posted December 3, 2018
A US-China Trade War ‘Armistice’?–Trump Blinks and Retreats at the G20 Meeting with Xi

The first reports emerging from the G20 meeting in Buenos Aires, December 2, 2018, were that Trump and Xi have agreed to put their trade war on hold, a kind of ‘trade war armistice’, at least for the next 90 days.

Trump entered into his meeting this past weekend with China’s president, Xi, having imposed $50 billion in tariffs at 25% on China goods imports last July, to which another $200 billion was added thereafter. Tariffs on the $200 billion were set at 10%, but were scheduled to rise to 25% on January 1, 2019. Before the US November elections, Trump further threatened to add a further $267 billion if China continued to refuse to meet with the US. But China didn’t take the bait. Trump’s strategy was transparent. His plan was to lure China into negotiations before the US elections so he could act tough for his political base before the US elections.

China refused to be sucked in and refused to come to Washington to be played by Trump. Instead, it agreed to meet at the G20 gathering this weekend, at a more neutral setting and after the US elections.

In the lead up to this weekend’s G20 US-China meeting, Trump sent conflicting signals to the Chinese. On the one hand, Trump praised China’s president Xi personally, while announcing the existing 10% tariff hikes on the $200 billion would rise to 25% next January 2019 and that another $267 billion would follow if China did not meet with him. Meanwhile, China’s counter tariffs on US imports were levied at 25% for its first $50 billion tariffs and set at only 10% on the additional $60 billion on US goods.

However, to date the US-China trade dispute is more like a trade skirmish than a trade war. The initial first $50 billion in tariffs levied by both US and China this past July have been selective. Most have not yet had a significant impact on their respective economies thus far after only four months in 2018. But in 2019 that $50 billion would start to have an impact. Moreover, the $200 billion additional US tariffs, levied at only 10%, have been largely offset by a roughly equivalent 10% decline in the value of China’s currency, the Yuan.

A rise in $200 billion US tariffs, from 10% to 25%, in 2019 would have an impact, however, in 2019. The likely response by China would be to raise its second $60 billion tariffs on US imports by an equal amount, from current 10% to 25%. That could very well mark the start of a true US-China trade war.

China could also add more non-tariff barriers, or slow its purchase of US Treasury bonds, or block approval of mergers of US companies globally with operations in China, or encourage boycotts of US goods in China, or allow its currency to devalue well below the current 10% decline. These are measures that are typical of true trade wars, but which have not been employed as yet by China or the US. Sparring with tariffs are just initial moves, especially when tariff rates are relatively low, selectively applied, and not fully implemented yet.

While the US and China were clearly on the brink of a bona fide trade war, but until the G20 meeting they had not quite taken that last step. Nor is it likely now that they will. The Trump-Xi meeting at the G20 represents a kind of a trade policy ‘rubicon’ which neither has crossed as yet. If the initial reports coming out of the G20 meeting are accurate, then Trump and Xi have so far continued to decide not to cross the river of no return with regard to a war over trade.

The question is why now the apparent ‘armistice’ in the trade war? Why, after months of threats and warnings aimed at China, has Trump decided to back down? For that’s exactly what the agreements with China at the G20 represent: Trump has backed off, making concessions, while the Chinese have only reiterated proposals they publicly offered over the course of the last six months.

The reasons for the Trump retreat lay in the significant changes in economic conditions since last spring. At the time Trump launched his ‘trade war’ last March 2018 the US economy was accelerating due to multi-trillion dollar tax cuts for investors and corporations; the global economy still appeared to be growing nicely; US profits were rising 20%-25% and stock markets booming; and the Fed, the central bank, was still relatively early in its scheduled interest rate hikes. But that’s all changed as of year end 2018.

With growing indications that the global economy is slowing—with another recession in Japan and German and Europe economies contracting and weakening facing the UK Brexit and Italian bank problems—the US and global stock markets in recent months had begun to retreat noticeably. Early signs since October of US economic slowdown in 2019 have begun to emerge, especially in construction and autos. Japan is in recession. Germany’s economy is contracting, with Europe not far behind facing imminent crises as well in the UK’s Brexit next March and growing debt refinancing problems in Italian, Greek and other Euro banks. And more emerging market economies continue to slip into recession.

Faced with these looming economic realities, as well as growing political pressure at home, Trump eagerly sought the meeting with Xi at the G20 gathering despite continued and intensifying in-fighting between the factions on his US trade negotiating team.

Those factions and divisions among the US elite concerning trade center around three issues: first, access by US bankers and multinational corporations to China markets, especially getting China to allow a 51% or more ownership of US corporate operations in China; second, China increasing its purchases of US exports, especially agricultural and energy products; and third, most important, China agreeing to slow its development of nextgen technologies like cybersecurity, artificial intelligence, and 5G wireless—which has assumed the codename in the US of ‘intellectual property’.

Anti-China hardliners—Robert LIghthizer, US office of trade director, Peter Navarro, special advisor on trade, and John Bolton, long time anti-China hawk and national security adviser to Trump—all of whom are closely allied with the Pentagon, military industrial US corporations, and intelligence agencies—have all preferred a trade war with China to achieve US technology objectives. They have been engaged in an internal US faction fight since last April with the two other US factions—i.e. the bankers and multinational corporations whose priority objectives have been to get open markets and majority ownership rights for US businesses, especially banks, in China; and US heartland agricultural and manufacturing exporters, who represent Trump’s red state political base, who want a return and an expansion of China purchases of US exports.

Since this past summer, the Lighthizer-Navarro-Bolton faction have clearly had Trump’s ear and have prevailed ensuring technology transfer is at the top of the list of US trade negotiations priorities. However, with the recent weakening of the US stock markets, indications of economic slowdown coming, and growing US business concerns of a bona fide US-China trade war deepening in 2019, Trump has shifted his position toward a softer line in trade negotiations with China, apparently retreating closer to positions of the other two factions in US-China trade negotiations. That softer line is evident in the G20 meeting tentative agreements announced by Trump and Xi.

Put another way, facing the shift to a bona fide trade war in 2019—in the midst of a slowing global and US economy and a likely steeper correction in US stocks and financial markets—Trump met Xi at the G20 and ‘blinked’, as they say.

That Trump clearly retreated is undeniable in the content of the G20 announcement following his meeting with Xi. Of course a Trump retreat is not the likely ‘spin’ it will be given in the US corporate media this coming week. The agreements will be characterized as a mutual ‘pause’ of some sort in what appeared as an inevitable trade war commencing January 2019.

But a consideration of the substance of the verbal agreement between Trump and Xi released this past weekend shows that Trump clearly backed off while Xi simply reiterated what the China team has already offered Trump and had already put on the table the last several months.

Here’s what was agreed in broad principle, at least according to early reports:

• Trump agreed not to allow the scheduled January 1, 2019 increase in US tariffs on $200 billion of imports from China to rise, from the current 10% tariff rate to the 25%.

• Trump agreed not to move forward with his threat of another $267 billion tariffs on.
These represent two clear concessions by Trump and amount to reversals of prior US positions. What about China’s response? Unlike Trump, there was no clear retreat from previous positions, i.e. concessions.

