantified medium-term macroeconomic framework—with quarterly or semi-annual targets—to be essential for the assessment of policies and progress made. Most also expect the Fund to assess structural reforms that are either macro-economically critical, or within the Fund’s core areas (e.g., tax system, exchange system, financial sector).[36]

This represents, simply, the expansion of the existing system of control of debtor countries, to those countries which won’t be so indebted in a formal sense, and hence which need more IMF ‘signaling’ to donors than is feasible with the standard annual Article IV surveillance reports. What the Nigerian case illustrates is that the IMF is pulling strings on behalf of the G8 ‘donor’ countries, and that the G8 will continue to support the IMF if such functions benefit northern countries.

A related financial issue – partly captured in the ‘payments to private creditors’ account – is African access to ‘portfolio capital’, which are private credits and investments used for Africa’s corporate securities, stock market investments, currency purchases and the like. This has mainly taken the form of ‘hot money’: speculative positions by private-sector investors. The main site of investment action has been South Africa’s stock exchange, and to a much smaller extent nascent share markets in Nigeria, Kenya, Zambia, Mauritius, Botswana, Ghanaand Zimbabwe(all of whose stock exchanges have at least $1 billion capitalisation). In 1995, for example, foreign purchases and sales were responsible for half the share trading in Johannesburg. But these flows have had devastating effects upon South Africa’s currency, with 30%+ crashes over a period of weeks during runs in early 1996, mid-1998 and late 2001.[37] In Zimbabwe, the November 1997 outflow of hot money crashed the currency by 74% in just four hours of trading.[38]

As a result, the performance of the eight major African stock markets has been extremely erratic, sometimes returning impressive speculative-style profits to foreign investors and sometimes generating large losses. With a market capitalisation of $409 billion in mid-2005, the Johannesburg Stock Exchange dwarfs the other seven (which share roughly $30 billion in capitalisation). In 2000-01 and 2003, the JSE was negative, but returned 12% in $-denominated profits in 2002, 40% in 2004 and 29% in the first half of 2005. (There are no exchange controls preventing foreign repatriation of recently-invested dividends and profits fromSouth Africa, and great controversy has erupted over the excessive outflows to the several huge London-registered corporations which were once South African.)

The other source of financial account outflows from Africathat must be reversed is capital flight. A major study by Leonce Ndikumana and James Boyce (updated in April 2008) estimated that from 1970 to 2004, total capital flight from 40 Sub-Saharan African countries was at least $420 billion (in 2004 dollars). The external debt owed by the same countries in 2004 was $227 billion; a substantial portion of debt was used for public infrastructure related investments, including water, even if (as noted below), the ‘returns’ were not impressive. Using an imputed interest rate to calculate the real impact of flight capital, the accumulated stock rises to $607 billion. According to Ndikumana and Boyce,

Adding to the irony of SSA’s position as net creditor is the fact that a substantial fraction of the money that flowed out of the country as capital flight appears to have come to the subcontinent via external borrowing. Part of the proceeds of loans to African governments from official creditors and private banks has been diverted into private pockets – and foreign bank accounts – via bribes, kickbacks, contracts awarded to political cronies at inflated prices, and outright theft. Some African rulers, like Congo’s Mobutu and Nigeria’s Sani Abacha, became famous for such abuses. This phenomenon was not limited to a few rogue regimes. Statistical analysis suggests that across the subcontinent the sheer scale of debt-fueled capital flight has been staggering. For every dollar in external loans to Africain the 1970-2004 period, roughly 60 cents left as capital flight in the same year. The close year-to-year correlation between flows of borrowing and capital flight suggests that large sums of money entered and exited the region through a financial ‘revolving door’.[39]

In at least 16 countries, a very strong case could be made that the inherited debt from dictators is legally ‘Odious’, since the citizenry were victimised both in the debt’s original accumulation (and use against them), and in demands that it be repaid: Nigeria under the Buhari and Abacha regimes from 1984-98 ($30 billion), South Africa under apartheid from 1948-93 ($22 billion), the DRC under Mobuto from 1965-97 ($13 billion), Sudan under Numeiri from 1969-85 ($9 billion), Ethiopia under Mengistu from 1974-91 ($8 billion), Kenya under Moi from 1978-2002 ($5.8 billion), Congo under Sassou from 1979-2005 ($4.5 billion), Mali under Trore from 1968-91 ($2.5 billion), Somalia under Siad Barre from 1969-91 ($2.3 billion), Malawi under Banda from 1966-94 ($2.2 billion), Togo under Eyadema from 1967-2005 ($1.4 billion), Liberia under Doe from 1980-90 ($1.2 billion), Rwanda under Habyarimana from 1973-94 ($1 billion), Uganda under Idi Amin Dada from 1971-79 ($0.6 billion) and the Central African Republic under Bokassa from 1966-70 ($0.2 billion).[40] Other undemocratic countries – includingZimbabwe under Mugabe in recent years ($4.5 billion) – could also be added to this list, which easily exceeds 50% ofAfrica’s outstanding debt.

The process also works via multinational corporations. In his book Capitalism’s Achilles Heel, Brookings Institution scholar Raymond Baker documents ‘falsified pricing, haven and secrecy structures and the illicit movement of trillions of dollars out of developing and transitional economies… Laundered proceeds of drug trafficking, racketeering, corruption and terrorism tag along with other forms of dirty money to which the US and Europe extend a welcoming hand.’ Adds John Christensen of the Tax Justice Network, nearly one third of the value of the annual production in sub-Saharan Africa was taken offshore during the late 1990s. Across the world, eight million ‘high net-worth individuals’ have insulated $11.5 trillion in assets in offshore-financial centres.[41]

Many of these financial accounts – especially relating to capital flight – highlight the extent to which exchange control liberalisation has occurred, especially in Africa. Ironically, IMF researchers – including the then chief economist, Kenneth Rogoff – finally admitted in 2003 that there was severe damage done through more than two decades of financial liberalisation. Rogoff and his colleagues (Eswar Prasad, Shang-Jin Wei and Ayhan Kose) admitted ‘sobering’ findings, namely ‘evidence that some countries may have experienced greater consumption volatility as a result… Recent crises in some more financially integrated countries suggest that financial integration may in fact have increased volatility’.[42] These conclusions are also conceded by the World Bank, which promoted financial liberalisation with a vengeance during the 1980s-90s. By 2005, even Bank staff had to concede that central objectives were not met:

To be sure, most African countries have introduced market-based reforms in their financial sectors. But post-liberalisation problems still need to be addressed. Financial reform programmes anticipated an initial increase in the spread between lending and deposit rates, but the spread continues to widen in many countries. Moreover, since liberalisation, many financial systems have seen high real interest rates. There has also been little financial deepening. While normally liberalisation was expected to encourage financial deepening, with a positive effect on savings mobilisation and credit allocation, for most of Africa, ratios of money and credit to GDP have not increased.[43]

Within Africa, the main driving force behind the liberalised, integrated financial system is the South African government.[44]Pretoria removed its main exchange control – the Financial Rand – in 1995 and permitted the offshore listing of the largest firms in 1998-2000. Results, during a period of alleged post-apartheid macroeconomic ‘stability’, included severe currency crashes in 1996, 1998 and 2000-01, followed by very high interest rate increases. The high rates exacerbated the already serious problem of stagnant investment, which was also affected by the late 1990s liberalisation of restrictions on movement of corporate financial headquarters. But because of prevailing power relations inPretoria andJohannesburg,South Africa’s official agenda is to amplify liberalisation.

In contrast to the subimperial project of South Africa, it is worth considering global financial reforms proposed by a self-styled post-imperial government, that of Norway. The ruling coalition’s October 2005 ‘Soria Moria Declaration’ set some high standards for shifts in North-South financial relations:

Norwaymust adopt an even more offensive position in the international work to reduce the debt burden of poor countries. The UN must establish criteria for what can be characterised as illegitimate debt, and such debt must be cancelled.
The Government will…:

  • work to ensure that the multilateral aid is increasingly switched from the World Bank to development programmes and emergency aid measures under the auspices of UN agencies. Norwegian aid should not go to programmes that contain requirements for liberalisation and privatisation, act as a spearhead for international agreements on new global financing sources that can contribute to a redistribution of global wealth and the strengthening of the UN institutions, such as aircraft tax, carbon dioxide tax, tax on arms trade or duty on currency transactions,…
  • work for greater openness aboutNorway’s role in the World Bank and the IMF and evaluate changes in the political management and mandate for Norway´s role,
  • support a democratisation of the World Bank and the IMF. Developing countries must be given much greater influence, among other things by ensuring that the voting right is not solely linked to capital contributions,
    lead the way in the work to ensure the debt cancellation of the poorest countries´ outstanding debt in line with the international debt relief initiative. The costs of debt cancellation must not result in a reduction of Norwegian aid, cf. the adopted debt repayment plan. No requirements must be made for privatisation as a condition for the cancellation of debt. The Government will support the work to set up an international debt settlement court that will hear matters concerning illegitimate debt…[45]

These are excellent promises, reflecting strong lobbying by the progressive Norwegian civil society organisations like the debt movement Slug and the country’s Attac branch, and a high level of social consciousness about the ills of corporate globalisation. Subsequent events indicated the potential for at least partial implementation of Soria Moria:

  • In October 2006, after many years of discussion, the Norwegian government cancelled debt dating to the late 1970s Shipping Export Credit Campaign.
  • The following month Oslohosted – and made a successful bid for the secretariat position of – the Extractive Industries Transparency Initiative, allowing critics of petro-mineral corruption a platform that was shared, ironically, with World Bank president Paul Wolfowitz.
  • A few weeks later, the government’s conference on the World Bank and International Monetary Fund (IMF) considered whether neoliberal conditions were still being imposed onThird Worlddebtors.
  • When, a few days later, the Nobel Peace Prize was given to an anti-poverty financier, Muhammad Yunus of Grameen Bank, the Oslo Nobel committee appeared to be acting consistent with the government’s agenda of putting a human face on globalisation and capitalism.
  • In February 2007, the government cut funding for the World Bank’s water privatisation facility in the wake of a critical report by two NGOs.
  • In August 2007, the Norwegian finance ministry mandated the Government Pension Fund, Global, to sell $14 million worth of shares in Vedanta Resources after its Council on Ethics found the firm’s subsidiaries were guilty of large-scale eco-social damage in India. This decision assisted Indian activists attempting to prevent alumina mining in Orisa. Several other major firms – Wal-Mart Stores, Freeport McMoRan Copper & Gold Inc., DRD Gold Limited, BAE Systems, Lockheed Martin Corporation – also suffered disinvestment by the Fund.

Together, at first blush, these initiatives appear to potentially shake post-Cold War North-South power relationships, and to suggest new prospects for a social-democratic reform agenda for global governance. However, much deeper dilemmas remain, because some of the Norwegian reforms legitimate the existing system rather than confronting and weakening it. In making an assessment especially of debt and financial institutions, the first factor to take into account is the adverse balance of forces at the global scale, given the fusion of neoliberal and neoconservative institutions and personnel.

For example,Norway’s own debt cancellation in late 2006 was interesting yet not decisive. There are NOK 4,4 billion in outstanding loans fromNorwayto theThird World. Of that amount, more than two thirds came from the Norwegian Ship Export Campaign during the late 1970s, when 156 ships were sold for NOK 3.7 billion to 21 countries via the Norwegian Guarantee Institute for Export Credits’. Within ten years, Gro Harlem Brundtland had determined that the campaign was economically unsustainable, benefitingNorwaymore than the countries, by maintaining its dying ship-building industry a bit longer. A further eighteen years later, after vast repayments on the illegitimate loans, the following countries still owe for the ships plus interest in arrears:

Myanmar: NOK 1 579 million
Sierra Leone: NOK 60 million
Sudan: NOK 772 million
Peru: NOK 48 million
Ecuador: NOK 225 million
Jamaica: NOK 19 million
Egypt: NOK 168 million

The late 2006 write-off only affectsMyanmar(Burma) andSudanonce they are readmitted to international financial markets, whileSierra Leonemust still go through its HIPC completion. The cost to the Norwegian government of the debt cancellation, it estimates, will be only NOK 577 million between 2007-21. The major question raised by this opening is whether reparations should be paid byNorwayto countries which already repaid loans for the ships. Leading debt campaigner John Jones of Networkers South North explains:

1. Norwayhas accepted co-responsibility for the debt tragedy. That is new. They have, however, not accepted the concept of ‘illegitimacy’. So the victory for the NGOs is only partial, albeit a significant partial one. It seems as if it has been important for the government ofNorway to accommodate the debt cancellation demand without upsetting the World Bank and the other major finance powers. And that is no good sign. To break this institutional loyalty will be the toughest challenge in the time to come. The new Norwegian government will have to prove it will change its former pro-World Bank attitude and follow up its basic policy paper on this issue. It will mean a change of mind or manpower in the bureaucracy at the Ministry of Foreign Affairs, and is no small task.

2. If the loans were granted on wrong premises,Norwayshould follow their logic to go into the question of repayment of money gone to serve these loans. In the case ofEcuadormore than $100 million has been repaid over the years to downpay $24 million. Originally the loan was only $59 million. The remaining $35 million has been ‘forgiven’ today. Hugo Arias’ alleged claim thatNorwayshould return the $100 million is well taken and correct. The original loan was misplaced and should be considered as part of internal Norwegian subsidy of shipyards and be financed as such.Ecuadoris a good example to show the story of debt and debt-payments.

3. The ‘forgiveness’ of Sierra Leone’s debt is pending on that country’s reaching the World Bank HIPC completion points. It so happens that Norwaydoes not accept privatisation conditionalities any longer, but has not detected what it means for Sierra Leoneto ‘reach completion points’ – yes – it implies privatisation. Someone at the ministry has not done their job. NGOs still will have to do it for them when it comes to keeping financial actors accountable.[46]

Similarly, Jones suggests that the way Oslorelates to the World Bank also requires more critical consideration. In February 2007, a Norwegian NGO – the Association of International Water Studies (FIVAS) – and the British World Development Movement campaigning group issued a report, ‘Down the Drain: How aid for water sector reform could be better spent’. This apparently persuaded development minister Erik Solheim to withdraw from the Bank’s Public Private Infrastructure Advisory Facility, whichOslo had funded with $2.85 million since 1999. According to Jones,

To be consistent in its policies, the ministry will be expected to look into funds used for private sector investment which is ten times bigger, and even its national NORFUND that channels billions into ‘risk taking private investments’ and unashamed privatisation projects. However, it is no secret that Solheim has signalled little personal interest in these cuts and has done little of substance to alter the government’s institutional set up or other policies to reduce neoliberal practices in general. He will have to come up with much more substantive measures to convince critics that his admissions to the NGOs are more than cheap bones to distract the dogs.[47]

According to Solheim, addressing the November 2006 conference on conditionalities, ‘We are not saying that liberal economic policies and privatisation are wrong. But it should be a choice of that country – through a democratic debate – not one made by international lenders or institutions.’[48] In the process, he not only missed an excellent opportunity to indeed say neoliberalism is ‘wrong’, he also neglected to consider the political content behind conditionality. This was also something that two major internal World Bank reviews in 2005-06 failed to do, in arguing the case that conditions on loans and debt relief have diminished, or that they simply assist toward broader objectives including borrower ownership, harmonisation, customisation, criticality, transparency and predictability.[49] In contrast, at least three critical NGO studies during 2005-06 found increases in neoliberal conditionality, in part by showing how definitional tricks by the Bank erased the problem without even identifying it.[50] According to these and other civil society critiques put forward to the Norwegian Conference on Conditionality,

  • Aggregate World Bank and IMF economic policy conditions rose on average from 48 to 67 per loan between 2002 and 2005;
  • World Bank and IMF continue to put conditions on privatisation and liberalisation despite the acknowledged frequent failures of these policies in the past;
  • The Bank does not give enough space for governments to define their own policies;
  • The continuing secrecy of World Bank and IMF negotiations with borrowing country governments inhibits the development of genuine broad based ‘ownership’ and leaves reform programmes open to the accusation that they have been illegitimately forced on governments by the Bank; and
  • IMF macroeconomic conditions, especially high interest rates aimed at combating moderate levels of inflation and stringent fiscal policies, impair much needed spending on social and economic development. [51]

Three Norwegian researchers contracted by the foreign ministry – Benedicte Bull, Alf Morten Jerve and Erlend Sigvaldsen – found that in forty Poverty Reduction Growth Facility loans, ‘privatisation is a condition in over half… In addition, 10 of the programs described in detail the privatisation plans of the government, but these were not included in the policy conditionalities. That means that in only 7 of the 40 cases did privatisation not figure as an important element of the PRGF.’[52] The Bull report is critical, to be sure. However, those in power might make the case that allegedly pragmatic changes warrant ongoing Norwegian support, particularly in relation to discontinued user fees for health and education, as well as water/energy utility practices. As the consultants claim, ‘All indications are that the IFIs have changed thinking and even practice with regard to privatisation and liberalisation conditionalities in the utility sector, allowing a wider specter of alternatives and increasing the emphasis on government as an important player.’