• China agreed to increase US purchases of agriculture goods (actually a restoration of prior levels) “immediately”, in order to ease the US trade deficit with China and boost US farmers and agribusiness. But China had already publicly offered to buy a further $100 billion in previous months. The joint communique coming out of the meeting only indicates to increase US purchases ‘in accordance with the needs of its domestic market’. The $100 billion is thus more a restoration of previous levels of China purchases of US agricultural and manufacturing exports.

• China agreed to open its markets to US banks and businesses further. But it had already also announced earlier this year it would allow 51% foreign ownership, and suggested it could even go to 100% in coming years. So this too was an ‘offer’ it had already made to the US this past summer.

What about the key tech transfer issue that has split the US elite and the US trade team? That primary demand of the US hard liners, which seemed paramount in preceding months, has been tabled for future discussion. Both US and China have only agreed to discussions for the next 90 days “with respect to forced technology transfers” and related issues. (Reuters report by Roberta Rampton and Michael Martina, 12/2/18, 1:23pm ET). So no agreement on technology. Just a mutual face-saver to meet again and agree “to further exchanges at appropriate times”.

Meanwhile, Trump retreats from raising tariff rates from 10% to 25% and agrees to drop threatening another $267 billion, while Xi simply restates prior offers about more purchases agricultural goods and more US banker access to China markets.

If China’s objective of the Buenos Aires meeting was to get Trump to halt imposing higher and more tariffs—while conceding nothing except further talks on the technology issue—in that objective China has clearly succeeded. Trump will no doubt spin the additional agricultural purchases and more market access as China ‘concessions’. But these were already conceded before the parties met in Buenos Aires.

In contrast, if Trump’s primary objective, driven by his anti-China hard line US faction, was to get China to slow nextgen technology development and tech transfer, and concede on intellectual property issues, then Trump has clearly retreated at the G20.

Nor is it likely, at the end of the 90 day hiatus early next March 2019, that Trump and the hard-liners faction bargaining position will be any stronger. The 90 day ‘armistice’ in the emerging US-China trade war might even result in Trump back-peddling further should economic and political conditions worsen appreciably in the interim.

If the global and US economies continue to weaken and slow, which is highly likely, pressure by the other two US trade factions—the one demanding an agreement with China based on more access to China markets and the other demanding settlement so long as China agrees to more purchase of US goods—will only be stronger.

Political developments related to Trump’s business relations in the US and with Russian Oligarchs eventually forthcoming by the Mueller investigation will also likely weaken Trump’s position with regard to resuming a hard line on further tariffs on China. Japan’s recession may also have deepened further by then. Germany’s current economic contraction may have spread to the rest of Europe, which is also facing a confluence of additional problems involving the UK Brexit and the Italian bank problems next spring 2019.

Since 2008 US economic GDP growth has typically slowed dramatically in the winter quarter, and the first quarter 2019 US GDP is likely to again slow significantly from 2018 GDP growth rates. That will be especially the case if the US central bank, the Fed, continues its interest rate hikes into 2019, which appears likely to do at least through next spring. Trump may also have to focus more on saving his recent US-Mexico-Canada trade deal in Congress. All the above will almost certainly provoke a further decline in US stock and other financial markets as investors grow even more uneasy with Trump policies and increase pressure on Trump to postpone further tariffs on China trade.

More US banker-multinational corporate access to China and more China purchase of US farm goods could supersede US hardline anti-China faction demands for China concessions on tech transfer and nextgen military technology development.

More market access and more China purchases would be easy to ‘spin’ as huge gains by the Trump administration. They’ll just keep talking about technology, while cutting off China companies’ access to mergers, acquisitions and joint ventures in the US and in other US allies’ economies.

Should that occur, the US-China so-called ‘trade war’ will prove as phony as have prior Trump threats to tear up NAFTA, or to fundamentally remake the South Korean-US free trade treaty, or to impose 25% tariffs on German autos and European imports, or Trump’s steel tariffs which are riddled with more than 3000 tariff exemptions. While Trump talked tough, all have turned out to be ‘softball’ trade deals granted by the US.

posted November 18, 2018
Global Oil Deflation 2018 & Beyond (with Addendum on 2014-15)

One of the key characteristics of the 2008-09 crash and its aftermath (i.e. chronic slow recovery in US and double and triple dip recessions in Europe and Japan) was a significant deflation in prices of global oil. After attaining well over $100 a barrel in 2007-08, crude oil prices plummeted, hitting a low of only $27 a barrel in January 2016. They slowly but steadily rose again in 2016-17 and peaked at about $80 a barrel this past summer 2018. Then the retreat started once again, falling to a low of $55 in mid-October. They remain around $56 today, likely to fall further in 2019 now that Japan and Europe appear entering yet another recession and US growth almost certainly slowing significantly in 2019, with the potential for a US recession rising in late 2019.

The question is what is the relationship between global oil price deflation, financial instability and crises, and recession? Is the current rapid retreat of oil prices since August 2018 an indicator of more fundamental forces underway in the global and US economy? What can be learned from the 2008 through 2015 experience?

In my 2016 book, ‘Systemic Fragility in the Global Economy’ (see my website, http://kyklosproductions.com) for reviews of the book, and its chapter on deflation’s role in crises), I explained that oil is not just a commodity but since the 1990s an important financial asset whose price affects other forms of financial assets (stocks, bonds, derivatives, currencies, etc.) and which, in turn, is affected by prices of other financial assets as well. Financial asset price volatility in general (bubbles and deflations) have a greater impact on the real economy than mainstream economists, who generally don’t understand financial markets and cycles, typically think. Their understanding how financial cycles interact with real business cycles is virtually nil in most cases.

What follows in an addendum to this article, in italics, are excerpts from the chapter from the ‘Systemic Fragility’ book that explain the role of global crude oil prices as financial asset prices. It considers oil prices from the crash period of 2008 through 2015 as it dropped to its low point at the end of that year and before oil prices once again began to rise from January 2016 through this past summer 2018.

Oil Price Deflation Revisited 2018

Oil is a commodity whose price is determined by the interaction of supply and demand; but it is also a financial asset the price of which is determined by global finance capitalists’ speculation in oil futures markets and the competition between various forms of financial assets globally. For the new global finance capital elite (also addressed in the book) look at the returns on investment (e.g. profits) from financial asset investing globally—choosing between oil futures, stocks, bonds, derivatives, currencies, real estate on a worldwide basis.
The price of crude oil futures drives the price of crude oil in the short and medium term, as a commodity as speculators bet on oil supply and demand; and the relative price of other types of financial assets in part also determine the demand of oil speculators for oil futures.
What this means is that simply applying supply and demand analysis to determine the direction of crude oil prices globally is not sufficient. Neither supply nor demand has changed since August 2018 by 30% to explain the 30% drop in crude oil to its current mid-$50s range; nor will it explain where oil prices will go in 2019. Nevertheless, that’s what we hear from economists today trying to explain the recent drop or predict the trajectory of global oil price deflation in 2019.