Yet it is also widely known that because of lower profits, economic problems in expanding supply grids to poor people, problems with currency conversions for profit repatriation and rising social resistance, the once inexorable march of European and US water firms into the Third World reversed beginning in 1998. This was the main basis for recommendations by the 2002-2003 Camdessus Commission for dramatic increases in publicly-subsidised risk insurance for water privatisers like the French firmSuez, which lost large amounts due to the political and financial meltdown inArgentina.

In short, it appears that in some crucial ways, the Norwegian consultants missed ‘the devil in the details’, and thus offer a less critical analysis than is warranted. This is reminiscent of the kind of thinking in Norad during the early 2000s, in which – as the agency’s website still claims in December 2006 (in a document not updated since May 2004) – ‘The increased focus in Norad on private sector development has in turn led to greater focus on developing countries’ financing of their own development. Efforts to increase tax revenues, provide savings opportunities for the population and provide possibilities for creating local investment capital have become more central components of development cooperation.’ Finally, while the withdrawal of $2.8 million of Norwegian grants to the World Bank’s Private Public Investment Advisory Fund in early 2007 was noted and appreciated especially by water justice campaigners, the subsequent state budget a few weeks later provided $200 million to the Bank for its International Development Association. HenceNorway’s role as a vanguard global financial reformer leaves a great deal to be desired.

In the meantime, the actual reform of the world financial system was being undertaken by Latin American and other medium-sised debtors, repaying their IMF loans early, hence disempowering the International Monetary Fund. To some extent this was made possible by the surpluses accumulated inVenezuela’s accounts by petroleum rents, and Hugo Chavez’s willingness to lend to neighbors. Supported by Chavez and Rafael Correa ofEcuador, the Bank of the South will potentially take forward the objective of South-South financial cooperation, although its initial size is modest.

Finally, then, consider Jane D’Arista’s work, so expansive in clarifying varied aspects of economic crisis and reform. In 1999, D’Arista suggested three proposals for rearranging global financial regulatory institutional arrangements. In its latest manifestation, as a PERI research paper in 2007, she suggests revising John Maynard Keynes’ mid-1940s International Clearing Union proposal to penalise exporters and mitigate processes of financial uneven development between countries.[53] This would work with two other reforms:

• The first proposal puts forward a plan for establishing a public international investment fund for emerging markets. Structured as a closed-end mutual fund, this investment vehicle would address the problems that have emerged with the extraordinary growth in cross-border securities investment transactions in the 1990s. The proposal advocates a role for the public sector in managing those problems so that private portfolio investment – now the dominant channel for flows into emerging markets – can promote steady, sustainable growth rather than the boom and bust cycles that so far have been its primary contribution.

• The second proposal recommends a new allocation of special drawing rights (SDRs), the international reserve asset issued by the International Monetary Fund (IMF). Issuing a new round of SDRs would provide substantial short-term relief from the debt burdens that aggravate imbalances in nations’ access to international liquidity and perpetuate policies favoring lower wages, fiscal and monetary austerity and deflation.

• The third proposal articulates an alternative to the privatised, dollar-based international monetary system that is a root cause of global instability and market failure. This proposal would create an international transactions and payments system managed by a public international agency in which cross-border monetary exchanges can be made in each country’s own currency. This critical feature would help governments and central banks conduct effective economic policies, including countercyclical initiatives, at a national level. Equally important, it would allow all countries — not just a privileged few — to service external debt with wealth generated in their domestic markets. Thus it would help end the unsustainable paradigm of export-led growth that now governs the global economy.[54]

Although the second idea, recapitalising and strengthening the IMF, is distasteful (and one she’s told me is not so crucial to her program), D’Arista’s ideas have coherence and vision, and are realistic insofar as they relate to existing international financial interrelationships. William Greider has given them the strongest endorsement, and it is worth recalling his view, from 2000, about the barriers to seeing them implemented:

The centers of financial wealth – especially the United States– would likely be the skeptics, since it requires them to surrender much of their ability to manipulate and dominate others… Many reformers will object that this subject is wildly premature, too abstract for citizens to grasp, too distant from present politics to engage their scarce energies… Someday, I predict, political leaders will be compelled to consider something like this, though I fear it may require a bloody catastrophe to get their attention.[55]

‘Someday’ is the operative word. Greider acknowledges that a major shake-up would be necessary: ‘When the United States developed into a truly national economy in the late nineteenth century, it suffered repeated, disastrous financial upheavals that eventually persuaded politicians, albeit reluctantly, to accept the need for a central bank. The question now is whether the world has yet had enough of the chaos and profiteering to accept something similar.’ Greider also notes that D’Arista’s sense of such power imbalances as exist within multilateral financial agencies today results in advocacy of institutional governance characterised by a rotating executive committee whose members are picked on grounds of both population and economic output.

4. Conclusion: Towards financial democratisation, deglobalisation and decommodification

To conclude, we must face up to a formidable challenge: the current balance of forces is terribly adverse, as suggested in the Appendix, which divides global ideologies into five categories: Neoconservative, Neoliberal, Post-Washington, Third World Nationalist and Global Justice. The basic barrier is that too many neoconservatives and neoliberals populate the multilateral institutions, so that not since perhaps 1996 when the Montreal Protocol agreed upon chlorofluorocarbon emission reductions, have we seen a serious global governance reform. In areas ranging from democratisation of the IFIs and UN Security Council, to climate change, to international aid and trade, efforts made to establish cooperative reforms across North and South have profoundly failed.

During the 1990s, Western donors (including Scandinavians) had effectively united with the Bretton Woods Institutions via the Paris Club, drawing in UN agencies and large corporations, with nearly uniform cooperation byThird Worldelites. The result was a coherent neoliberal bloc which in the mid-2000s was taken over by notable neoconservative officials, leading to multilateral reform gridlock:

  • the European Union chose the outgoing Spanish Francoist finance minister Rodrigo Rato as IMF managing director in mid-2004, and his replacement in September 2007, Dominique Strauss-Kahn (from the neoliberal wing of the Socialist Party), was nominated by Nicolas Sarkozy and bulldozed through the selection process without even the charade of consultation (the US and Europe collectively hold 53% of voting shares and Washington immediately supported the Euro prerogative), at a time the Bretton Woods ‘democracy deficit’ had caused a recognised legitimacy crisis;
    Paul Wolfowitz – the architect of the illegal US/UK/Coalition of the Willing war against Iraq – was appointed by Bush to head the World Bank in March 2005, and when in June 2007 he was forced out due to petty nepotism, Wolfowitz was replaced by fellow neocon Robert Zoellick, formerly Bush administration US Trade Representative and member of the Project for a New American Century (hence signatory to a 1998 letter to Bill Clinton advocating an invasion of Iraq on grounds that ‘American policy cannot continue to be crippled by a misguided insistence on unanimity in the UN Security Council’);
    the European Union’s hardline trade negotiator Pascal Lamy won the directorship of the World Trade Organisation in early 2005, confirming the lack of room for trade reform;
      the US-influenced choice for UN secretary general to replace Kofi Annan in 2007 was Ban Ki-moon, who proved himself loyal the first week on the job when he endorsed Washington’s unprovoked bombing of Somalia;
    the head of UNICEF, chosen in January 2005, was Bush’s agriculture minister Ann Veneman, although theUSAandSomaliaare the only two out of 191 countries which refused to ratify the United Nations Convention on the Rights of the Child;
      for another key UN post in February 2005, the outgoing neoliberal head of the World Trade Organisation, Supachai Panitchpakdi from Thailand (who served US and EU interests from 2003-05), was chosen to lead the United Nations Conference on Trade and Development;
    the Bush adminstration’s undersecretary of state Christopher Burnham was made UN undersecretary general for management, notwithstandingWashington’s persistent UN dues-chiseling;
      Bush’s choice to direct the UN’s World Food Programme was Josette Sheeran, former managing editor of the neocon newspaper

Washington Times,

      owned by the South Korean Moonies (an appointment Ban allegedly promoted); and
  • to ensure that Washington’s UN directives retained powerful – bullying and often sinister – force, Bush appointed the notorious John Bolton as USAmbassador in mid-2005, and in December 2006, after the Democrat-controlled Congress refused to endorse Bolton, replaced replaced him with former USAmbassador to occupied Iraq, Zalmay Khalilzad.[56]

So the hope for global economic reform top down, seems myopic. Instead, what kinds of examples can we find, bottom-up, that correspond to the pressures of global financial volatility, and social resistance? The next paper in this series will address the ways grassroots activists are moving forward against an undemocratic and destructive global financial system. The spirit is in keeping with a strong normative statement by a leading 20th century economist:

I sympathize with those who would minimize, rather than with those who would maximize, economic entanglement among nations. Ideas, knowledge, science, hospitality, travel – these are the things which should of their nature be international. But let goods be homespun whenever it is reasonably and conveniently possible and, above all, let finance be primarily national.[57]

John Maynard Keynes, writing these words in 1933, sounds similar to the protesters at the World Trade Organisation’sSeattlemeeting, who called for the deglobalisation of capital, through the globalisation of people. Can this principle be found in grassroots activism that relates to global economic injustice, especially in the sphere of finance? One must look rather closely, but yes, and we take up the story in coming pages.

[Patrick Bond is director of the Centre for Civil Society and Research Professor,SchoolofDevelopment Studies,UniversityofKwaZulu-Natal,Durban,South Africa. This is the first of three papers presented at the UKZN Centre for Civil Society, about theUSfinancial crisis (October 3), implications forSouth Africa(October 24) and social resistance there (October 31). A version was presented to a conference on the Political Economy of Monetary Policy and Financial Regulation, in honour of Jane D’Arista, at the University of Massachusetts Political Economy Research Institute (PERI), University of Massachusetts, Amherst, May 2, 2008.]

Notes

[1]. Longer versions of the material in this section can be found in Bond, P. (2006), Talk Left, Walk Right, Pietermaitzburg, University of KwaZulu-Natal Press; and in an article, ‘Post-Imperialist North-South Financial Relations?’, in Studies in Political Economy, 81, 2008.

[2]. In retirement, Camdessus remained an active agent of the Washington Consensus. In 2001 he served as an advisor to Pope John Paul II. In 2002-03 he was head of a World Water Forum infrastructure financing panel that was extremely controversial. In June 2003 he was chosen as the G8’s special liaison forAfrica, and played a role in promoting the New Partnership forAfrica’s Development.

[3]. Manuel, T. (2002), ‘Remarks to the International Business Forum at the International Conference on Financing for Development,’Monterrey, 18 March.

[4]. See Bond, P. (Ed)(2002), Fanon’s Warning: A Civil Society Reader on the New Partnership for Africa’s Development, Africa World Press and AIDC, pp.141-142 for a discussion of the primary pilots and their failings.

[5]. United Nations (2002), ‘Report of the International Conference on Financing for Development,’ A/CONF.198/11,Monterrey,Mexico, 22 March, Statement by Mike Moore, Director-General, World Trade Organisation. The IMF and Bank tend to underestimate the recurrent costs associated with most basic-needs goods, because the institutions generally insist on cost-recovery and self-financing.

[6]. The citations are from United Nations, ‘Report of the International Conference on Financing for Development,’ paragraphs 2,4,25,39,41,49,52,54,71.

[7]. For a critique of NEPAD’s pro-HIPC financing arguments, see Bond, P. (Ed)(2005) Fanon’s Warning, Trenton, Africa World Press, pp.183-192. NEPAD only adds that more resources are required and a few more countries added to those elegible for relief.

[8]. The quote by Manuel demonstrated a smug analysis of HIPC and a surprisingly unambitious reform agenda (Manuel, T. (2002), ‘Mobilizing International Investment Flows: The New Global Outlook,’ Speech to the Commonwealth Business Council, 24 September). Ironically however, while inMonterrey, Manuel began to admit the programme design flaws: ‘We also need to ask: will the debt relief provided by the HIPC Initiative lead to sustainable debt levels? If the answer is no we would need to look at ways to address the areas of concern of the HIPC framework’ (Manuel, ‘Remarks to the International Conference on Financing for Development’). Such talk was cheap, for in neither the Monterrey Consensus nor NEPAD, nor any initiative of Manuel’s, was HIPC’s failed framework substantively addressed.

[9]. Financial Times,27 February 2003. This possibility, often stated at the programme’s outset by civil society critics, was only hinted at inMonterrey’s main source of official information: International Monetary Fund and International Development Association (2001), ‘The Impact of Debt Reduction under the HIPC Initiative on External Debt Service and Social Expenditures,’Washington, 16 November. The Bank, paradoxically, blamed failure upon ‘political pressure’ to cut debt further as the key reason repayments were still not ‘sustainable.’

[10]. Jubilee Plus (2003), ‘Real Progress Report on HIPC,’London, September.

[11]. Manuel, T. (2002), ‘Remarks at the Finance Minister´s Retreat,’ International Conference on Financing for Development,Monterrey,Mexico, 19 March.

[12]. Ellis-Jones, M. (2003), ‘States of Unrest III: Resistance to IMF and World Bank Policies in Poor Countries,’London, World Development Movement, April, p.3.

[13]. Jubilee South (2001), ‘Pan‑African Declaration on PRSPs,’ Kampala, 12 May. The document serves as Appendix Four to Bond and Manyanya, Zimbabwe’s Plunge.

[14]. Nyamugasira, W. and R.Rowden (2002), ‘New Strategies, Old Loan Conditions: Do the IMF and World Bank Loans support Countries’ Poverty Reduction Strategies? The Case ofUganda,’Uganda National NGO Forum and RESULTS Educational Fund,Kampala, April.