What Mainstream Economists Don’t Understand

Mainstream economists are indoctrinated in the idea that only supply and demand determine prices. It harkens back to the influence of classical economics of the 18th century and Adam Smith. Supply and demand are the appearance of price determination. What matters are the forces behind, beneath and below that cause the changes in supply and demand. Those forces are the real determinants. But mainstream economists typically deal at the surface of appearances, which is why their forecasts of economic directions in the medium and longer term are so poor.

Looking at recent explanations and analyses by mainstream economists, and their echo in the business media, we get the following view:
First, it is clear that there are three major sources of oil supply globally today: US production driven by technology and the shale fracking revolution. Second, Russian production. Third, OPEC, within which Saudi Arabia and its allies, UAE, Kuwait, etc. Each produce about 10-11 million barrels per day, or bpd.

Since this summer, US fracking has resulted in roughly an additional 670,000 barrels a day by October compared to last July 2018. Both Saudi and Russian production has added roughly 700,000 more, each respectively. Offsetting the supply increase, in part, has been a reduction in output by Venezuela and Iran—both driven by US sanctions and, in the case of Venezuela, US longer term efforts to prevent the upgrading and maintenance of Venezuelan production.

The more than 2 million bpd increase in global crude oil supply by the global oil troika of US- Russia-Saudi has, on the surface, appeared as a collapse in global oil prices from $80 to $55, or about 30% in just a few months. Projections are supply increases will drive global oil prices still lower in 2019: US forecasts for 2019 are for an average of 12.06 million bpd; for Russia an average of 11.4 million bpd; and for Saudi an average of 10.6 million bpd. (Sources: EIA and OPEC secretariat).

Demand & Supply as Mere Appearance

So the appearance is that supply will drive global oil prices still lower in 2019. But what about demand? Will the forces behind it drive oil price deflation even further? And what about other financial asset markets’ price deflation? Will declines in stock, bond, derivatives, and currencies prices result in financial capitalist investors increasing their demand for oil futures as they shift investing from the collapse of values in those financial markets to oil? Or will it reduce their investing in oil futures as other financial asset markets prices deflate, as a psychological contagion effect spreads across financial asset markets in general, oil futures included?

While mainstreamers focus on and argue that pure supply considerations will predict the price of oil, my analysis insists that a deeper consideration of forces are necessary. What’s driving, and will continue to drive, oil prices are Politics, other financial markets’ price deflation, and Demand that will be driven by renewed recessions in the major advanced economies (Europe, Japan, then US, and continued GDP slowdown in China).

As global economic growth slows, now clearly underway, more than half of the world’s oil producers will increase oil production. Russia, Venezuela, Iraq, smaller African and Asia producers, are dependent on oil sales to finance much of their government budgets. As real growth slows, and recessions appear or worsen, deficits will rise further requiring more government revenues from oil sales. What these countries can’t generate in revenues from prices they will attempt to generate from more sales volume. Even Saudi Arabia has entered this group, as it seeks to generate more revenue to finance the development of its non-energy based economy plans.

So Russia and much of OPEC for political reasons will increase supply because of slowing economies—i.e. because of Demand originally and Supply only secondarily. As the global economy continues to slow Demand forces trump those of Supply. But the two are clearly mutually determined. It’s just that Demand has now become more determining and will remain so into 2019.

Debt as a Driver of Global Oil Deflation

But what’s ultimately behind the Demand forces at work? In the US it’s technology, the fracking revolution, driving down the cost of oil production and thus its price. It’s also corporate debt, often of the junk quality, that has financed the investment behind the oil production output rise. Drillers are loaded with junk bond debt, often short term, that they must pay for, or soon roll over now at a higher interest rate in 2019 and beyond. They must produce and sell more oil to pay for the new technology driven investment of recent years. And as the price falls they must produce and sell still more to generate the revenue to pay the interest and principal on that debt.
So is it really Supply, or is it more fundamentally the debt and technology that’s driving US shale output, that in turn is adding to downward global price pressures? Is it Supply or is it the way that Supply has been financed by capitalist markets?

Similarly, in the case of Russia and much of OPEC, is it Supply or is it the need of those countries to finance their government growing debt loads (and budgets in general) by generating more sales revenue from more oil output, even as the price of oil falls and thereby threatens that oil revenue stream?

Whether at the corporate or government level, the acceleration of debt in recent years is behind the forces driving excess oil production and Supply that appears the cause of the emerging oil price deflation.

Politics as a Driver of Global Oil Deflation

Domestic and global politics is another related force in some cases. Clearly, Russia is engaged in an increase in its military research and other military-related government expenditures. Its governing elite is convinced the US is preparing to challenge its political independence: NATO penetration of the Baltics and Poland, the US-encouraged coup in the Ukraine, past US ventures in Georgia, etc. has led to Russian acceleration of its military expenditures. To continue its investment as the US attempts to impose further sanctions (designed to cut Russia connections with Europe in particular), and as Russia’s economy slows as it raises its domestic interest rates in order to protect its currency, Russia must produce and sell more oil globally. It thus generates more demand for its oil competitively by lowering its price. Demand for Russian oil increases—but not due to natural economic causes as the world economy slows. It increases because it shifts oil demand from other producers to itself.

Saudi politics are also in part behind its planned production increase. It has stepped up its military expenditures as well, both for its war in Yemen and its plans for a future conflict with Iran. The Saudi government investment in domestic infrastructure also requires it to generate more oil revenue in the short term.

The recent Russian-Saudi(OPEC) agreement to reduce or hold oil production steady has been a phony agreement, as actual and planned oil production numbers clearly reveal.

Not least, there’s the question of global financial asset markets’ in decline with falling asset prices and how that impacts the oil commodity futures financial asset market. Once again, changes in oil supply and demand simply do not fluctuate by 30% in just a couple months. The driver of oil prices since July 2018 must be financial speculation in oil futures.

Here it may be argued that investors are factoring in the slowing global economy, especially in Europe and Japan, in coming months. They may be shifting investment out of oil futures as a speculative price play, and into US currency and even stocks and bonds. Or into financial asset markets in China. Or speculating on returns in select emerging market currencies and stocks that have stabilized in the short term and may rise in value, producing a nice speculative gain in the short run. The new global finance capital elite looks at competitive returns globally, in all financial asset markets. It moves its money around quickly, from one asset play to another, enabled by technology, past removal of controls on global money capital flows, easy borrowing, and ability to move quickly in and out of what is a complex network of highly liquid financial asset markets worldwide. As it sees global demand and politics playing important short term roles in global oil price declines, it shifts investment out of oil futures and into other forms of financial assets elsewhere in the global economy. Less supply of money capital for investing in oil futures reduces the demand for oil futures, which in turn reduces demand for oil and crude oil prices in general.