[15]. Anonymous (2001), ‘Angolan Civil Society Debates Way Forward,’ World Bank Watch SA? SA Watch WB!, December; Bendaña, A. (2002), ‘Byebye Poverty Reduction Strategy Papers, and Hello Good Governance,’ Unpublished paper, Managua; Cafod, Oxfam, Christian Aid and Eurodad (2002), ‘A Joint Submission to the World Bank and IMF Review of HIPC and Debt Sustainability,’ London, Oxford and Brussels, August; Cheru, F. (2001), The Highly Indebted Poor Countries Initiative: a human rights assessment of the Poverty Reduction Strategy Papers, Report submitted to the United Nations Economic and Social Council, New York, January; Costello, A., F. Watson and D. Woodward (1994), Human Face or Human Facade? Adjustment and the Health of Mothers and Children, London, Centre for International Child Health; Gomes, R.P., S.Lakhani and J.Woodman (2002), ‘Economic Policy Empowerment Programme,’ Brussels, Eurodad; Malawi Economic Justice Network (2001), ‘Civil Society PRSP Briefing,’ Issue 8, December 21, Lilongwe; McCandless, E. and E.Pajibo (2003), ‘Can Participation Advance Poverty Reduction? PRSP Process and Content in Four Countries,’ Afrodad PRSP Series, Harare, January; Ong’wen, ‘O (2001), ‘The PRSP in Kenya,’ World Bank Watch SA? SA Watch WB!, December; Panos (2002), ‘Reducing Poverty: Is the World Bank’s Strategy Working?,’London, September; Tanzanian Feminist Activism Coalition (2001), ‘Position Paper,’ Dar es Salaam, 6 September; Wilks, A. and F.Lefrançois (2002), ‘Blinding with Science or Encouraging Debate?: How World Bank Analysis Determines PRSP Policies,’London, Bretton Woods Project.

[16]. Afrodad (2001), ‘Civil Society Participation in the Poverty Reduction Strategy Paper Process: A Synthesis of Five Studies conducted inBurkina Faso,Mauritania,Mozambique,Tanzania andUganda,’Harare, April.

[17]. McGee, R. (2002), ‘Assessing Participation in Poverty Reduction Strategy Papers: A Desk-Based Synthesis of Experience in sub-SaharanAfrica,’Sussex, University of Sussex Institute for Development Studies.

[18]. Business Day,20 March 2002.

[19]. Center of Concern, International Gender and Trade Network and Institute for Agriculture and Trade Policy (2003), ‘IMF‑World Bank‑WTO Close Ranks Around Flawed Economic Policies,’ Washington, Geneva and Minneapolis, http://www.coc.org/resources/articles/ display.html?ID=484. See also reports of the 13 May 2003 meeting between the WTO and Bretton Woods Institution leaders. According to the Bretton Woods Project, a progressive London NGO, ‘The Bank, in its trade agenda for the coming year, admitted that it is ‘concerned with a possible trade-off of liberalisation policies with increases in inequality¼and a rise in unemployment for specific groups in the short-term.’ Rather than question the policy prescription, the response is to ensure the ‘appropriate design of compensation mechanisms’’ (http://www.brettonwoods.project.org).

[20]. United Nations, ‘Report of the International Conference on Financing for Development,’ Final Resolution, pa62-63.

[21]. A reformed IMF International Monetary and Financial Committee opens the door for greaterThird World inputs, but this has not changed power relations.

[22]. World Bank (2003), ‘Proceedings of Press Conference,’ Dubai, http://www.worldbank.org, 22 September.

[23]. Wade, R. (2001), ‘Capital and Revenge: The IMF and Ethiopia,’ Challenge, September/October.

[24]. Stiglitz, J. (2002), Globalisation and its Discontents,London, Penguin, p.35.

[25]. Cited in Wade, ‘The Invisible Hand of the American Empire.’

[26]. Guardian, 21 May 2003.

[27]. Round, R. (2002), ‘CBC Commentary,’ 20 March.

[28]. Wilks, A. (2005), ‘SellingAfrica Short’, European Network on Debt and Development,Brussels, 21 June.

[29]. Green Left Weekly (2005), ‘Africa needs Justice not Charity’, 29 June.

[30]. Ambrose, S. (2005), ‘Assessing the G8 Debt Proposal and its Implications’, Focus on Trade,25 September 2005.

[31]. IMF, Regional Economic Outlook, p.10.

[32]. Weissman, R. (2005), ‘Nigeria Debt Disgrace,’Washington, 20 October.

[33]. Cited by Jubilee USA (2005), ‘Nigerian Threat to Repudiate Helps Force Paris Club to Deliver Debt cancellation’, Press Release,Washington, 20 October.

[34]. Global AIDS Alliance (2005), ‘Nigeria’s Creditors Should be Ashamed’, Press Release,Washington, 20 October.

[35]. Ambrose, S. (2005), ‘IMF Adds a New Tool to its Bag of Tricks’, Economic Justice News (50 Years Is Enough), 8, 3, http://www.50years.org/cms/ejn/v8n3, September.

[36]. International Monetary Fund (2005), ‘Policy Support and Signaling in Low-Income Countries’, Policy Development and Review Department, Washington, Annex 1, p.25.

[37]. Bond, P. (2003), Against Global Apartheid: South Africa meets the World Bank, IMF and International Finance,London, Zed Books andCape Town,University ofCape Town Press, Afterword.

[38]. Bond, P. and M.Manyanya (2003),Zimbabwe’s Plunge: Exhausted Nationalism, Neoliberalism and the Search for Social Justice,London, Merlin Press, Pietermaritzburg, Universty of KwaZulu-Natal Press andHarare, Weaver Press.

[39]. Ndikumana, L. and J.Boyce (2008), ‘Capital Flight from Sub-Saharan Africa’, Tax Justice Focus, 4, 1, p.5.

[40]. Toussaint, Your Money or Your Life, p.384. See also http://www.jubileeplus.org/analysis/reports/dictatorsreport.htm.

[41]. Baker, R. (2005), Capitalism’s Achilles Heel , London, Wiley; and Christenson cited in Campbell, D. (2005), ‘Where they Hide the Cash’, Guardian, 5 December.

[42]. Prasad, E., K.Rogoff, S.J.Wei and M.Ayhan Kose (2003), ‘Effects of Financial Globalization on Developing Countries: Some Empirical Evidence,’ Washington, International Monetary Fund, March 17, pp.6-7,37.

[43]. World Bank (2005), ‘Meeting the Challenge of Africa’s Development: A World Bank Group Action Plan’, Africa Region,Washington, 7 September, pp.32-33.

[44]. Bond, P. (2004), ‘Bankrupt Africa: Imperialism, Subimperialism and Financial Politics’, Historical Materialism, 12, 4.

[46]. Jones, J. (2006), Personal Communication, 7 October.

[47]. Jones, J. (2007), Personal Communication, 24 February.

[48]. Moskwa, W. (2006), ‘Norway Presses International Lenders on Conditions,’ Reuters, 28 November.

[49]. Two analyses from within the Bank which do not question the merits of neoliberal conditions, just their effectiveness, are World Bank (2005), ‘Review of World Bank Conditionality’, Washington, September, http://siteresources.worldbank.org/PROJECTS/Resources/40940-1114615847489/ConditionalityFinalDCpaperDC9-9-05.pdf. ; and World Bank (2006), ‘Development Policy Lending Retrospective,’ Washington, July, http://www-wds.worldbank.org/external/default/WDSContentServer/IW3P/IB/2006/07/14/000012009_20060714104555/Rendered/PDF/367720rev0pdf.pdf

[50]. Eurodad (2006), ‘World Bank and IMF Conditionality: A Development Injustice,’ Brussels, June, http://www.eurodad.org/uploadstore/cms/docs/Microsoft_Word__Eurodad_World_Bank_and_IMF_Conditionality_Report_Final_Version.pdf; ActionAid (2006), ‘A Shadow Review of World Bank Conditionality,’ London, September, http://www.actionaid.org.uk/doc_lib/what_progress.pdf; and Christian Aid (2005), ‘Challenging Conditions: A New Strategy for Reform at the World Bank and IMF,’ London, July, http://www.christian-aid.org/indepth/607ifis/index.htm

[51]. ‘CSO Common Statement on the Norwegian Conference on Conditionality’,Oslo, November 2006.

[52]. Bull, B., A.Jerve and E.Sigvaldsen (2006), ‘The World Bank’s and the IMF’s use of Conditionality to Encourage Privatization and Liberalization: Current Issues and Practices’, Report prepared for the Norwegian Ministry of Foreign Affairs as a background for the Oslo Conditionality Conference, November 2006.

[53]. As she put it, ‘A revision of Keynes’ proposed structure is necessary because payments imbalances are no longer settled by transactions through central banks but through private financial institutions. An international clearing agency that would meet current needs and conditions would have to include a mechanism for clearing private cross-border payments as well as create a reserve system that would reinstate transactions among central banks as the primary channel for settling balance of payments surpluses and deficits.’

[54]. D’Arista, J. (1999), ‘Reforming the Privatized International Monetary and Financial Architecture’, Philomont, VA, Financial Markets Center, reprinted in Challenge, May-June, 2000, 43, 3.

[55]. Greider, W. (2000), ‘Time to Rein in Global Finance’, The Nation, 24 April.

[56]. Eric Toussaint and Danueb Millet (2005), ‘Multilateral Institutions Taken Hostage’, Le Soir, 15 April; Deen, T. (2005), ‘ UN Faces New Political Threats From US’, Inter Press Service, http://www.ipsnews.net/news.asp?idnews=31152, 23 November; Hooper, J. and E.Pilkington (2006), ‘UN to appoint former Moonie as head of World Food Programme’, The Guardian, 6 November.

[57]. Keynes, J.M. (1933), ‘National Self‑Sufficiency,’ Yale Review, 22, 4, p.769.

The financialization of the American economy has corrupted capitalism by concentrating wealth and has corrupted democracy by the use of this concentrated wealth to concentrate political power. This lobby power of Wall Street has influenced the political process to provide the privileges that allow the concentration of wealth. For example speculation with borrowed money and the repeal of the Glass-Steagall.Act.

 

The Constitutional responsibility to “ control currency and credit for the general welfare” has not been honored from the beginning and has been an impediment. Now it has grown to a size that threatens the future of economic freedom.

 

The following is part of a letter to the Cato Institute from Ray Carey on this subject.

My proposition is that our country’s economy is in the middle stages of a “financialization” in which financial services dominate the job growth economy rather than support it. The threat that this presents to free markets is huge, complex, and fast moving. Cato is one of the few organizations with the free market mission and the sophistication to turn back this tide, if not tsunami.

Concentrated wealth is at record levels and has provoked the usual outrage from the “have nots” and their representatives, along with the usual nonsense from the “trickle down” representatives of the “ haves.”  This concentration, with visible evidence of individual greed, has helped change our international image from the beacon towards freedom to an arrogant bully trying to run the world.  Less attention is paid, however, to broad wealth distribution, as a critical  principle in Smith’s economic dynamic to spread wealth around the world.  Free markets work when additional volume reduces costs and prices that then allow more people to buy if they have spendable income. (pp. 278-284)[1] Henry Ford figured this out in 1915 and raised wages to $5 a day so his workers could buy the model T’s. Globalization is now managed on the mercantilist philosophy in which profits are presumably maximized by suppressing wages and benefits. (p.182, 193). This cannot work in the long-term because people need money for reciprocal purchases in order to energize the economic perpetual motion machine that can eliminate material scarcity in the world.

Kevin Phillips in Boiling Point called attention to what financialization can do to great nations: first Spain in the 16th century, Netherlands in the 18th, Great Britain in the 20th, and now our turn?  The manifestations are a shifting of taxes from capital to the middle class, shrinking of manufacturing, an explosive growth of financial services, and record concentration of wealth. (p. 258). Profits are now so good in financial services that they seem insulated from the big cash settlements required by so many cases of wrong doing.

In your mission to support free markets you properly identify the ideologues of the American Empire who push a strong government agenda that is in contradiction to the proper role of America, which is to spread the benefits of economic freedom around the world. I regard, however, the ideologues of the liberalization of capital markets as an equal threat to America’s future. The two in combination are truly scary.  Apparently the ideologues of the liberalization of capital markets quit studying Smith before they got to the part about neutral money, and control of the speculators. Financial services have grown from 4% to 40% of total corporate profits with  the share of total S&P market capitalization up to 25%. GM and Ford make 125% and 157% of their profits from financial services, that is, they are losing money on cars. Imagine what the overall numbers would look like if we followed Smith’s advice and treated financial services as administrative expenses to be subtracted from the wealth of nations

The financialization threat to our long-term economic success is the result of mistakes caused by the lobbying of Wall Street and the inability of Congress to dig deep and get it right. These mistakes are in fiscal and monetary matters that few have the financial sophistication to examine and challenge. The two big mistakes were Nixon floating the dollar without an alternative stabilizing mechanism, and ERISA pumping $100 billion a year into Wall Street with no examination of whether the money went into investment in the job growth economy or only into pushing up stock prices. There was similar lack of examination of how much it cost to get from savings to investment. The mutual funds, for example, contradicted the laws of supply and demand by raising their prices at the same time that the volume of their business was growing strongly. (p. 204) These two mistakes caused the excessive liquidity and volatility that provoked the financialization of the economy. Inattention to the fundamentals of this savings-investment equation continues in the discussion of privatizing social security, that is, where does the money go, and how much does it cost to get there?

Greedy CEOs are a popular target as many were seduced by ultra-capitalism with millions of stock options. (pp.118-123) All CEOs, however, were pressured to choose short-term earnings over long-term growth. The short-term choice gave some the high P/E to acquire other companies. Others were forced to sacrifice long-term plans because they knew that if they did not protect their high P/E they were easy targets for the take-over artists. (Chapter 8) M&A activity is heating up again but with a new twist, the presence of the hedge funds including lots of wage earners’ pension money.  They will do new damage with their large war chests, unregulated status, and knowledge of how to play games with derivatives.

In Democratic Capitalism I examine the rise of ultra-capitalism in detail but only after a full examination of democratic capitalism, its philosophy and protocols. (Chapters 4&5) Despite the clarity and comprehensive treatment of democratic capitalism by Adam Smith, Karl Marx and John Stuart Mill, and the experimental verification by Robert Owen, (chapter 3) it has never been presented as a coherent whole for student examination in Business or Law schools or, for that matter, in the liberal arts despite their mission to improve the human condition. There has been a massive intellectual default during the whole industrial revolution by those who could have presented the good capitalism but have preferred to stay with their contempt for commerce that has persisted from the time of Plato.  The result is that democratic managers must continue to reinvent democratic capitalism.

The democratic capitalist proposition has not changed: investing in people in a moral environment maximizes profits. Owen demonstrated this synergy of quality of life, moral values, and profits in practice. Mill later connected the dots among these crucial components but few paid attention then and now. (p.49) If democratic capitalism is not examined in the university, and is rarely mentioned in the popular media, as Bill Greider asked in one of his books: Who Will Tell the People? I hope that Cato will examine this opportunity.

Fortunately the problems are susceptible to simple solutions that are detailed in my book: they include tax-free dividends for low-and-middle income wage earners, (pp.183, 193) a change in measurement of corporate performance from quarterly and annual e.p.s. to a three year running average of sales, cash flow, and profits, (p. 395) and a steady reduction of the borrowing leverage for speculation.  These actions would activate the trillions of dollars of 401(k) and pension money that are now subsidizing Wall Street, move the stock market away from its casino function back to being a source of equity capital for growth, and regulate speculation with borrowed money, the persistent impediment to capitalism functioning at full potential. There are other actions needed in support of democratic capitalism including reform of the U.N. but they are not relevant unless lives are being improved and the world is uniting in economic common purpose. (pp.482-493) The intention of our Founders to harmonize democracy and capitalism was partially accomplished and the concept is still attractive to a huge democratic majority—if properly presented. They now have little influence on the political process but represent the potential voting power to support reform once an agenda is defined.