Conclusion

What this foregoing discussion and analysis suggests is the following:

• Looking at oil supply solely or even primarily is to look at appearances only
• But Supply & Demand analyses of oil prices are also superficial analyses of appearances. They are intermediate causal factors at best.
• What matters are real forces that more fundamentally determine supply and demand
• Politics, technology, and debt financing are more fundamental forces driving supply and demand in the intermediate and longer run.
• Oil is not just a commodity, since the 1990s especially; it has become a financial asset whose price is determined in the short run increasingly by speculative investing shifts by global finance capital elites.
• As financial assets, oil prices are determined in the short run globally by the relative price of other competing financial assets and their prices
• The structure of the global economy in the 21st century is such that a new global finance capital elite has arisen, betting on a wide choice of financial assets available in highly liquid financial asset markets, across which the elite moves investments quickly and easily due to new enabling technologies and past deregulation of cross-country money capital flows

To summarize, as it appears increasingly that politics (domestic budgets and revenue needs, US sanctions, rising military expenditures, trade wars, etc.) and a slowing global economy are causing downward pressure on oil demand and thus oil prices; this price pressure is exacerbated by a corresponding increase in production and supply as a result of rising corporate and government debt and debt-servicing needs. However, in the very short run of weekly and monthly price change, it is global oil speculators betting on further oil price deflation and shifting asset investment returns elsewhere that is the primary driver of global oil deflation.

Global oil prices are in determined by other financial asset market price deflation underway in the short term, and in turn determine in part price deflation in other financial asset markets. Global oil prices cannot be understood apart from understanding what’s happening with other financial asset markets and prices.

Understanding and predicting oil prices is thus not simply an exercise in superficial supply and demand analysis, and even less so an exercise primarily in forecasting announcements of production output plans by the big three troika of US-Russia-Saudi.

ADDENDUM: Oil Deflation 2014-15
(excerpt from book,‘Systemic Fragility in the Global Economy’, Clarity Press, 2016)

As the global economy steadily drifts toward deflation today, a debate has arisen between whether there is ‘good deflation’ and ‘bad deflation’.

An application today of the ‘good deflation’ vs. ‘bad deflation’ debate is the spin given of late by media and some mainstream economists to the recent collapse of world crude oil prices. The collapse of crude oil is argued as representing ‘good deflation’. That is, its net effects will be positive for consumption and therefore economic growth. Consumers’ savings from lower oil prices will be spent on other goods and services. The problem with this view is that it assumes a one to one shift of spending, from oil and gasoline to other products and services. It thus ignores the more likely possibility of consumers using the extra income from lower oil prices to pay down past debt or to save, as they worry about the future of the economy. Some of the oil (gasoline) price reduction is also spent on imports, which produce no net benefit for the growth of the economy in question and in fact net negative for GDP growth. And in oil producing economies, the net effects are clearly negative, as the collapse in oil prices means sharp declines in real investment and therefore jobs and incomes, and in turn consumption, for a broad spectrum of the economy.

The oil deflation is good deflation assertion furthermore ignores the related deflationary effects on both goods and financial assets prices that occur as prices for global oil deflates. For oil is not just a commodity but also a financial asset; and as it collapses its contagion spreads to other financial assets. The good deflation vs. the bad deflation is thus mostly a fantasy, and one of the many propositions that permeate mainstream economic analysis today that qualify as more ideology than science.

It is irrefutable that a major trend in oil and commodities deflation has been well underway in the global economy since 2014 and shows little sign thus far of abating. In 2014 alone, oil commodity prices deflated by more than 50%. A brief, partial recovery in 2015 restored the price decline to about 40%. But in the second half of 2015 oil prices began another further fall, to the low $40 range, equivalent to a roughly two thirds drop from previous peaks. More importantly, the consensus is that oil prices will continue to deflate well into 2016, given slowing global demand and continuing excess supply.

Crude oil futures prices are a kind of financial asset that is traded on global exchanges. As a financial security, deflation has been the case just as have prices for the physical commodity itself.

The global oil glut is often explained as a case of excess supply or declining demand. But supply and demand explanations are not the fundamental causes. These concepts are only ‘intermediary’ explanations and are often employed to obscure the real causes that drive the supply and demand changes. In the case of global oil, these fundamental forces are in part political and part economic, although the politics and economics are inseparable. In 2014 the Saudi-Emirates alliance in the middle east decided to drive down the price of global oil in order to bankrupt and destroy their emerging competition in the US among the fracking shale oil and gas companies is one fundamental force behind the collapse of global oil prices. Technology enabled the rise of competition from US shale producers, which challenged Saudi and friends’ ability to dominate world oil price. The Saudis thus created an excess supply added to the extra supply brought to world markets by US shale producers. So the real cause of the excess supply, and thus falling global oil prices, is the intensification of competition between regional global capitalist forces. To say simply ‘supply’ is thus to obfuscate the real causes behind the supply.

But the demand element, and forces behind it, have also been a major contributory factor in the oil price collapse. Those more fundamental demand side forces include the slowdown in the China economy, and the causes behind that development in turn.
Technology also qualifies as a fundamental force playing a role on the demand side driving down oil prices. Alternative energy like solar and other forms is reducing the demand for oil. It is not so much the actual impact of alternative energy in the immediate period, but the generally accepted prospect by global oil producers that it will soon have a major impact. Politics plays a role here as well, as climate change is becoming an accepted fact within voting electorates.

In short, to understand the dynamics of the current global oil glut and deflation, it is necessary to view it from a broader perspective, one that accounts for inter-capitalist competition in various forms, changing technology, and politics within and between capitalist states. It is not a simple question of supply and demand. That is the mere appearance of the causation of the oil deflation. The essence lies in capitalist technology change, shifting relationships of economic power between the regions, financial structure and policy changes, and political forces as well.

Other commodity price deflation—for copper, iron ore, aluminum, other industrial metals, etc.—is also driven by many of the same forces underlying the global oil deflation: The current slowing of the Chinese economy and therefore demand for industrial commodities. But also the prior overproduction of these commodities that grew in the wake of the China-EME development boom of 2010-2012. The overproduction could not have been possible, however, without the financialization of the global economy that was also occurring, nor without the massive injection of money capital by central banks in the US-UK-EU-Japan that took place as well from 2009 on that debt-financed the expansion. Financialization thus preceded overproduction. And now that overproduction is ‘feeding back’ on the financial side, resulting in financial asset price deflation.

A specific US example of this general process of oil commodity output boom and subsequent financial asset bust has occurred in the case of the expansion of the shale oil-gas fracking industry in the US after 2009. The shale boom could not have happened without US banks and shadow banks providing a mountain of corporate junk bond financing to the drillers and shale producers, amounting to hundreds of billions of dollars of new credit in the last few years. So finance enabled the shale overproduction, which resulted in the oversupply of the oil in the US and globally, which then provoked the Saudi response and further global oil over-supply, at a time when global demand was also weakening. What appears as over-production is thus more fundamentally the consequence of finance capital expansion.
A short list of different commodities shows, according to the Bloomberg Commodities Index covering 22 major commodity classes, that commodities deflation as of August 2015 had declined to its lowest level since 1999, contracting by 40% in just the past three years. The key commodities of copper and iron, have fallen 25% and 45%, respectively. And the rout is accelerating. The S&P GSCI Total Return Index of 24 commodities fell 14% just in July 2015, to levels of 2008.