I appreciate that you have read my book and find it of interest and hope that others at Cato have read it. It is the product of 30 years of running companies, including 18 as Chairman and CEO of ADT, and then 15 years of intensive study about what free markets need to function at full potential. Full potential meaning feeding, sheltering, clothing, educating, and providing good health for over 6 billion humans, and meaning the substitution of economic common purpose for violence in a world now trapped by reciprocal atrocities. Chapter 10 includes ten hypotheses in a logic trail that leads, according to my analysis, to a world of peace and plenty. Please study hypothesis # 1 that requires validation before proceeding to the other hypotheses. It argues that Marx was right when he rearranged the economic system, culture, and political structure to give priority to economics to be assimilated by the culture with government then restructured in its support. Acceptance of this hypothesis has profound implications.

Cato concentrates on the pathologies of collectivism, which you do very well. You do not, however, in your examination of the role of government in the free market, emphasize acceptance of Adam Smith’s qualifications for the free market to function. The “peace, easy taxes, and a tolerable administration of justice” is understood by most, but the specification for neutral money and control of the speculators, (prodigals and projectors as Smith called them) does not seem to register with many.  Neutral money was highlighted in our Constitution as the responsibility to “control currency and credit for the general welfare” The importance of neutral money has also been emphasized by 20th century free market philosophers such as Friedrich Hayek who identified the worst sin of government as non-democratic privileges that result in money having a dominating influence in the commercial process. We are in the grip of the Great American Contradiction that frees what should be controlled, and controls what should be freed. The government tells companies what shoes to wear and ladders to use while simultaneously deregulating monetary matters and suspending market disciplines. (pp 263-265)

From the time ofHamiltonthe wealthy and powerful have enjoyed privileges to speculate with borrowed money resulting in economic panics from 1818 to 1929.  In the past quarter century, however, this impediment to free markets has escalated into a dominance that threatens permanent damage to our economy.  Imperial overstretch, budgets deficits, and current account deficits putsAmericainto uncharted and dangerous territory. Reform must begin by purging ultra-capitalism (chapter 7) and moving to democratic capitalism in the domestic economy followed by leadership of the world to the benefits of free markets. How did the most successful free market economy in history give up economic leadership for the use of military power to run the world?

Please consider that Collectivism with all of its micromanagement waste and inefficiencies is the Democratic response to concentrated wealth from privilege. In a vague way the Collectivist thinks that they are justified to tax and spend because they see the enormous concentrated wealth and know that much of it is the product of government privilege. Our government is polarized between those protecting privilege to concentrate wealth and those trying to redistribute it. This grid lock can be broken only by discovering that democratic capitalism is the superior free market system, based on traditional values, that improves the human condition thus satisfying the missions of the left and the right. The problem is that no one, except those enjoying the feast, understands the fiscal and monetary policies that provide the privileges and consequently the free market continues to be corrupted. This is where I believe that Cato has a unique capability. You have the mission to support free markets, the financial sophistication to understand the corruptions and solutions, and the infrastructure to promote real reform.

I argue that the best way to defeat collectivism is a move to democratic capitalism that not only distributes wealth broadly but before that creates more wealth. Once wage earners are enjoying a “capital wage” along with their labor wage they will pressure government to copy democratic capitalistic principles and restructure from rules based micromanagement to results based decentralization and empowerment.  Conversely, the “starve the beast” Republican plan now being followed, in combination with the expected economic decline, can cause social tensions worse than the Great Depression that came close to destroying this great democratic experiment.

In my first letter to your President Ed Crane in 1989 I identified ERISA pension money as the reason that Wall Street was able to dominate Corporate America. At that time, you will remember, the world was a promising place with economic freedom spreading to Eastern Europe, South America, andSoutheast Asia.  I was convinced that the end of Communism was the beginning of the world of peace and plenty, and that the parts of the world still full of violence and misery would gradually be changed to economic freedom by the pressure of their people who could see the benefits of economic freedom on TV and the Internet. I usedSingaporeas the case study in how economic freedom can improve lives in an authoritarian government with political freedoms following once the freedom genie is out of the bottle. (pp. 449-451) Despite this encouraging progress the competing momentum from ultra-capitalism caused me to warn of an insidious development as our economy was becoming steadily more financialized.

Democratic Capitalism, in chapter 7, defines ultra-capitalism as the combination of old-fashioned mercantilism that treats the wage earner as a disposable cost commodity, and finance capitalism that is dominant over, not supportive of, the job-growth economy. Chapter 8 is a play that depicts the terrible choice facing CEOs, and chapter 9 is  “Enron, the Poster boy for Ultra Capitalism.”  It argues that while Enron may be about greedy executives it is, more importantly, about how the Wall Street-Washington nexus provides government privileges for easy credit that allow Enrons to happen.

Several chapters of my book are a textbook about democratic capitalism and promote a “capital wage” through tax-free dividends for low-and-middle income wage earners. Also presented are ways to create more wealth and spread it broadly through profit sharing and ownership plans like the Care and Share that I designed and put in place at ADT. These plans are the most motivational because the wage earner has to put up some of their own money.  These plans will not work unless the culture is changed to participation through trust and cooperation. (pp. 45-47)  (United Airlines gave worker ownership a bad name because they did not change the culture.)     .

I have a tendency to concentrate on the evils of ultra-capitalism and not describe the wonders of democratic capitalism sufficiently. This is because ultra-capitalism is the bone in our economic throat that must be removed before the benefits of economic freedom can be released again. During our visit, however, I hope to have the time to present why democratic capitalism is the most profitable because it is moral. Not quite conventional wisdom about any type of capitalism, but I think it is a proposition that can be validated. Similarly, the conventional wisdom that the government and the culture must contain the “animal spirits” of a economic system that is amoral at best, and more likely immoral, is reversed because there is evidence that the moral environment of democratic capitalism actually spreads a benign infection to the contiguous community. This should not be surprising as trust and cooperation is the natural condition of humans and will be carried into the community from people in companies that encourage this culture. I also propose, contrary to conventional wisdom, that the Great Depression did not destroy the theory of free markets finding equilibrium. The cause of the Crash of ’29 and the Great Depression was speculation with borrowed money in contradiction to Smith’s classical economic theory, followed by three monstrous mistakes byHoover. The free market will find equilibrium if currency and credit is, in fact, controlled for the general welfare. (pp 209-216).

Another case study that I believe is critical to understanding the economic threat is the damage done to the Asian “Tigers” in 1998. Rubin and Clinton jawboned emerging economies into taking down cross border capital controls so that “free capital could roam the world looking for the most efficient investment.”  A good theory but in practice it became speculative capital rushing around the world looking for a quick chance to make money. The lack of controls of hot money (short-term loans) and currency speculation  (or even the threat of it) drove the currency down as much as 70%. It had been clear since Soros defeated the British in 1992 that the speculators with borrowed money have more power than the central bankers. BaselI, written by the central bankers club, BIS, inSwitzerland, did not find ways to monitor the quality of loans by requiring a matching component of long-term money and, in fact, wrote reserve rules that encouraged short-term loans. Neither did they have ways in a crisis to automatically convert short-term loans into long term. Hot money was able to rush in and out at great speed.  BIS  is now working on Basel II but these deliberations can take six years and there is no evidence of popular participation. The money tree is now $2 trillion a day in Forex, $1.2 trillion a day in derivatives. Soros warns of calamities ahead if we do not learn how to purge the instabilities. Who is representing the people in Basel II?

Indonesia, the world’s largest Muslim nation, was the poster boy of how to improve the lives of people through economic freedom because it lowered the number of those under the poverty line from 40% to 10% in a few decades by standard free market moves.  American led ultra-capitalism then drove the Indonesians living in poverty back under 50% in a matter of weeks. Another Muslim, the prime Minister of Malaysia, called currency speculation unnecessary, unproductive, and immoral at a speech at a World Bank meeting in Hong Kong.  Footnotes to this tragedy: Indonesia became a location for terrorist training and funds; the popular media did not understand the economic causes and turned it into a political event easier to report; and finally the “Tigers’ did not even need more capital because of a high level of savings. The earlier opening up of Indonesiafor foreign investment was real investment with real people working, not speculative money going into their stock market or excessively risky ventures. The Treasury Department and the IMF then treated a liquidity problem with standard cures and further slowed down growth. (pp 278-284). Joseph Stiglitz examined the confusion between a liquidity crisis and a capital crisis in Globalization and Its Discontents. (p. 280)

It is the ideologues of the liberalization of capital markets that I want to address in this letter, but before I leave the ideologues of the American Empire I want to call attention to Niall Ferguson’s 2004 book Colossus. Ferguson wishes that we were imperialists like Great Britain because he believes that Empires must stay and manage like the British did. In other words, we have the worst of both worlds in that we start actions like an Empire, but do not follow up with the requisite administration. Contrary to Ferguson’ sentimental and sanitized retrospection of  British imperialism, Joseph Nye, former Dean of the Kennedy School of Government and former Secretary of Defense, positions America as a leader towards economic common purpose and a strong team player in containing the violence. The title of his book summarizes it well: The Paradox of American Power, Why the World’s Only Superpower Can’t Go It Alone. (p.486)

In FDR’s view World War II was fought for two reasons, certainly to defeat Fascism but also to end Empires in the world.  Subsequently the British left India but unfortunately DeGaulle was repositioning France in the worst possible way and refused to leave Vietnam or Algiers until a lot more blood of young people was shed. LaterAmericafollowed the French intoVietnamand 54,000 young Americans lost their lives.

Back in 1987 Prof Paul Kennedy of Yale called attention in The Rise and Fall of Great Powers (p. 170) to “imperial overstretch” that precedes the fall of great nations  America now represents about one-fifth of the world’s population but almost one-half of all military spending. This spending, combined with the financialization of our economy, has put this great democratic experiment in jeopardy. According to Hegel, the humans’ move toward freedom is one of struggle and contradiction with three steps forward and two back. Is it possible that for the first time we are in serious danger of two forward, three back?  If true, what a tragic unnecessary failure.

Additional matters for discussion include:

  • The savings investment equation, fundamental to the success of capitalism,  was largely ignored in ERISA and is in danger of being ignored in the privatization of social security discussions. The assumption is that the stock market is an efficient way to move savings into productive investment. Not true, the stock market is a casino with a mission of making money on money with some of it flowing into the job growth economy. At the time of ERISA companies were putting cash away for only a fraction of their pension obligations. ERISA in effect took trillions of dividend or growth dollars out of companies and gave it to Wall Street where only a part of it ended in real investment. IPOs peaked at about $45 billion dollars but they became another scam. I have been unable to find out how much other equity capital comes out of the stock market each year, does Cato know? Most of the ERISA money goes into a hydraulic pressure to buy stock while M&As and stock buy-backs reduce the total stock. As demand goes up and supply goes down, the price has only one way to go, until fear takes over from greed.
  •  ERISA funding gave the market the clout to dominate companies through enormous rewards and punishments for quarterly and annual e.p.s. (pp. 254, 255). CEOs became Pavlov’s dogs and after receiving enough big juicy bones for beating quarterly e.p.s., or electric shocks for missing by a few cents, all became trained and some even learned how to cheat to get the big bones and avoid the shocks. This quarterly/annual measurement is not responsive to the normal dynamics of business and until we change the measurement to a three-year running average of cash flow, sales, and profits ultra-capitalism will continue to dominate and companies will continue to manage for the short term.  Can it be that simple, just change the measurement and accountability to three components and a three-year average? Yes, and until we do the analysts will run the economy.
  • The reforms coming out of Congress are, as usual, cosmetic “gotcha” oversight rules that will cost money and reform nothing. Every CEO I know feels responsible for the numbers in the annual report. Telling him or her that they will go to jail for 20 years for bad numbers is both insulting and silly. Predictions of cash flow could have prevented the Enron smash up as it would have demonstrated that they did not know how much cash they were burning every year from their many screwed up projects.   A clever CFO can fake cash flow but not for long and not against predictions.
  • Once Investment Bankers shifted to pricing their services on a percentage of the deal, the deals exploded most of them either bad or not very good in the long-term. (pp. 120, 121). Bankers, lawyers, accountants, serial CEO acquirers, and acquired CEOs, all feasted on billions of dollars with no risk and little accountability.  Even CEOs responsible for making the models work insulated themselves with multi-million dollar severance agreements. Anti-trust is a delicate instrument in a free market but we have gone too far in the wrong direction. Serial acquirers like Sandy Weil and Dennis Koslowski must be constrained by reasonable percentage of market controls. In 2005 the M&A game is heating up again energized by the investment bankers salivating over the big fees and the CEOs who know that playing monopoly is easier than running a business and is sure to stick millions in the CEO’s pocket. The pattern will be the same: fire thousands, hype earnings, pump the stock, collect on options, and do not worry too much about how much red meat was cut in the process. Witness Carly at H-P, it takes years to realize how dumb most of these deals are.
  • The “ fairness opinion” is a joke. How many bankers are prepared to recommend or write an opposing opinion when a deal means millions of dollars and no deal means zero? Until investment bankers go back to pricing their services by time related advisory fees, deals will proliferate and stockholders will be exploited.
  • Asset inflation: Speculation with borrowed money has caused every recession and depression in this country’s history from 1818 to 1929 to the recent bubble economy. (pp. 209-216). The Chairman of the Federal Reserve Board, however, does not think that preventing asset inflation is their job although vigorous action to prevent price inflation is. The latter protects the asset value of the wealthy and favors the creditor class while action to prevent asset inflation protects ordinary people. Contrary to Greenspan’s testimony to Congress asset inflation can be prevented by transaction taxes, higher short-term capital gains taxes, higher stock margin requirements, and bank reserve requirements that move up as stocks appreciate beyond corporate earnings growth, or real estate beyond inflation. (pp. 216-222; 271-274).
  • LTCM is a good case study in the extremes of leverage up to 98% of the bets. It is a good case study of how hedge funds raise the risk in order to feed the steady demand for increasing earnings as they moved from “market neutral” to “directional.” It is a good case study of how the government suspends market disciplines by bailing out private interests who have screwed up. (pp. 287-292). The argument that no public money was used in the bankers’ bail out does not pass scrutiny as the S&L debacle showed how fast the insurance money runs out leaving the taxpayer holding the bag.
  • Glass Steagall and Citigroup: The lobby power of Wall Street was demonstrated by the repeal of Glass Steagall including Citigroup’s arrogance in putting together their various enterprises in anticipation of the repeal. (pp 298-300). It is a case study of why we need to protect the system from the conflict of interest of commercial bankers providing easy credit for bad loans, so that the investment bankers can get big fees for the bad deals. These banking functions were separated in the 1930s and Enron in 2001 showed why it was a good idea to prevent the damage from easy credit from government privileges. Greedy executives are a symptom not a cause. Volker’s purchase of Continental Illinois in 1984 ushered in the “too big to fail” era, a major violation of market disciplines.(pp. 264, 265). The repeal of Glass Steagall in 1999 ushers in the “really too big to fail” threat to market disciplines. Free of regulation, criminal actions by Citi bankers have become endemic from theU.S. toJapan, toEurope.
  • Enron, along with Freddie Mac, Fannie Mae, Goldman Sachs, and many others are case studies of the danger from derivatives. When they needed better quarterly earnings at Enron, they put out the call to “crank the dials,” meaning raise the risk on trading and even revalue certain future estimates. (Chapter 9). Goldman Sachs is now a public company motivated by the stock price, and as more than a quarter of their earnings are from “trading” they do the same type of pumping when their earnings are weak. Warren Buffett and his partner Charlie Munger called derivatives time bombs that will explode damaging both the players and the economy. (pp. 311-316). Greenspan, however, with his liquidity obsession, has consistently opposed regulation of derivatives and hedge funds and the game playing goes on. Both parties to a contract can change the future value taking the difference into current earnings free of audit or necessity to reconcile the two estimates.  Derivatives are not only unregulated but are increasingly used to avoid regulation of basic banking. Balance sheets and traditional references like a debt-equity ratio have become meaningless. This zero-sum game will be reconciled only when the future contracts mature. How many bi-lateral self-serving estimates will do damage then no one knows. OFHEO is now requiring Fannie Mae to write off $9 billion of losses on derivatives. Why do we have so many agencies involved in monetary and fiscal matters?
  • It is hard to find a single financial motivation on Wall Street that is consistent with the obligation to the customer, the wage earner. Specialists became technically obsolete over two decades ago but still manage to take their slice of the pie. There are more stockbrokers than steel workers now, most of them on commission. When Mr. Merrill founded Merrill Lynch he insisted that brokers be on salary to avoid the obvious conflict of interest, where did Mr. Merrill go?
  • Big bang accounting. Under ultra-capitalism serial acquirers maintained earnings momentum by the acquire and fire method with write offs of future expenses guaranteeing a good following year. Once on the merry-go-round they had to keep acquiring or the music would stop. The big bang announcements were usually made with an estimate of how many would be fired which became the CEO manhood check by Wall Street and bumped the stock up. (p.109).  Conversely, a CEO building a company who chooses to reduce manpower by attrition and retraining does not have the same benefit of the big bang and has to report lower earnings during the years of reduction. Tax laws consistently favor ultra-capitalism.
  • Stock buy backs. Another example of tax laws favoring ultra-capitalism is the inducement to buy back stock instead of spending the money on growth programs or sending the money back into the economy through dividends. (pp. 123, 187, 212). Stock buy backs were defended as “tax efficient” which they were until taxes were relaxed on dividends for the wealthy. Hundreds of billions of dollars were wasted on stock buy backs to arithmetically improve the price of the stock.
  • “Lightly regulated” Hedge funds have tripled in number in six years and now include smaller investors and the wage earners’ pension money. Their defenders describe their function as providing a “discipline” but most of their mission is to make money on money. (pp. 270,271). Derivatives and the influence of hedge funds are spreading through the economic system like a cancer and now infect Mergers and Acquisitions and specific events such as the run up in the price of oil. Speculators with borrowed money thrive on volatility, businesses hate it. The rules favor the speculators and protect them from regulation (pp. 300-304).
  • Forms of worker ownership have been recognized for a long time as the way to motivate the wage earner to produce and innovate with an automatic broad distribution of wealth resulting. (Chapter 5). How can we continue to ignore the system that can create more wealth and distribute it broadly? Jeff Gates in Ownership Solution presents support for worker ownership as the long-sought “Middle Way,” including prominent Republicans and Democrats as well as Martin Luther King’s widow and Gorbachev, one of the 20th century’s visionaries. (pp 150, 151). When ERISA was passed into law Senator Russell Long’s committee down the hall was passing 15 laws that gave ESOP tax benefits for worker ownership.(p. 149). What a tragedy that the committees working on these laws were not introduced to each other. The greatest savings-investment opportunity in history was lost when they neglected to couple the ERISA’s trillions of dollars with some place to go with tax-free-dividends for a secure double digit return to the wage earner, their “capital wage.”  In the immortal words of J.P. Morgan  “Don’t tell to me about return on capital, tell me about return of capital!”
  • Greenspan did not want two Bushes to miss a second term and propped up the economy with artificially low interest rates resulting in an explosive housing market. The signs are now scary: since 2001 the economy has grown $1.3 trillion while debt has grown $4.2 trillion; our savings rate of 1% can be compared to Europe’s almost 10%; and home values have gone up $ 4 trillion. The financially sophisticated, however, are getting ready as the majority of the home refinancing is being converted to floating rate and over half of the $365 billion of corporate bonds issued last year were also on floating rates. Many were hedged with derivatives like rate swaps but many others were doing reverse swaps converting long-term interest rates into short term in order to reduce costs and hype earnings. I study the problem all the time but like most do not really understand all the other things going. At this writing, for example, there is confusion about the yield curve with short term rates going up while long-term rates are going down. Derivatives encourage metaphors: are they time bombs, the tip of the iceberg, or “Alligators Lurking in the Swamp” as Carol Loomis of Fortune called then back in 1994? (pp. 268-271)?
  • Citi had trouble making their quarterly estimate in the fourth quarter of 2004 so they took over $800 million out of their reserve for bad loans, 15 cents a share, and beat the analyst’s estimate by 1 cent!  Back when the NY banks destroyed many South American countries’ economies by pushing too many petrodollars on them, they had a way to avoid writing off non-performing loans, they just loaned them more money so they could pay the interest and avoid being classified as non-performing. (pp. 258-261). Much more sophisticated game playing now goes on in banking stimulated as usual by stock options: SPEs, structured finance, off-balance-sheet debt, and many other artifices that make bank statements a work of fiction. $171.8 billion, or 15.7% of Citi’s total debt, can not be found on the balance sheet; it had to be searched for in the footnotes. (p 369). For these reasons bankers should be on straight salary with five-year performance bonuses corrected for loan write offs and reserve increases. Chairman Greenspan regularly advises Congress that derivatives do not need regulation because they get their money from banks that are regulated, and he’s not kidding.
    • The Fed has been between a rock and a hard place for many years because the efforts to prop up the economy has required zero cost money while the growing current account deficit  (p. 196) normally needs higher bond yields to keep the Japanese and Chinese reasonably happy. The experts do not agree but it seems probable that when our foreign bankers have a better alternative we are in for big trouble.  A couple of points higher on interest rates and imagine all those floating rate loans bankrupting homeowners, companies, and our government.
    •  Our position as the world’s reserve currency has many benefits but the Euro is making steady progress as an alternative with our share of the total shrinking from around 85% to 65% in a few years partly caused by its lower value.South Koreajust dumped dollars provoking a strong negative stock market response. The more polite term is “diversification.”  Is this another part of the gathering “Perfect Storm?”
    • One aspect of our financialized economy is the ability of financial services companies to make money playing the interest-rate, “carry trade,” game.  Hedge funds have borrowed lots of 2% money and have gone into junk bonds because as long as the leveraging opportunities exist, and the interest rate does not go up too high, it is a license to steal. If the government were controlling the currency and credit for the general welfare there would be an exit strategy for the taxpayer but only the unregulated hedge funds have an exit strategy- get out first.
    • ERISA’s mission was to protect pensions, however, many pensions are now under-funded. During the 1990’s bubble economy companies were allowed to hype their earnings by using the fictitious stock price to lower their pension cash-funding obligation. Now many industries’ pension plans such as automobiles, airlines and steel, with big obligations under defined benefit plans, are broke to the tune of hundreds of billions of dollars.  Again the only question is how long the insurance will hold up and when will the taxpayer take up the load.

 

In support of my call to Cato for help I  resort to one of Cato’s Letters dated November 26, 1720:   

National credit can never be supported by lending money without security, by raising stocks and commodities by artifice and fraud to unnatural and imaginary levels, and consequently delivering up helpless women and orphans, with the ignorant and unwary, but industrious subject, to be devoured by pickpockets and stock- jobbers, a sort of vermin that are bred and nourished in the corruption of the state.

 

I hope that we have learned from our misfortunes so that we may expect that no privileges and advantages be granted for which ready money might be got. I dare pronounce before-hand, that every scheme which they themselves propose to make their bubble and roguery thrive again, will be built upon the life and misery of this unhappy nation.

 

If our money be gone, thank God, our eyes are left. Sharpened by experience and adversity we can see through disguises, and will be no more amused by moon-shine.

 

Sharpened by experience and adversity these questions remain:

Are financial services progressively dominating the economy?

 

      If so, is this a serious threat to the free market economy?

                       

              If so, will the Cato Institute analyze and recommend actions?

 

                       

 

            Ray Carey

careydcntr@aol.com

http://www.democratic-ca[italism.com


[1] All references are to my book Democratic Capitalism available from AuthorHouse, Amazon, or my website http://www.democratic-capitalism.com.

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US-Led Commodity Boom: Fake Prices, Global Crises

Thu, Jun 30, 2011

Global Meltdown, United States

By David KERANS (USA)

US-Led Commodity Boom: Fake Prices, Global Crises

When I first entered the floor and learned about oil pricing, it was clear that the cash market, where real barrels of oil were bought and sold, was where pricing was decided. Later, it became increasingly clear that the source of prices was coming from the futures markets that I engaged in, with the cash market following along—a true case of the tail wagging the dog. Even more recently, it has become increasingly clear that the massive growth in standardized and custom oil swaps (in indexes, for example) have been the primary movers of the futures markets and then of cash prices. This is the hair on the tail of the dog wagging the dog, I guess…

Oil trader Dan Dicker

As any attentive shopper or driver almost anywhere in the world could tell you, the prices of basic things like food and gasoline have risen faster than inflation in the last five or ten years. In US Dollar terms, prices for all 24 commodities in the most widely traded commodity index fund rose by an average of about 100 percent from 2003 to 2008, for instance. And the pace is not letting up now. Gold rose by 30 percent in 2010, copper by 33%, wheat by 47, corn by 52, cotton by 92, and so on…Analysts, journalists, government agencies, and market players wedded to a traditional supply and demand calculus have struggled to explain the price explosion. Again and again they have reached for the same straws: positing resource scarcity, weather shocks, ravenous demand in Asia, the decline of the dollar relative to other currencies. These explanations do carry some weight, but they are woefully inadequate to account for the staggering ascent of commodity prices. Very slowly, the world is beginning to understand that supply and deman no longer governs the markets in basic commodites. It would be wise to come to grips with the forces that have taken the reins of commodity pricing as soon as possible, to weigh the consequences of the shift, and to take appropriate action to limit the damage.

The Financialization of Commodities

As we detailed in a previous piece for this forum, the transformation of the world’s primary commodity markets into playthings for speculators and vehicles for price inflation began in the 1990s, when the Commodities Futures Trading Commission (CFTC) secretly caved in to pressure from the biggest Wall Street banks and exempted them from restrictions that had successfully minimized the role of speculation in the movement of commodity prices. The big banks were now free to trade on commoodity markets in scale, generating heavy profits for themselves and amplifying the volatility of these markets.

More important for our purposes here, the relaxation of restrictions on speculators opened the door for two forms of financial innovation that would bastardize commoodity markets. First, the big banks created commodity index funds, that keep investors money in contracts for the delivery of comodities in the near future. All of the money in this fast-growing investment category serves to inflate futures prices above the level they would attain in a market where producers and end-users dominated, as opposed to investors (who are simply speculators, where commodities are concerned). And, inexorably, prices on the cash (or “spot”) market for end users inflate in harmony with the futures prices (anyone selling to an end user is aware of the price of contracts for delivery one or two months out, and can look to store his product for delivery at a later point in time if the cash market price falls too far below the futures).

Second, the banks engineered myriad derivative products to facilitate betting on commodity prices, especially oil. While the influx of money into these products has not been quantifiable with any precision, it has clearly sufficed to shoot commodity prices in one or another direction (generally upward) on innumerable occasions. As the quote above attests, experienced market watchers no longer have any doubts about financial flows replacing supply-demand fundamentals as the primary determinant of price.

Tethering Commodities to the Stock Market

Because the separation of commodity prices from supply and demand fundamentals is still little appreciated, the freshly developed correlation between prices and stock markets is almost unknown outside narrow specialist circles devoted to studying these markets. Traditionally, higher commodity prices have not shown any consistent correlation to stock market performance, which makes perfect sense. Thus, on the one hand companies have to pay more for inputs when commodity prices are high, and are unable to pass all of these costs on to their customers. Historically, on the other hand, commodity prices have risen when economies are accelerating, which tends to be good for corporate profits (and stock prices). But the gradual financialization of commodities over the last two decades has generated a very different relationship between commodities and stocks, and for a simple reason: when financial markets are rising, asset managers have more money to invest, and now they can (and do) direct a portion of it into commodities (alternatively, of course, when stock markets are falling, asset managers are liable to withdraw some of their allocations to commodities).

Measurement of the correlation between oil prices and the S&P 500 illustrates the transformation as clearly as can be. The basic Pearson correlation coefficient (perfect correlation registering as 1, perfect negative correlation as -1) between the two tended to range from -0.2 to +0.2 at almost all times throughout the 1990s. The coefficient trended above 0 from the turn of the century, and has moved up steadily ever since, reaching an astonishing 0.6 in 2010.

Winners and Losers?

Keeping track of the winners and losers in the financialization of commodity markets is not quite as elementary as one would think. Oil refiners tend to be losers, for instance, because the market for their raw material, oil, has metamorphosized (and, hence, inflated) more thoroughly than have markets in refined oil products. Oil production companies proper have tended to prosper, naturally, but quite a few have run up enormous losses while setting up side operations in oil trading. The surest winners have been the biggest Wall Street banks (the asset management and trading arms of that are devoted to the commodity sector), and a whole fleet of winners are to be found among specialized commodity trading funds, which now number in the hundreds. Taken together, these players now bring enormous resources to bear on the traditionally sleep commodity markets. One running—but invariably incomplete–estimate, from Barclay’s Capital, pegged the capital lodged in commodity-based investment vehicles at $451 billion as of April, an all-time high.

The surest losers, on the other hand, are consumers the world over. The poor around the world are under severe stress from escalatin food prices. The United Nations Food and Agriculture Organization (FAO) Food Price Index has been at record levels all year, and at last check stood at 37 percent above already-inflated year-ago levels. Just yesterday, newly appointed FAO chief Jose Graziano da Silva confirmed at his inaugural press conference that he is well aware of the source of the crisis: “High prices will remain not only a few years. This is not only a temporary imbalance. This is related to financial markets and until we reach a more stable financial situation worldwide, commodities prices will reflect that.”

In the developed world, meanwhile, higher prices are sapping consumer purchasing power, slowing the economy, and constraining government tax receipts. As disturbing as the wealth transfer within the country may be, the wealth transfer from the US to oil exporters is also alarming. The country has imported an average of about 4.5 billion barrels of crude oil and oil products per year in the last five years. Taking a very modest estimate of a $20 per barrel inflation from financialization of oil (Goldman Sachs recently admitted the real figure was anywhere from $21-27 per barrel), that is an export of $90 billion per year. A good portion of the huge petrodollar stashes of oil exporting countries returns to the US via purchases of Treasury bills, it is true. But, inevitably, the fast-swelling soveriegn wealth funds of commodity-rich nations are beginning to prey on prostrate local governments in the US that are privatizing infrastructure and other assets.

What is To Be Done?

The last decade has provided ever sharper reminders of the dangers inherent in deregulated commodity markets, dangers the Commodities Exchange Act of 1936 kept under control quite well until Wall Street and the CFTC undermined it in the 1990s. There is no good reason to allow a free market in commodities. The free market fundamentalist orthodoxy that invokes the holiness of liquidity in maximizing market efficiency is plainly irrational as regards commodities, where liquidity has only served to undermine the functioning of supply and demand. The solution is to return to the regime begun in 1936, and to bolster it to account for new features of the financial landscape. The government and the CFTC should simply forbid all but a very select, licensed cohort of traders from participating in commoodity markets for trading purposes. This would banish index funds and exchange traded funds from commodity markets, and restore the primacy of supply and demand fundamentals.

Who is holding up reform?

Alas, the special interest that has driven the financialization of commodities in the US is Wall Street, which happens to be the most politically powerful special interest of all (together with the defense sector, one could argue). It is no accident that during the three months that the Senate and the CFTC began earnest deliberation on financial reform (including commodity markets) the number of lobbyists registering to approach the CFTC jumpred by 22 percent. Nor is it an accident that the CFTC’s reform efforts to date have been halting and tightly circumscribed. In place of the fundamental reforms outlined above (banishing speculators from commodity markets), measures now under discussion are much less aggressive. They would merely lower the number of futures contracts a market participant could buy (“position limits”), or raise the amount of capital required to purchase a contract for future delivery (“margin requirements”). For a variety of reasons, such steps would not suffice to keep the speculators at bay. And the CFTC will not attempt to impose changes of any kind before 2012 at the earliest.

Contrast te CFTC’s supine regulatory “effort” with the decisive intervention of the federal government and the relevant commodity exchange (the COMEX) against speculators in silver in 1980. At theat time, before monied interests had captured and tamed nearly all federal agencies, the regulators forced speculators out of that market, and silver prices promptly shrank by 77 percent. Times have certainly changed in Washington, and not for the better.

Might the Republican or Democratic Party step in and pressure the CFTC to act forcefuly in the interest of the great majority of the people? It would be naive to expect so. On the whole, the Republican-controlled House of Representatives has taken the phenomenon of rising prices as an opportunity to demand more deregulation of the oil industry (to open up lands for drilling, and to relax offshore drilling regulations). Most Democrats, for their part, have taken it as an opportunity to score political points by demanding repeal of about $4 billion per year in various tax subsidies the government has been giving oil companies.Moreover, and predictably, the Republicans are going so far as to block the funding the CFTC will need to enforce whatever new rules and regulations do emerge.

Will the World Wait?

International pressure could certainly influence the trajectory of commodity market reform, especially in Europe, home to influential exchanges of its own as regards many commodities (the London Metals Exchange, to name just the most famous). France has pushed for genuine measures to minimize speculation, and for international coordination to ensure success. But other European powers, especially Britain (home to an outsized financial sector) have not been cooperating with enthusiasm. Inevitably, therefore, recent meetings of the G20 did not provide cause for optimism regarding the problem of speculation in commodity markets.

While the prospects for radical reform of commodity markets may not look bright, large economic players will not necessarily accept the status quo. Thus Saudia Arabia, which has profited enormously from higher oil prices, has expressed its distrust and disturbance regarding manipulation in US oil markets by renouncing its traditional alliegiance to the US benchmark oil price (the WTI) as regards the pricing of its voluminous exports to America. Other oil-exporting countries have seriously considered taking the same step. They recognize that the speculator-driven pricing mechanism of US markets leaves them vulnerable to rapid price crashes, as happened with US-exchange traded oil in late 2008 and early 2009 (it fell far more sharply than did other oil price benchmarks, because speculators unwound their positions). Shifting to non-US price indexes is one step on the way to the international oil trade moving much of its business to non-US exchanges, at which point the US dollar would not likely retain its monopoly on the denomination of this business. Talk naturally continues regarding the establishment of an Asian oil benchmark (presumably Russian Eastern Siberian Pipeline Oil or ESPO) and the formation of an accepted exchange there. The consequences for the US dollar could be palpable (the denomination of trade in US dollars provides a continuous “transactional demand” for US dollars). At the very least, the world should welcome the prospect of US exchanges facing competition for their business.

Meanwhile, in the absence of real repair of commodity markets, the tightening correlation between US equity markets and commodity prices raises a provocative question for all international organizations exerting influence on economic and financial policy coordination.Given the agony that escalating food and oil prices have been visiting on poorer populations around the world in the last few years, might orchestration of a controlled collapse of US stock markets be a great blessing for humanity?

Source: Strategic Culture Foundation

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EU Politics Financialized, Economies Privatized: Breakup Of Euro? – Analysis

Written by:

June 3, 2011

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Last month Iceland voted against submitting to British and Dutch demands that it compensate their national bank insurance agencies for bailing out their own domestic Icesave depositors. This was the second vote against settlement (by a ratio of 3:2), and Icelandic support for membership in the Eurozone has fallen to just 30 percent. The feeling is that European politics are being run for the benefit of bankers, not the social democracy that Iceland imagined was the guiding philosophy – as indeed it was when the European Economic Community (Common Market) was formed in 1957.

By permitting Britain and the Netherlands to blackball Iceland to pay for the mistakes of Gordon Brown and his Dutch counterparts, Europe has made Icelandic membership conditional upon imposing financial austerity and poverty on the population – all to pay money that legally it does not owe. The problem is to find an honest court willing to enforce Europe’s own banking laws placing responsibility where it legally lies.

The reason why the EU has fought so hard to make Iceland’s government take responsibility for Icesave debts is what creditors call “contagion.” Ireland and Greece are faced with much larger debts. Europe’s creditor “troika” – the European Central Bank (ECB), European Commission and the IMF – view debt write-downs and progressive taxation to protect their domestic economies as a communicable disease.

Like Greece, Ireland asked for debt relief so that its government would not be forced to slash spending in the face of deepening recession. “The Irish press reported that EU officials ‘hit the roof’ when Irish negotiators talked of broader burden-sharing. The European Central Bank is afraid that any such move would cause instant contagion through the debt markets of southern Europe,” wrote one journalist, warning that the cost of taking reckless public debt onto the national balance sheet threatened to bankrupt the economy.[1] Europe – in effect, German and Dutch banks – refused to let the government scale back the debts it had taken on (except to smaller and less politically influential depositors). “The comments came just as the EU authorities were ruling out investor ‘haircuts’ in Ireland, making this a condition for the country’s €85bn (£72bn) loan package. Dublin has imposed 80 percent haircuts on the junior debt of Anglo Irish Bank but has not extended this to senior debt, viewed as sacrosanct.”

EUEU

At issue from Europe’s vantage point – at least that of its bankers – is a broad principle: Governments should run their economies on behalf of banks and bondholders. They should bail out at least the senior creditors of banks that fail (that is, the big institutional investors and gamblers) and pay these debts and public debts by selling off enterprises, shifting the tax burden onto labor. To balance their budgets they are to cut back spending programs, lower public employment and wages, and charge more for public services, from medical care to education.

This austerity program (“financial rescue”) has come to a head just one year after Greece was advanced $155 billion bailout package in May 2010. Displeased at how slowly the nation has moved to carve up its economy, the ECB has told Greece to start privatizing up to $70 billion by 2015. The sell-offs are to be headed by prime tourist real estate and the remaining government stakes in the national gambling monopoly OPAP, the Postbank, the Athens and Thessaloniki ports, the Thessaloniki Water and Sewer Company and the telephone monopoly. Jean-Claude Juncker, Luxembourg’s Prime Minister and chairman of the Eurozone’s group of finance ministers, warned that only if Greece agreed to start selling off assets (“consolidating its budget”) would the EU agree to stretch out loan maturities for Greek debt and “save” it from default.[2]

The problem is that privatization and regressive tax shifts raise the cost of living and doing business. This makes economies less competitive, and hence even less able to pay debts that are accruing interest, leading toward a larger ultimate default.

The textbook financial response of turning the economy into a set of tollbooths to sell off is predatory. Third World countries demonstrated its destructive consequences from the 1970s onward under IMF austerity planning. Europe is now repeating the same shrinkage.

Financial power is to achieve what military conquest had done in times past. Pretending to make subject economies more “competitive,” the aim is more short-run: to squeeze out enough payments so that bondholders (and indeed, voters) will not be obliged to confront the reality that many debts are unpayable except at the price of making the economy too debt-ridden, too regressively tax-ridden and too burdened with rising privatized infrastructure charges to be competitive. Spending cutbacks and a regressive tax shift dry up capital investment and productivity the long run. Such economies are run like companies taken over by debt-leveraged raiders on credit, who downsize and outsource their labor force so as to squeeze out enough revenue to pay their own creditors – who take what they can and run. The tactic attack of this financial attack is no longer overt military force as in days of yore, but something less costly because its victims submit more voluntarily.

But the intended victims of predatory finance are fighting back. And instead of the attacker losing their armies and manpower, it is their balance sheets that are threatened – and hence their own webs of solvency. When Greek labor unions (especially in the public enterprises being privatized), the ruling Socialist Party and leading minority parties rejected such sacrifices, Eurozone officials demanded that financial planning be placed above party politics, and demanded “cross-party agreement on any overhaul of the bail-out.” Greece should respond to its wave of labor strikes and popular protest by suspending party politics and economic democracy. “The government and the opposition should declare jointly that they commit to the reform agreements with the EU,” Mr. Juncker explained to Der Spiegel.

Criticizing Prime Minister George Papandreou’s delay at even to start selling state assets, European financial leaders proposed a national privatization agency to act as an intermediary to transfer revenue from these assets to foreign creditors and retire public debt – and to pledge its public assets as collateral to be forfeited in case of default in payments to government bondholders. Suggesting that the government “set up an agency to privatize state assets” along the lines of the German Treuhandanstalt that sold off East German enterprises in the 1990s,” Mr. Juncker thought that “Greece could gain more from privatizations than the €50 billion ($71 billion) it has estimated.”[3]

European bankers had their eye on the sale as much as $400 billion of Greek assets – enough to pay off all the government debt. Failing payment, the ECB threatened not to accept Greek government bonds as collateral. This would prevent Greek banks from doing business, wrecking its financial system and paralyzing the economy. This threat was supposed to make privatization “democratically” approved – followed by breaking union power and lowering wages (“internal devaluation”). “Jan Kees de Jager, Dutch finance minister, has proposed that any more loans to Greece should come with collateral arrangements, in which European state lenders would take over Greek assets in the event of a sovereign default.”[4]

The problem is that ultimate default is inevitable, given the debt corner into which governments have recklessly deregulated the banks and cut property taxes and progressive income taxes. Default will become pressing whenever the ECB may choose to pull the plug.

The ECB makes governments unable to finance their spending by central banks of their own

Introduction of the euro in 1999 explicitly prevented the ECB or any national central bank from financing government deficits. This means that no nation has a central bank able to do what those of Britain and the United States were created to do: monetize credit to domestic banks. The public sector has been made dependent on commercial banks and bondholders. This is a bonanza for them, rolling back three centuries of attempts to create a mixed economy financially and industrially, by privatizing the credit creation monopoly as well as capital investment in public infrastructure monopolies now being pushed onto the sales block for bidders – on credit, with the winner being the one who promises to pay out the most interest to bankers to absorb the access fees (“economic rent”) that can be extracted.

Politics is being financialized while economies are being privatized. The financial strategy was to remove economic planning from democratically elected representatives, centralizing it in the hands of financial managers. What Benito Mussolini called “corporatism” in the 1920s (to give it its polite name) is now being achieved by Europe’s large banks and financial institutions – ironically (but I suppose inevitably) under the euphemism of “free market economics.”

Language is adopting itself to reflect the economic and political transformation (surrender?) now underway. Central bank “independence” was euphemized as the “hallmark of democracy,” not the victory of financial oligarchy. The task of rhetoric is to divert attention from the fact that the financial sector aims not to “free” markets, but to place control in the hands of financial managers – whose logic is to subject economies to austerity and even depression, sell off public land and enterprises, suffer emigration and reduce living standards in the face of a sharply increasing concentration of wealth at the top of the economic pyramid. The idea is to slash government employment, lowering public-sector salaries to lead private sector wages downward, while cutting back social services.

The internal contradiction (as Marxists would say) is that the existing mass of interest-bearing debt must grow, as it receives interest – which is re-invested to earn yet more interest. This is the “magic” or “miracle” of compound interest. The problem is that paying interest diverts revenue away from the circular flow between production and consumption. Say’s Law says that payments by producers (to employees and to producers of capital goods) must be spent, in the aggregate, on buying the products that labor and tangible capital produces. Otherwise there is a market glut and business shrinks – with the financial sector’s network of debt claims bearing the brunt.

The financial system intrudes into this circular flow. Income spent to pay creditors is not spent on goods and services; it is re-invested in new loans, or on stocks and bonds (assets in the form of financial and property claims on the economy), or increasingly on “gambling” (the “casino capitalism” of derivatives, the international carry trade (that is, exchange-rate and interest-rate arbitrage) and other financial claims that are independent of the production-and-consumption economy. So as financial assets accrue interest – bolstered by new credit creation on computer keyboards by commercial banks and central banks – the financial rake-off from the “real” economy increases.

The idea of paying debts regardless of social cost is backed by mathematical models as complex as those used by physicists designing atomic reactors. But they have a basic flaw simple enough for a grade-school math student to understand: They assume that economies can pay debts growing exponentially at a higher rate than production or exports are growing. Only by ignoring the ability to pay – by creating an economic surplus over break-even levels – can one believe that debt leveraging can produce enough financial “balance sheet” gains to pay banks, pension funds and other financial institutions that recycle their interest into new loans. Financial engineering is expected to usher in a postindustrial society that make money from money (or rather, from credit) via rising asset prices for real estate, stocks and bonds.

It all seems much easier than earning profit from tangible investment to produce and market goods and services, because banks can fuel asset-price inflation simply by creating credit electronically on their computer keyboards. Until 2008 many families throughout the world saw the price of their home rise by more than they earned in an entire year. This cuts out the troublesome M-C-M’ cycle (using capital to produce commodities to sell at a profit), by M-M’ (buying real estate or assets already in place, or stocks and bonds already issued, and waiting for the central bank to inflate their prices by lowering interest rates and untaxing wealth so that high income investors can increase their demand for property and financial securities).

The problem is that credit is debt, and debt must be paid – with interest. And when an economy pays interest, less revenue is left over to spend on goods and services. So markets shrink, sales decline, profits fall, and there is less cash flow to pay interest and dividends. Unemployment spreads, rents fall, mortgage-holders default, and real estate is thrown onto the market at falling prices.

When asset prices crash, these debts remain in place. As the Bubble Economy turns into a nightmare, politicians are taking private (and often fraudulent) bank losses onto the public balance sheet. This is dividing European politics and even threatening to break up the Eurozone.

Breakup of the Eurozone?

Third World countries from the 1960s through 1990s were told to devalue in order to reduce labor’s purchasing power and hence imports of food, fuel and other consumer goods. But Eurozone members are locked into the euro. This leaves only the option of “internal devaluation” – lowering wage rates as an alternative to scaling back payments to creditors atop Europe’s economic pyramid.

Latvia is cited as the model success story. Its government slashed employment and public sector wages fell by 30 percent in 2009-10. Private-sector wages followed the decline. This was applauded as a “success story” and “accepting reality.” So now, the government has put forth a “balanced budget amendment,” to go with its flat tax on labor (some 59 percent, with only a 1 percent tax on real estate). Former U.S. neoliberal presidential candidate Steve Forbes would find it an economic paradise.