Commodities deflation has a contagion effect on other financial assets and securities. For example, as commodities prices fall, that decline has the effect of causing the currencies of the countries dependent on commodity exports to fall as well—i.e. further deflate. Commodities deflation also drags down stock market prices in those economies’ stock exchanges. Thereafter, commodities deflation eventually spills over to non-commodity goods prices in turn. The feedback on financial assets then occurs in reverse as well, and stock and bond prices weaken still further. A downward deflationary spiral occurs, with goods, and financial asset price deflation each depressing the other.

At some point the downward deflation spiral leads to a rise in defaults. Defaults lead to bankruptcy, which lead to asset firesales and in turn an acceleration of financial asset deflation and its spread. There is thus a dynamic process of debt-deflation-default that sets in, with defaults feeding back on deflation, exacerbating it further, and real debt rising as well. The tip of the iceberg of this process is evident in the case of the huge global commodities trading company, Glencore, that investors and markets just became aware in September 2015 was on the verge of technical bankruptcy. Having taken on massive debt in its expansion phase before 2014, falling commodities prices and export volumes are resulting in a classic example of collapsing income revenue as its real debt rises. Glencore’s stock price thus collapsed 30% in a single day recently. And there are many ‘Glencores’ out there in the global economy whose CEOs and managers are attempting to cover up their severe debt financing problems.

Another example of how defaults result from the debt-deflation dynamic and in turn feed back on it is the imminent crisis brewing in the junk bond market in the US associated with the shale producers approaching bankruptcy. A spillover in junk bond defaults from shale to the rest of the junk bond market is a likely consequence as well. And how a general junk bond crisis affects other financial markets in the US, and globally, is anyone’s guess.

What global oil and commodities deflation reveals is that it is both real physical product (goods) deflation and simultaneously financial asset deflation. And that financial asset deflation is capable of precipitating and exacerbating a vicious downward spiral of negative interaction between goods and financial asset deflation. Not least, that interaction is capable of spilling over to the rest of the economy as well.

Dr. Jack Rasmus is author of the forthcoming book, ‘The Scourge of Neoliberalism: US Policy from Reagan to Trump, Clarity Press, 2019, and the previously published, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity 2017, & ‘Systemic Fragility in the Global Economy’, Clarity 2016.He hosts the radio show, Alternative Visions, and blogs at jackrasmus.com. His twitter handle is @drjackrasmus.

posted November 10, 2018
None Dare Call It Victory: Part 1 US 2018 Election Analysis

For months, the leadership of the Democratic Party hyped the message that a ‘blue wave’ was on its way that would politically engulf Trump and reverse his policies. Well, the wave washed up on shore on November 6, 2018, but Trump barely got his feet wet.

The failure of Democratic Party leaders’ 2018 strategy to deliver as promised in the November 6, 2018 midterm elections should also raise some serious questions about its strategy going forward for 2020. That strategy focused on running women and a few veterans in suburban districts and targeting the independent voter—a Suburbia Strategy—i.e. an approach apparently abandoning the 2008 successful Democratic strategy of targeting millennials, blacks and latinos, and union workers, who since 2012 have been steadily reducing their support for Democrats. But the Dems believe their new Suburbia Strategy works. As former House Speaker, Nancy Pelosi, declared to the media on November 6 after polls closed, the Dems had just won “a great victory”. But was it ‘great’? Or even a ‘victory’?
And is the Suburbia Strategy targeting women and independents in the ‘burbs a formula for winning anything but a couple dozen or so toss up, suburban House districts in off year elections? If not, what is—given the Democrat Party’s abandonment of former strategies that once were successful?

If one listens to the talking heads of pro-Democratic media like MSNBC or anti-Trump CNN, they echoed Pelosi in believing the answer is ‘yes’. The message was the Dems won big time. Center-left periodicals like The Nation magazine declared “We Won!”. Even Democracy Now reported it was an “Historic Midterm”. More mainstream liberal media, like the Washington Post, editorialized the election gave the Dems in 2020 “a path to victory”. Ditto similar spin from the New York Times.

A closer analysis, however, shows if the Dems repeat and run their suburbia-women-independents strategy again two years from now it will be a path to defeat in 2020. And if they then lose again and do not stop Trump again two years from now– for they certainly did not stop Trump this stop around as they promised—it will likely be their end as a major party contender in national politics in the 2020s.

None Dare Call It Victory

True, the Dems won the US House of Representatives, but not by any historic margin. Not like they lost it in 2010. The average historical turnover of House seats in midterms for decades has been about 30. That’s probably the upper limit of what Dems will win in 2018, give or take a few more yet to be decided seats by late vote tallies. And it may be less than 30. A net swing of 30 in the House is just an average recovery of seats for the out party in midterms. That’s not an historic sweep or blue wave by any means. Trump won’t lose sleep over that.

But he will stay up late now tweeting a clear victory for his team in the Senate, where results for 2018 will soon prove strategically devastating for the Dems. Historically in midterm elections the out party is able to swing its way a net gain on average of 4 seats in the Senate. But the Democrats lost four seats, not gained them. That’s an historic defeat. In the Senate, the blue wave predicted to roll in was replaced by the red tide that continued to roll out.

Sad to say, the Dems’ Suburbia Strategy has failed to put any dent into the Trump machine, which deepened its hold on red states America, even if the Dems chipped away at its ragged edge here and there. And that failure has consequences. Here’s just some:
• With the Senate now even more firmly behind Trump, with a majority of 54 Republicans, any possibility of impeachment of Trump by the House is out of the question. Moreover, Trump will now likely get to select a third conservative, pro-business Supreme Court judge. And with a 54 majority, he could nominate Genghis Khan and the ‘in his pocket’ Senate would vote him up.

• A locked in Senate majority also means that Mitch McConnell will now go even more aggressive attacking social security, Medicare, education spending than he’s already signaled. And watch for an even larger flood of highly conservative, mid-level federal court appointments than those that have already been pushed through Congress.

• The Democrats’ Senate debacle will not only solidify the big handouts to businesses and investors in tax cuts and deregulation under Trump’s first two years, but will mean a Senate now firmly in the hands of Republicans and Trump willing to undertake renewed attacks on abortion rights, on immigrants, and workers’ rights for another two years.

• Another immediate consequence is that Trump’s 2018 $4t trillion tax cuts for investors, businesses, and the wealthiest 1% and his sweeping deregulation of business are now firmly entrenched for at least another six years. It’s not surprising that the US stock market surged 545 pts. on November 7, the day after the elections. Investors and the wealthy now know the Trump windfall tax that boosted their profits and capital gains by 20%-25%, and his deregulation policies that lowered costs even more, are now baked in long term.