“Saving the euro” is a euphemism for governments saving the financial class – and with it a debt dynamic that is nearing its end
regardless of what they do. The aim is for euro-debts to Germany, the Netherlands, France and financial institutions (now joined by vulture funds) are to preserve their value. (No haircuts for them). The price is to be paid by labor and industry.

Government authority is to lose most of all. Just as the public domain is to be carved up and sold to pay creditors, economic policy is being taken out of the hands of democratically elected representatives and placed in the hands of the ECB, European Commission and IMF.

Spain’s unemployment rate of 20%, much as in the Baltics, with nearly twice as high an unemployment rate among recent school graduates. But as William Nassau Senior is reported to have said when told that a million Irishmen had died in the potato famine: “It is not enough!”

Can anything be enough – anything that works for more than the short run? What “helping Greece remain solvent” means in practice is to help it avoid taxing wealth (the rich aren’t paying) and help it roll back wages while obliging labor to pay more in taxes while the government (i.e. “taxpayers,” a.k.a. workers) sells off public land and enterprises to bail out foreign banks and bondholders while slashing its social spending, industrial subsidies and public infrastructure investment.

One Greek friend in my age bracket has said that his private pension (from a computing company) was slashed by the government. When his son went to collect his unemployment check, it was cut in half, on the ground that his parents allegedly had the money to support them. The price of the house they bought a few years ago has plunged. They tell me that they are no more eager to remain part of the Eurozone than the Icelandic voters showed themselves last month.

The strikes continue. Anger is rising. When incoming IMF head Christine Lagarde was French trade minister, she suggested that: “France had to revamp its labor code. Labor unions and fellow ministers balked, and Ms. Lagarde backtracked, saying she had expressed a personal opinion.”[5] This opinion is about to become official policy – from the IMF that was acting as “good cop” to the ECB’s “bad cop.”

I suppose that all that really is needed is for people to understand just what dynamics are at work that make these attempts to pay in vain. The creditors know that the game is up. All they can do is take as much as they can, as long as they can, pay themselves bonuses that are “free” from recapture by public prosecutors, and run to their offshore banking centers.

*This article is an excerpt from Prof. Hudson’s work in progress, “Debts that Can’t be Paid, Won’t Be,” to be published later this year.

Footnotes

[1] Ambrose Evans-Pritchard, “Iceland offers risky temptation for Ireland as recession ends,” The Telegraph, December 8, 2010.

[2] Bernd Radowitz and Geoffrey T. Smith, “Juncker Calls for Greek Privatization Agency,” Wall Street Journal, May 23, 2011, based on Juncker’s earlier interview in Der Spiegel magazine.

[3] Ibid.

[4] Peter Spiegel, “Greek assets could go to ‘fund of experts’,” Financial Times, May 24, 2011, Dimitris Kontogiannis, Kerin Hope and Joshua Chaffin, “Greece to sell stakes in state-owned groups,” Financial Times, May 24, 2011, and Alkman Granitsas, “Greece Speeds Up Plans to Sell Off State-Held Assets,” Wall Street Journal, May 24, 2011.

[5] Alessandra Galloni and David Gauthier-Villars, “France’s Lagarde Seeks IMF’s Top Job,” Wall Street Journal, May 26, 2011.

*This article is an excerpt from Prof. Hudson’s upcoming book, “Debts that Can’t be Paid, Won’t Be,” to be published later this year.

About the author:Prof. Hudson is Chief Economic Advisor to the Reform Task Force Latvia (RTFL). Michael Hudson is President of The Institute for the Study of Long-Term Economic Trends (ISLET), a Wall Street Financial Analyst, Distinguished Research Professor of Economics at the University of Missouri, Kansas City and author of Super-Imperialism: The Economic Strategy of American Empire (1968 & 2003), Trade, Development and Foreign Debt (1992 & 2009) and of The Myth of Aid (1971). For more of his writing check out his website: http://michael-hudson.com.

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Daniel Dicker

Daniel Dicker

Oil trader, thestreet.com columnist; Author, ‘Oil’s Endless Bid’

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Food Commodity Speculation Adds to Egypt Unrest

Posted: 01/30/11 10:43 AM ET
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While the protests in Egypt are politically motivated, there is also little doubt that the rage of the populace there, as well as in Tunisia, Yemen, Algeria and elsewhere, is being inflamed by the huge and volatile increases in basic food prices.

While the seeds for huge percentage increases in corn, wheat, sugar, coffee and of course oil are based in some fundamental supply shortages, they have been unnecessarily hypercharged by the influx of investor money, speculative energy and the panic of governments trying to stockpile basic foods and quench the growing hostility of its people.

We’ve seen this movie before, in 2007-2008, but it hasn’t looked nearly as bad as this. Massively spiking commodity price inflation, before the global financial collapse, was a far easier problem to find solutions for and contain. Now, with practically all Western governments in the midst of austerity budgeting, less money is available to help Middle Eastern and other emerging nations find adequate and subsidized supplies.

But this movie rerun is in widescreen Technicolor: the across-the-board food price increases have never seen this kind of spike before, ever.

Wheat is up 75% in the last 12 months, corn up a little more. Coffee is up 85% and cotton a spectacular 140%.

While flooding in Australia, a drought in Russia and weak harvests in India and China are the fundamental drivers for this upwards trend, there is little doubt that investors and traders looking to diversify and capitalize on the supply shortages are moving these prices much more significantly and faster. Commodity index investment increased an estimated and whopping $80B dollars last year, bringing total long-only commodity index investment to $350B, according to Barclays. Another $30B of commodity ETF investment is also overwhelmingly long-only, as short commitment in these instruments is normally well under 5% of float.

Financial buying of commodities in indexes and ETF’s, with the speed that these instruments operate, overwhelm the futures mechanisms and cause much greater volatility and overall higher prices. We’ve seen this roller coaster ride play itself out once already in oil, moving from 2005-2008 to $147 a barrel, only to collapse to $32 dollars in March of 2009, before re-initiating its upwards trajectory.

Whether financial investment in commodities can be absorbed by a free market or not, this kind of boom/bust cycle, now playing itself out again in other critical foodstuffs, is intensely destabilizing and threatens the order in brittle governments around the globe.

And governments have been forced to play into this struggle. Increased stockpiling of basic commodities has added to the frenzy of price increases: Algeria and Saudi Arabia have doubled their usual stockpile of wheat, Bangladesh and Indonesia have tripled orders for rice.

The mechanism for halting, or even slowing down the massive money flows into financialized commodities is lacking. Small steps on position limits and transparent clearing, mandated under Dodd-Frank legislation, have seen widespread pushback from industry advocates and trading companies. Rules for the energy markets, mandated by Dodd-Frank to be in place and operating today under the Commodity Futures Trading Commission (CFTC), are at least another year away, if they are coming at all. Very little looks to be changing.

And with very little changing, we might have to get used to these street scenes in Egypt and other emerging nations elsewhere, as rage from native populations spills over from the spiking prices of simple food basics.

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Published Jun 5 2011 by UNCTAD, Archived Jun 13 2011

New UNCTAD study charts impact of financial investors on commodity prices

by Staff

Geneva, 5 June 2011 – The “financialization” of commodity markets has changed trading behaviour and significantly affects the prices of such basic goods as staple foods, a new UNCTAD study says. The study focuses on how financial investors in commodity markets rely on information related to just a few commonly observable events or on mathematical models, rather than on the physical realities of supply and demand.

The study, titled “Price Formation In Financialized Commodity Markets: The Role Of Information” was prepared by UNCTAD with support from the Chamber of Workers Vienna (Arbeiterkammer Wien).

Its empirical findings, backed up by interviews with market participants, indicate that financialization – reflected in rising volumes of financial investments in commodity derivatives markets – has encouraged herding behaviour through which price determination in commodity markets increasingly follows the logic of financial investment rather than market fundamentals. That can cause damage in the “real” economy, where prices for goods such as food affect health and well-being, especially in less-wealthy countries.

The study further shows how the behaviour of commodity prices, especially oil, over the business cycle has changed fundamentally. In earlier business cycles, commodity prices and equity prices evolved differently, reflecting more clearly the distinct fundamentals underlying different markets. In the most recent business cycle, on the other hand, oil prices surged immediately after the trough of the cycle, even before share prices started to rise.

UNCTAD recommends various measures to dampen the adverse effects of financialization, including greater transparency in commodity trading; internationally coordinated regulation of commodity exchanges; and direct intervention by market authorities to deflate price bubbles.

Fundamentals and other factors affecting rising commodity prices

 

The mid-2000s marked the start of a trend of steeply rising commodity prices, accompanied by increasing volatility in prices. Since mid-2009, and especially since the summer of 2010, global commodity prices have been rising again. These developments coincide with major shifts in commodity market fundamentals, particularly in emerging economies. Fast growth, increasing urbanization, a growing middle class with changing dietary habits, the use of food crops to produce biofuels, and a decline in the growth rates of agricultural production and productivity, have all contributed to upward pressure on food commodity prices.

But UNCTAD argues that the financialization of commodity markets has introduced new forces that affect prices. Traders increasingly follow other participants´ trading decisions. A wide range of motivations leads to this “intentional herding”. Uncertainty arising from gaps in market transparency and the effects of equity market developments on commodity prices is central to this behaviour. It may therefore be rational for market participants to imitate the position-taking of others, or simply to follow the trends by basing decisions on an interpretation of historic price series.

Financial markets´ anticipation of global economic recovery seems to have played a disproportionate role in the current bout of commodity price inflation, the study says. The strong impact of financial investors on prices, which UNCTAD calls “the new normal of commodity price determination”, can provoke a tightening of monetary policy in spite of the still very low utilization of global industrial capacities. This could recently be observed in China, India and the euro area, the study contends. The fact that monetary policy reacts to price pressure stemming from rising commodity prices, rather than to bottlenecks in industrial production, points to an aspect of the impact of financialization on the real economy that has so far been underestimated, namely sending the wrong signals for effective macroeconomic management.

The mounting evidence

Financial investors´ impacts on commodity prices are revealed through various channels. A number of studies indicate that price bubbles formed in 2007-2008 for such commodities as crude oil and maize. But while index investors were significant price drivers prior to the financial crisis, the importance of money managers (such as hedge funds) has increased since then. Money managers follow an active trading strategy that may build and unwind positions very rapidly, and are the most typical market participants to engage in herd behaviour. There has been a close correlation between price changes and position changes of money managers since 2009, as high as 0.80 in the oil market, UNCTAD says. Prior to the recent price correction, excessive speculation is estimated to have accounted for 20 per cent of the crude oil price.

Cross-market correlations among different commodity markets have also increased recently, indicating that factors other than fundamentals have been driving commodity prices. To illustrate that, an analysis of the reactions of commodity prices to announcements of economic indicators shows that, within minutes of the release of United States unemployment data in 2010, prices reacted similarly across different commodity markets that have little in common. This is not what would be expected to happen in a market where decisions are based purely on fundamentals. While it is true that the oil price should have a strong link with economic activity, and that such activity is reflected in labour market data, unemployment is a lagging indicator that reacts rather late in the cycle. For cocoa, for example, there can hardly be any link between United States employment and world chocolate consumption.

In a more recent example (from the period after the new study was completed), on 5 May 2011, Brent crude oil prices dropped by 8 per cent in a single trading day. While some weak economic data had been issued, no major change in fundamentals had occurred. Rather, some prominent cheerleaders had turned bearish, encouraging other traders to follow suit and triggering computer-based trading that turned a minor initial readjustment of positions into a rout.

The UNCTAD research team complemented its analysis with a survey of various commodity market participants. Traders and investors interviewed by UNCTAD largely agree that substantial price distortions and herding effects occur in the short term due to the participation of financial investors. The survey findings also highlight the growing importance in the market of these investors who, due to their financial strength, can move prices in the short term. This accentuates volatility, which may harm markets and drive hedgers with an interest in physical commodities away from commodity derivatives markets. The increased volatility results in more margin calls and higher financing requirements, the report says.

Transparency, transparency and more transparency

In light of the vital role information flows play in commodity price developments, UNCTAD suggests a number of policy responses to improve market functioning. Among them:

  • Increased transparency in physical commodity markets to reduce uncertainty, through enhanced data quality and timeliness, particularly with respect to inventories. This would allow participants to more accurately assess current and future fundamental supply and demand relationships;
  • Better flow of and access to information in commodity exchanges, especially regarding position-taking by different categories of market participants in derivatives markets. In particular, measures designed to ensure reporting requirements for trading on European exchanges similar to those enforced in United States exchanges would considerably improve transparency of trading and discourage regulatory migration;
  • Tighter regulation of financial players, such as establishing position limits aimed at containing financial investors´ impacts on commodity markets, while proprietary trading by financial institutions that are involved in hedging transactions of their clients could be prohibited because of conflicts of interest. This calls for finding the right balance between being overly restrictive in the imposition of limits on speculative position holdings and being overly lax, including in surveillance; and
  • Possible direct commodity price stabilization measures such as occasional targeted interventions by the competent market authorities to deflate price bubbles and help market participants better recognize market fundamentals. As in the case of currency and, more recently, the bond markets, it is possible for a central bank or other appropriate authority to engage in the financial markets as a market maker or as the one institution that is able to shock the market when it overshoots.

For more information, please contact:
UNCTAD Communications and Information Unit
T: +41 22 917 5828
T: +41 79 502 43 11
E: unctadpress@unctad.org
Web: www.unctad.org/press
or
Mr. Joerg Mayer, Economist
T: +41 22 917 57 22
E: joerg.mayer@unctad.org

Editorial Notes

UNCTAD press release on their new report-KS.

Original article available here

The Conversation>

>

Published Jun 5 2011 by UNCTAD, Archived Jun 13 2011

New UNCTAD study charts impact of financial investors on commodity prices

by Staff

Geneva, 5 June 2011 – The “financialization” of commodity markets has changed trading behaviour and significantly affects the prices of such basic goods as staple foods, a new UNCTAD study says. The study focuses on how financial investors in commodity markets rely on information related to just a few commonly observable events or on mathematical models, rather than on the physical realities of supply and demand.

The study, titled “Price Formation In Financialized Commodity Markets: The Role Of Information” was prepared by UNCTAD with support from the Chamber of Workers Vienna (Arbeiterkammer Wien).

Its empirical findings, backed up by interviews with market participants, indicate that financialization – reflected in rising volumes of financial investments in commodity derivatives markets – has encouraged herding behaviour through which price determination in commodity markets increasingly follows the logic of financial investment rather than market fundamentals. That can cause damage in the “real” economy, where prices for goods such as food affect health and well-being, especially in less-wealthy countries.

The study further shows how the behaviour of commodity prices, especially oil, over the business cycle has changed fundamentally. In earlier business cycles, commodity prices and equity prices evolved differently, reflecting more clearly the distinct fundamentals underlying different markets. In the most recent business cycle, on the other hand, oil prices surged immediately after the trough of the cycle, even before share prices started to rise.

UNCTAD recommends various measures to dampen the adverse effects of financialization, including greater transparency in commodity trading; internationally coordinated regulation of commodity exchanges; and direct intervention by market authorities to deflate price bubbles.

Fundamentals and other factors affecting rising commodity prices

 

The mid-2000s marked the start of a trend of steeply rising commodity prices, accompanied by increasing volatility in prices. Since mid-2009, and especially since the summer of 2010, global commodity prices have been rising again. These developments coincide with major shifts in commodity market fundamentals, particularly in emerging economies. Fast growth, increasing urbanization, a growing middle class with changing dietary habits, the use of food crops to produce biofuels, and a decline in the growth rates of agricultural production and productivity, have all contributed to upward pressure on food commodity prices.

But UNCTAD argues that the financialization of commodity markets has introduced new forces that affect prices. Traders increasingly follow other participants´ trading decisions. A wide range of motivations leads to this “intentional herding”. Uncertainty arising from gaps in market transparency and the effects of equity market developments on commodity prices is central to this behaviour. It may therefore be rational for market participants to imitate the position-taking of others, or simply to follow the trends by basing decisions on an interpretation of historic price series.

Financial markets´ anticipation of global economic recovery seems to have played a disproportionate role in the current bout of commodity price inflation, the study says. The strong impact of financial investors on prices, which UNCTAD calls “the new normal of commodity price determination”, can provoke a tightening of monetary policy in spite of the still very low utilization of global industrial capacities. This could recently be observed in China, India and the euro area, the study contends. The fact that monetary policy reacts to price pressure stemming from rising commodity prices, rather than to bottlenecks in industrial production, points to an aspect of the impact of financialization on the real economy that has so far been underestimated, namely sending the wrong signals for effective macroeconomic management.

The mounting evidence

Financial investors´ impacts on commodity prices are revealed through various channels. A number of studies indicate that price bubbles formed in 2007-2008 for such commodities as crude oil and maize. But while index investors were significant price drivers prior to the financial crisis, the importance of money managers (such as hedge funds) has increased since then. Money managers follow an active trading strategy that may build and unwind positions very rapidly, and are the most typical market participants to engage in herd behaviour. There has been a close correlation between price changes and position changes of money managers since 2009, as high as 0.80 in the oil market, UNCTAD says. Prior to the recent price correction, excessive speculation is estimated to have accounted for 20 per cent of the crude oil price.

Cross-market correlations among different commodity markets have also increased recently, indicating that factors other than fundamentals have been driving commodity prices. To illustrate that, an analysis of the reactions of commodity prices to announcements of economic indicators shows that, within minutes of the release of United States unemployment data in 2010, prices reacted similarly across different commodity markets that have little in common. This is not what would be expected to happen in a market where decisions are based purely on fundamentals. While it is true that the oil price should have a strong link with economic activity, and that such activity is reflected in labour market data, unemployment is a lagging indicator that reacts rather late in the cycle. For cocoa, for example, there can hardly be any link between United States employment and world chocolate consumption.

In a more recent example (from the period after the new study was completed), on 5 May 2011, Brent crude oil prices dropped by 8 per cent in a single trading day. While some weak economic data had been issued, no major change in fundamentals had occurred. Rather, some prominent cheerleaders had turned bearish, encouraging other traders to follow suit and triggering computer-based trading that turned a minor initial readjustment of positions into a rout.

The UNCTAD research team complemented its analysis with a survey of various commodity market participants. Traders and investors interviewed by UNCTAD largely agree that substantial price distortions and herding effects occur in the short term due to the participation of financial investors. The survey findings also highlight the growing importance in the market of these investors who, due to their financial strength, can move prices in the short term. This accentuates volatility, which may harm markets and drive hedgers with an interest in physical commodities away from commodity derivatives markets. The increased volatility results in more margin calls and higher financing requirements, the report says.

Transparency, transparency and more transparency

In light of the vital role information flows play in commodity price developments, UNCTAD suggests a number of policy responses to improve market functioning. Among them:

  • Increased transparency in physical commodity markets to reduce uncertainty, through enhanced data quality and timeliness, particularly with respect to inventories. This would allow participants to more accurately assess current and future fundamental supply and demand relationships;
  • Better flow of and access to information in commodity exchanges, especially regarding position-taking by different categories of market participants in derivatives markets. In particular, measures designed to ensure reporting requirements for trading on European exchanges similar to those enforced in United States exchanges would considerably improve transparency of trading and discourage regulatory migration;
  • Tighter regulation of financial players, such as establishing position limits aimed at containing financial investors´ impacts on commodity markets, while proprietary trading by financial institutions that are involved in hedging transactions of their clients could be prohibited because of conflicts of interest. This calls for finding the right balance between being overly restrictive in the imposition of limits on speculative position holdings and being overly lax, including in surveillance; and
  • Possible direct commodity price stabilization measures such as occasional targeted interventions by the competent market authorities to deflate price bubbles and help market participants better recognize market fundamentals. As in the case of currency and, more recently, the bond markets, it is possible for a central bank or other appropriate authority to engage in the financial markets as a market maker or as the one institution that is able to shock the market when it overshoots.

For more information, please contact:
UNCTAD Communications and Information Unit
T: +41 22 917 5828
T: +41 79 502 43 11
E: unctadpress@unctad.org
Web: www.unctad.org/press
or
Mr. Joerg Mayer, Economist
T: +41 22 917 57 22
E: joerg.mayer@unctad.org

Editorial Notes

UNCTAD press release on their new report-KS.

Original article available here

The Conversation

>

UN Report Calls for Regulation to Curb Commodity Speculators
Bookmark
Print E-mail
Herding behaviour in commodity markets creates price bubbles that put many basic foodstuffs out of the reach of millions in the developing world. Tighter government regulation is required to curb speculation and stabilise food prices, says a report by UNCTAD.New UNCTAD study charts impact of financial investors on commodity prices – UNCTAD

UN report calls for regulation to curb speculators pushing up food prices – Phillip Inman, The Guardian

Link to PDF of report: Price Formation In Financialized Commodity Markets – The Role Of Information

9th June 2011


New UNCTAD study charts impact of financial investors on commodity prices

5th June 2011 – UNCTAD

The “financialization” of commodity markets has changed trading behaviour and significantly affects the prices of such basic goods as staple foods, a new UNCTAD study says. The study focuses on how financial investors in commodity markets rely on information related to just a few commonly observable events or on mathematical models, rather than on the physical realities of supply and demand.

The study, titled “Price Formation In Financialized Commodity Markets: The Role Of Information” was prepared by UNCTAD with support from the Chamber of Workers Vienna (Arbeiterkammer Wien).

Its empirical findings, backed up by interviews with market participants, indicate that financialization – reflected in rising volumes of financial investments in commodity derivatives markets – has encouraged herding behaviour through which price determination in commodity markets increasingly follows the logic of financial investment rather than market fundamentals. That can cause damage in the “real” economy, where prices for goods such as food affect health and well-being, especially in less-wealthy countries.

The study further shows how the behaviour of commodity prices, especially oil, over the business cycle has changed fundamentally. In earlier business cycles, commodity prices and equity prices evolved differently, reflecting more clearly the distinct fundamentals underlying different markets. In the most recent business cycle, on the other hand, oil prices surged immediately after the trough of the cycle, even before share prices started to rise. UNCTAD recommends various measures to dampen the adverse effects of financialization, including greater transparency in commodity trading; internationally coordinated regulation of commodity exchanges; and direct intervention by market authorities to deflate price bubbles.

Fundamentals and other factors affecting rising commodity prices

The mid-2000s marked the start of a trend of steeply rising commodity prices, accompanied by increasing volatility in prices. Since mid-2009, and especially since the summer of 2010, global commodity prices have been rising again. These developments coincide with major shifts in commodity market fundamentals, particularly in emerging economies. Fast growth, increasing urbanization, a growing middle class with changing dietary habits, the use of food crops to produce biofuels, and a decline in the growth rates of agricultural production and productivity, have all contributed to upward pressure on food commodity prices.

But UNCTAD argues that the financialization of commodity markets has introduced new forces that affect prices. Traders increasingly follow other participants´ trading decisions. A wide range of motivations leads to this “intentional herding”. Uncertainty arising from gaps in market transparency and the effects of equity market developments on commodity prices is central to this behaviour. It may therefore be rational for market participants to imitate the position-taking of others, or simply to follow the trends by basing decisions on an interpretation of historic price series.

Financial markets´ anticipation of global economic recovery seems to have played a disproportionate role in the current bout of commodity price inflation, the study says. The strong impact of financial investors on prices, which UNCTAD calls “the new normal of commodity price determination”, can provoke a tightening of monetary policy in spite of the still very low utilization of global industrial capacities. This could recently be observed in China, India and the euro area, the study contends. The fact that monetary policy reacts to price pressure stemming from rising commodity prices, rather than to bottlenecks in industrial production, points to an aspect of the impact of financialization on the real economy that has so far been underestimated, namely sending the wrong signals for effective macroeconomic management.

The mounting evidence

Financial investors´ impacts on commodity prices are revealed through various channels. A number of studies indicate that price bubbles formed in 2007-2008 for such commodities as crude oil and maize. But while index investors were significant price drivers prior to the financial crisis, the importance of money managers (such as hedge funds) has increased since then. Money managers follow an active trading strategy that may build and unwind positions very rapidly, and are the most typical market participants to engage in herd behaviour. There has been a close correlation between price changes and position changes of money managers since 2009, as high as 0.80 in the oil market, UNCTAD says. Prior to the recent price correction, excessive speculation is estimated to have accounted for 20 per cent of the crude oil price.

Cross-market correlations among different commodity markets have also increased recently, indicating that factors other than fundamentals have been driving commodity prices. To illustrate that, an analysis of the reactions of commodity prices to announcements of economic indicators shows that, within minutes of the release of United States unemployment data in 2010, prices reacted similarly across different commodity markets that have little in common. This is not what would be expected to happen in a market where decisions are based purely on fundamentals. While it is true that the oil price should have a strong link with economic activity, and that such activity is reflected in labour market data, unemployment is a lagging indicator that reacts rather late in the cycle. For cocoa, for example, there can hardly be any link between United States employment and world chocolate consumption.

In a more recent example (from the period after the new study was completed), on 5 May 2011, Brent crude oil prices dropped by 8 per cent in a single trading day. While some weak economic data had been issued, no major change in fundamentals had occurred. Rather, some prominent cheerleaders had turned bearish, encouraging other traders to follow suit and triggering computer-based trading that turned a minor initial readjustment of positions into a rout.

The UNCTAD research team complemented its analysis with a survey of various commodity market participants. Traders and investors interviewed by UNCTAD largely agree that substantial price distortions and herding effects occur in the short term due to the participation of financial investors. The survey findings also highlight the growing importance in the market of these investors who, due to their financial strength, can move prices in the short term. This accentuates volatility, which may harm markets and drive hedgers with an interest in physical commodities away from commodity derivatives markets. The increased volatility results in more margin calls and higher financing requirements, the report says.

Transparency, transparency and more transparency

In light of the vital role information flows play in commodity price developments, UNCTAD suggests a number of policy responses to improve market functioning. Among them:

  • Increased transparency in physical commodity markets to reduce uncertainty, through enhanced data quality and timeliness, particularly with respect to inventories. This would allow participants to more accurately assess current and future fundamental supply and demand relationships;
  • Better flow of and access to information in commodity exchanges, especially regarding position-taking by different categories of market participants in derivatives markets. In particular, measures designed to ensure reporting requirements for trading on European exchanges similar to those enforced in United States exchanges would considerably improve transparency of trading and discourage regulatory migration;
  • Tighter regulation of financial players, such as establishing position limits aimed at containing financial investors´ impacts on commodity markets, while proprietary trading by financial institutions that are involved in hedging transactions of their clients could be prohibited because of conflicts of interest. This calls for finding the right balance between being overly restrictive in the imposition of limits on speculative position holdings and being overly lax, including in surveillance; and
  • Possible direct commodity price stabilization measures such as occasional targeted interventions by the competent market authorities to deflate price bubbles and help market participants better recognize market fundamentals. As in the case of currency and, more recently, the bond markets, it is possible for a central bank or other appropriate authority to engage in the financial markets as a market maker or as the one institution that is able to shock the market when it overshoots.

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UN report calls for regulation to curb speculators pushing up food prices

5th June 2011 – Phillip Inman, The Guardian

Government intervention may be needed to burst the huge bubble that has developed in the price of commodities such as food staples and oil, a UN report says .

Prices have rocketed in response to dysfunctional commodities markets, according to the report, which also disputes the view of many senior economists and central bankers that commodity prices have jumped as a result of a surge in demand.

“The changing role of commodity markets, which are turning into financial markets, has enormous repercussions for the economy,” said one of the report’s authors – Heiner Flassbeck, a director at the UN conference on trade and development (Unctad).

“The possibility of allowing governments’ direct intervention in the physical and financial markets needs to be considered,” the study concluded.

Investors are encouraged to behave like a herd, says the report, with few incentives to arbitrage or bet against the tide of rising prices. Without checks and balances in the system, investors create price bubbles that put many basic foodstuffs out of the reach of millions in the developing world.

Oil may be as much as 20% over valued while maize, the staple food of many developing world economies, is subject to wild swings in price.

The report follows a similar investigation by Christian Aid, which urged world leaders to commission a review of commodity markets after it found that a huge influx of profit seeking investors distorted the market. The charity blamed pension funds and other long term investors for pushing up prices by seeking high returns from investment in commodities’ markets.

In April, the World Development Movement blamed Barclays Capital, the investment banking arm of the high street bank, for driving up prices. BarCap is the UK’s biggest player in food commodity trading, and one of the top three banking players along with Goldman Sachs and Morgan Stanley. BarCap has pioneered the creation of derivatives that allow pension funds and other investors traditionally barred from commodities exchanges to bet on food prices. Nearly $270bn is invested in derivatives that follow commodity prices, up from $90bn in 2005, according to Unctad.

A separate report by the UN special rapporteur on the right to food, Olivier De Schutter, argued that the appetite for investments in commodities was even higher. He found that commodity index funds rose from $13bn (£7.9bn) in 2003 to $317bn by 2008. While there are no definitive figures on how those index funds break down, one estimate suggested their holdings in agricultural commodity markets rose from about $3bn to more than $55bn over that period.

Using these new derivative products, pension funds, especially in the US, have invested large slices of their overall portfolio in commodities as it has become more difficult to generate above average returns from more traditional sources of income, such as stock and bond markets.

Unctad, which commissioned the report, said the efficient market hypothesis that many economists believe regulates trading in commodity markets has broken down.

“If the efficient market hypothesis were to apply, commodity price developments would reflect nothing but information on fundamentals. However, this study shows that the hypothesis does not apply to the present commodity futures markets,” the report says.

“Another major factor is the financialisation of commodity markets, which has played a significant role in price developments in recent years,” the report says. Its importance increased steadily after 2004, as reflected in rising volumes in commodity derivatives markets – both at exchanges and over the counter (OTC). “This phenomenon is a serious concern, because the activities of financial participants tend to drive commodity prices away from the levels justified by market fundamentals, with negative effects on producers and consumers.”

Traders interviewed by the report’s authors said they were encouraged to join other traders buying commodities by a lack of transparency over what was happening in the market. Traders are unaware of other buyers and their trading positions, information that can prove crucial when deciding to buy or sell a commodity.

They said the situation in the EU was worse than the US, where regulators produced weekly reports on rule changes and trends. Largely unregulated over-the-counter markets, which allow individual institutions to trade with each other away from the main markets, also needed greater transparency, it said.

Unctad said a transaction tax on commodity trading, which could raise billions for investment in developing countries, would slow the pace of financial markets, limiting the scope for misinformation.

Commodity prices reached a record in 2008 as traders anticipated a rapid recovery from the credit crunch of 2007, but the market crashed after the collapse of Lehman Brothers. In the last six months prices have soared again, though not yet to 2008 levels. Critics of commodity traders fear a slowdown in the global economy could trigger a sell-off in commodity derivatives, triggering exaggerated falls in prices.

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