While Trump’s Republicans expanded their control of the Senate throughout nearly all the rest of ‘red America’, by unseating Democrat Senators in Indiana, Missouri, Florida, and North Dakota, they retained control of strategic governorships in Georgia, Florida, Ohio, and elsewhere. The Republican red state governorships are strategic for several reasons: first, because Florida and Ohio are key swing states in presidential elections. They are also states that have been notorious in the past for manipulating election outcomes (Florida 2000), Ohio (2004) and suppressing voters’ right. Like Florida and Ohio before, in 2018 Georgia appears to be leading the way in voter suppression, as is North Dakota where potentially 30,000 Native Americans’ voting rights were restricted. Both states have been identified for weeks as having undertaken voter suppression measures.

Moreover, Republicans will likely win the governorship in Georgia, where votes are still being contested in a narrow result. And should they win, it will be only because Georgia’s Republican governor candidate, Brian Kemp, as the standing Secretary of State in charge of elections, personally engineered the voter suppression on his own behalf.

Another swing state, North Carolina, also notorious for voter suppression initiatives, has now just passed a ballot measure to allow its legislature to restrict voters rights still further. The Trump voter suppression offensive remains thus well intact and continues to expand its footprint in anticipation of 2020 elections.

What should worry Democrats for 2020 is that all these swing states with long standing voter suppression and gerrymandering histories—i.e. Florida, Ohio, Georgia, North Carolina (add Texas as well)—will remain in the hands of Trump Republican governors come the 2020 elections.

• The Senate and strategic Governorship wins for Trump will now embolden red state right wing radicals to become even more aggressive and organized. Bannon and his billionaire buddies—the Mercers, Adelsons, et. al.—will see to that.

• Not the least significant consequence of the questionable Democratic victory is that Trump is now, in a way, in a stronger position to deal with the Mueller investigation.

He fired his Justice Dept. Secretary, Jeff Sessions, the day after the elections, replacing him with yet another ‘yes man’, Whitaker. Rod Rosenstein, the second in charge at the Department and liaison with Mueller, may likely be next pushed out. That leaves Mueller out on a limb—unless he moves the investigation to the House under the Democrats before getting fired himself. But that shift would make the Mueller investigation look like a partisan Democratic investigation.

• And no one should expect the House Democrats now to seriously pursue Trump impeachment.

The House has authority to raise impeachment but the Senate must conduct the impeachment trial, and that’s just not going to happen now with 54 solid Republican Senators and Trump knows it. So the Dems in the House won’t even try to raise impeachment on the House floor. They’ll do a PR campaign for the media from the perch of House Committee hearings. No matter what Trump does from here on out, no matter what House committee hearings turn up in his tax returns (which will not be shared with the public), and no matter what Mueller reports out, it will all be a ‘smoke and mirrors’ offensive to stop Trump by Pelosi and her Dems in the US House of Representatives.

The Pelosi-Trump Bipartisan ‘Lovefest’

Further mitigating against any Democratic moves against Trump in the House is what appears to be an emerging ‘love fest’ between Trump and Nancy Pelosi. Pelosi repeatedly emphasized in her statement to the press on November 6,, the Democrat party leadership is going to go big on bipartisanship (again!). She signaled to Trump a desire for bipartisanship several times. Trump quickly responded to the overture by calling Pelosi, praising her publicly, and then tweeting that she should be the Speaker of the House now that the Dems have taken it back.

So Obama era Democrat Party bipartisanship is back, and we know what that produced: Obama continually held out the bipartisan offer, the Republican dog continually bit his hand. Mitch McConnell refused and turned down offers to compromise again and again. The result was a failure of an economic recovery for all but bankers and investors. Obama’s 2008 coalition and base thereafter dribbled away and then disappeared altogether in 2016. The Obama 2008 coalition of youth, latinos, blacks and union labor dissolved as fast as it was formed. The result of that was not only the debacle of 2016, but the subsequent conservative conquest of the Supreme Court and virtually the entire federal judiciary under Trump, an across the board wipeout of decades of business regulations, a $4 trillion tax windfall for business, investors and wealthy households, a total retreat on climate change, and a descent into a nasty political culture of emerging ‘white nationalism’ and increasing social violence and polarization. It all began with Obama’s naïve bipartisanship that we now see Democrat Party leaders like Pelosi (and no doubt the corporate moneybags on the DNC) attempting to resurrect once again.
Bipartisanship is a political indicator of a party no longer convinced of its own ability to lead and forge a new direction. Contrast the results of Democratic Party bipartisanship from Obama to Pelosi with Republican party rejection of anything bipartisan. Who prevailed proposing bipartisanship? Who won rejecting it? Yet, here we go again with Obama-like bipartisanship being offered by Pelosi. It will be a set-up for Democratic failure in 2020, just as it was after 2008.

Here’s my prediction why:

A bipartisan approach by the Democrat House will result in Dems getting the short end of the legislative stick once again. Policy areas where Pelosi-Trump may agree include

• infrastructure spending,
• limits on prescription drug price gouging by big Pharma companies,
• token 5% tax cuts for median income family households,
• paid family leave

But Pelosi legislative proposals will then run into a wall of opposition in Mitch McConnell’s Senate that will demand significant cuts to Medicare, Medicaid, Food Stamps, Housing, Education and other programs as a condition of Senate support for passage of their proposals. In addition, to get something passed, the Pelosi Dems will have to agree to watered down versions of their proposals as well. They’ll then get outmaneuvered in House-Senate conference committee, agreeing to the watered down proposals and the least publicly obvious and onerous of McConnell’s cuts to social programs—i.e. just to get something passed. If they don’t agree to McConnell’s compromises, they will appear to be voting against their own proposals. Either way, the Dems again will look ineffective again to their base, as they had throughout 2008-16. They will have walked into the bipartisan trap, and Trump-McConnell will slam the door behind them in 2020.

But we’ve seen that story before—under Jimmy Carter after 1978, in Bill Clinton’s second term, and during Obama’s first.

Dr. Jack Rasmus is author of the forthcoming book, ‘The Scourge of Neoliberalism: US Policy from Reagan to Trump’, by Clarity Press, 2019, and ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression, Clarity Press, August 2017. He hosts the Alternative Visions radio show on the Progressive Radio Network and blogs at jackrasmus.com. His twitter handle is @drjackrasmus. His video, radio and interviews are available for download at his website, http://kyklosproductions.com

posted November 10, 2018
The Unraveling of America: US Conditions on Eve of Midterm Elections

As Americans went to the polls yesterday, November 6, 2018, no doubt some were thinking of the hordes of immigrants we’re told are invading the US southern border. Or they were remembering the pipe bombs, the killings in Pittsburg, or the racist murders occurring almost daily elsewhere that barely get press coverage anymore.

If they’re Millennials, they may be considering whether even to vote or not, since neither wing of the corporate Party of America—aka Republicans or Democrats—have done much for them over the past ten years. Burdened mostly with low paying service jobs and $ trillion dollar student debt payments that consume roughly 37% of their paychecks, with real incomes well below what their parents were earning at their age, and with prospects for the future even more bleak, many Millennials no doubt wonder what’s in it for them by voting for either party’s candidates. Will Millennial youth even bother to turn out to vote? As an editorial in the Financial Times business newspaper recently noted, “Only 28% of Americans aged 18 to 29 say they are certain to vote this November”. Political cynicism has become the dominant characteristic of much of their generation—deepening since the politicians’ promises made in 2008 have failed to materialize under Obama and now Trump.

If they’re Latinos and Hispanics, as they go to the polls they are aware their choice is either Trump Republicans who consider them enemies, criminals and drug pushers; or Democrats who, in the past under Obama, deported their relatives in record numbers and repeatedly abandon programs like DACA (‘Dreamers) as a tactical political necessity, as they say. Who will they trust least? One shouldn’t be surprised if they too largely sit it out, harboring a deep sense of betrayal by Democrats and concern they may soon become the next ‘enemy within’ target of Trump and his White Nationalist shock troops who are being organized and mobilized behind the scenes by Trump’s radical right wing buddy, Steve Bannon, and his billionaire and media friends.

If they’re African Americans, they know from decades of experience that nothing changes with police harassment and murders, regardless which party is in power.

If they’re union workers in the Midwest, they know the Democrats are the party of free trade and job offshoring, while Republicans are the party favoring low minimum wages, elimination of overtime pay, privatization of pensions, and cuts to social security.
All these key swing groups of Millennials, Hispanics, African-Americans, and union workers in the midwest—i.e. those who gave Obama an overwhelming victory in 2008, gave him one more chance in office in 2012 despite failure to deliver, and then gave up on the unfulfilled promises in 2016—will likely not be thinking about the real ‘issues’ as they go to the polls. For the ‘Great Distraction’ is underway like never before.

The Great Distraction

It’s the ‘enemy within’ that’s the problem, we’re told by Trump. And the ‘enemy without’. Or, in the case of the immigrant—it’s both: the enemy without that’s coming in! So put up the barbed wire. Grab their kids when they arrive, as hostage bait. Send the troops to the border right now, to stop the hordes that just crossed into southern Mexico yesterday. Hurry, they’re almost here, rapidly proceeding to the US on foot. (They run fast, you see). They’re in Oaxaca southern Mexico. They’ll be here tomorrow, led by Muslim terrorists, carrying the bubonic plague, and bringing their knapsacks full of cocaine and heroin.

And if the enemy immigrant is not enough is not enemy enough, the ‘enemy within’ is increasingly also us, as Trump adds to his enemies list the ‘mob’ of Americans exercising their 1st amendment rights to assembly and protest against him. And don’t forget all those dangerous Californians who won’t go along with his climate, border incarceration, trade or other policies. Or their 80 year old Senator Diane Feinstein, their ring-leader in insurrection. They’re all the ‘enemy within’ too. The chant ‘lock ‘em up’ no longer means just Hillary. So Trump encourages and turns loose his White Nationalist supporters to confront the horde, the mob, and their liberal financiers like George Soros. If all this is not an unraveling, what is?

Not to be outdone in the competition for the Great Distraction, there’s the Democrats resurrecting their age-old standby ‘enemy without’: the Russians. They’re into our voting machines. Watch out. They’re advancing on Eastern Europe, all the way to the Russian-Latvian border. Quick, send NATO to the Baltics! Arrange a coup partnering with fascists in Ukraine! Install nuclear missiles in Poland! And start deploying barbed wire on the coast of Maine and Massachusetts, just in case.

However, behind all the manufactured fear of immigrants, US demonstrators, and concern about violence- oriented white nationalists whipped up and encouraged by Trump and his political followers—lies a deeper anxiety permeating the American social consciousness today. Much deeper. Whether on the right or left, the unwritten, the unsaid, is a sense that American society is somehow unraveling. And it’s a sense and feeling shared by the left, right, and center alike.

Both sides—Trump, Republicans, Democrats, as well as their respective media machines—sidestep and ignore the deep malaise shared by Americans today. Older Americans shake their heads and mumble ‘this isn’t the country I grew up in’ while the younger ask themselves ‘is this the country I’ll have to raise my kids in’?

There’s a sense that something has gone terribly wrong, and has all the appearance will continue to do so. It’s a crisis, if by that definition means ‘a turning point’. And a crisis of multiple dimensions. A crisis that has been brewing and growing now for at least a quarter century since 1994 and Newt Gingrich’s launching of the new right wing offensive that set out purposely to make US political institutions gridlocked and unworkable until his movement could take over—and succeeded. It’s a crisis that everyone feels in their bones, if not in their heads. The dimensions of the unraveling of America today are many. Here’s just some of the more important:

Growing Sense of Personal Physical Danger

Mass and multiple killings and murders are rampant in America today, and rising. So much so that the media and press consciously avoid reporting much of it unless it involves at minimum dozens or scores of dead. There are more than 33,000 gun killings a year in the US now. 90 people a day are killed by guns. While we hear of the occasional school shooting, the fact is there are 273 school shootings so far just in 2018. That’s one per school day.

The suicide rate in America is also at record levels, with more than 45,000 a year now and escalating. Teen age suicides have risen by 70% in just the last decade. The fastest rate of increase is among 35-64 year olds. People are literally being driven crazy by the culture, the insecurities, the isolation, the lack of meaningful work, the absence of community, and the hopelessness about a bleak future that they’re killing themselves in record numbers.

And let’s not forget the current opioid crisis. The opioid death rate now exceeds more than 50,000 a year. These aren’t folks over-dosing in back alleys and crack houses. These are our relatives, neighbors and friends. And the ‘pushers’ are the big pharmaceutical companies and their salespersons who pushed the Fetanyl and Oxycontin on doctors telling them it was safe—just like the Tobacco companies maintained for decades that cigarettes were ‘safe’ when their tests for decades showed their product produced cancer. Big Pharma knew too. They are the criminals, and their politicians are the paid-for crooked cops looking the other way. All that’s not surprising, however, since Big Pharma is also the biggest lobbyist and campaign contributor industry in the US.

So it’s 33,000 gun killings, 43,000 suicides, and 50,000 opioid deaths a year. Every year. That compares to US deaths during the entire 8 years of Vietnam War of 56,000! That’s a death rate over three years roughly equal to all Americans who died during the three and a half years of World War II! We all got rightly upset over 2500 killed on 9-11 by terrorists. But the NRA and the Pharmaceutical companies are the real terrorists here, and politicians are giving them a complete pass.

Instead of Big Pharma CEOs and leaders of the National Rifle Association (NRA), we’re told the real enemies are the desperate men, women and children willing to walk more than a thousand miles just to get a job or to escape gang violence. Or we’re told it’s the Russians meddling in the 2016 election and threatening our democracy—when the real threat to American democracy is home grown: In recent court-sanctioned gerrymandering; in mass voter suppression underway in Georgia, North Dakota, and elsewhere; in the billions of dollars being spent by billionaires, corporations, and their political action committees this election cycle to ensure their pro-business, pro-wealthy candidates win.

News of these real killing machines goes on every day, creating a sense of personal insecurity that Americans have not felt or sensed perhaps since the frontier settlement period in the 19th century. It’s not the immigrants or the Russians who are responsible for the guns, suicides, and drug overdoses. But they certainly provide a useful distraction from those who are. People feel the danger has penetrated their communities, their neighborhoods, their homes. But politicians have simply and cleverly substituted the real enemies with the immigrant, the mob, and that old standby, the Russians.

Income & Wealth Inequality Accelerating

Another dimension of the sense of unraveling is the economic insecurity that hangs like a ‘death smog’ over public consciousness since the 2008-09 crash. As more and more average American households take on more debt, work more part time jobs or hours, and adjust to a declining standard of living, they are simultaneously aware that the wealthiest 1% or 10% are enjoying income and wealth gains not seen since the ‘gilded age’ of the late 19th century. The share of national pre-tax income garnered by the top 10% has risen from 35% in 1980 to roughly 50% today. That’s 15% more to the top, equivalent to roughly than $3 trillion more in income gains by the top 10% that used to be distributed among the bottom 90%.

How could an America that once shared income gains from economic growth among its classes and across geography from World War II through the 1970s have now allowed this to happen, many ask? And why is it being allowed to get worse?

There are many ways to measure and show this economic unraveling. Whether national income shares for workers and wages falling from 64% to 56% of total national income; or the distribution to the rich of more than a $1 trillion a year every year since 2009 in stock buybacks and dividend payments; or the $15 trillion in tax cuts for investors, businesses, and corporations since 2001; or Trump’s recent $4 trillion tax windfall for the same; or stock market values tripling and quadrupling since 2009; or stagnant real wage gains for the middle class and declining real wages for those below the median.

Whatever dimension or study or statistic, the story is the same. Economic gaps are widening everywhere. And everyone knows it. And except for that noble, modern Don Quixote of American Politics, Bernie Sanders, it appears no one in either party is proposing to reverse it. So the awareness festers below the surface, adding to the realization that something is no longer right in America.

The sense of economic unraveling may have slowed somewhat after 2010, but it continues none the less, as millions of Americans are forced to assume low paying service jobs. Working two or more jobs to make ends meet. Taking Uber and gig work on the side. Going on Medicaid or foregoing health insurance coverage altogether. Moving to lower quality housing and taking on more room-mates. Treading economic water in good times, and sinking and gasping for air during recessions and in the bad times. Just making due. While the wealthy grow unimaginably wealthier by the day.

Never-Ending Wars

The sense of anxiety is exacerbated by the never ending wars of the 21st century. How is it they never end, given the most powerful military and funding of more than $1 trillion a year every year, it is asked?

Newspaper headlines haven’t changed much for 17 years. The war in Afghanistan and elsewhere continues. Change the dates and you can insert the same news copy. With more than 1000 US bases in more than 100 countries, America since 2001 has been, and remains, on a perpetual war footing. All that’s changed since 2000 is that the USA no longer pays for its wars by raising taxes, as it had throughout its history. Today the US Treasury and Federal Reserve simply ‘borrow’ the money from partners in empire elsewhere in the world—while they cut taxes on the rich at the same time.

And the annual war bill is going up, fast. Trump has increased annual spending on ‘defense’ by another $85 billion a year for the past two years. Approaching $150 billion if the notorious US ‘black budget’ spending on new military technology development—not indicated anywhere in print—is added to the amount. And more is still coming in the next few years, to pay for new cybersecurity war preparation, for next generation nuclear weapons, and for Trump’s ‘space force’. Total costs for defense and war—not just the Pentagon—is now well over $1 trillion annually in the US. And with tax cutting for those who might pay for it now accelerating, the only sources to pay for the trillion dollar plus annual US budget deficits coming for the next decade is either to borrow more or cut Social Security, Medicare, education and other social programs. And those cuts are coming too—soon if one believes the public declarations of Senate Republican Majority leader, Mitch McConnell.

Technology Angst

As our streets and neighborhoods become more dangerous, as inequality deepens, as wars, tax cuts for the rich and social program cuts for the rest become the disturbing chronic norm— awareness is growing that technology itself is beginning to tear apart the social fabric as well. Admitted even by visionaries and advocates of technology, the negatives of technology may now be outweighing its benefits.
Studies now show problems of brain development in children over-using hand-held screen devices. Excessive screen viewing, studies show, activates the same areas of the brain associated with other forms of addiction. Social media is encouraging abusive behavior by enabling offenders to hide. What someone would not dare to say or do face to face, they now freely do protected by space and time. Social media is transforming human communications and relations rapidly, and not always positively. It is also enabling the acceleration of the surveillance state. Massive databases of personal information are now accessible to any business, to virtually any governments, and to unscrupulous individuals around the globe intent on blackmail, threats, and worse. Privacy is increasingly a fiction for those participating in it.

And employment is about to become more precarious because of it. Technology is creating and diffusing new business models, destroying the old, and doing so far too rapidly to enable adjustment for tens of millions of people. Amazon. Uber. Gig economy. Wiping out millions of jobs, increasing hours worked, uncertainty of employment, lowering of wages. And next Artificial Intelligence. Projected by McKinsey and other business consultants to eliminate 30% of current jobs by the end of the next decade. Where will my job be in ten years, many now ask themselves? Will I be able to make it to retirement? Will there be anything like retirement any more after 2035?
Unchecked and unregulated accelerating technological change is adding to the sense of social unraveling of key institutions that once provided a sense of personal security, of social stability, of a vision of a future that seemed more related to the present, rather than to an even more anxiety ridden, uncertain, unstable future.

A Culture Increasingly Coarse & Decadent

When the President of the US brags he could shoot someone on the street corner and (his) people would still love him, such statements raise the ghostly spectre of prior decades when the vast majority of German people thought the same of Hitler. And when one of his closest advisers, Rudy Guliani, declares publicly that ‘Truth is not the Truth’, it amounts to an endorsement for an era of lies and gross misrepresentation by public figures. With chronic lying the political norm, what can anyone believe from their elected officials, many now ask? It’s no longer engaging in political spin for one’s particular policy or program. It’s politics itself spinning out of control. Public political discourse consists increasingly to targeting, insulting, vilifying, and threatening one’s political opponents. Trump’s railing against politicians and government itself smacks of Adolph’s constant insulting indictment of democratically elected Weimar German governments and leaders in the 1920s. It leaves the American public with a nervous sense of how much further can and will this targeting, personalizing, and threatening go?

But the political culture is not the only cultural element in decline. A broader cultural decline has become evident as well. Americans flock to view films of dystopia visions of America, of zombies, and ever-intense CGI violence where fictitious super heroes save the world. More of popular music has become overtly misogynous, angry, mean, and violent in both sound and lyrics. And has anyone recently watched how high schoolers now dance, in effect having sex with their pants on?

Collapse of Democratic Institutions

Not least is the sense of unraveling of political institutions and the practice of democracy itself. As a recent study estimated, Democracy is in decline in the US, having dropped in an aggregate score of 94 in 2010 to a low of 86 today—when measured in terms of free and fair elections, citizen participation in politics, protection of civil rights and liberties, and the rule of law. The study by the non-profit, Freedom House, concluded “Democracy is in crisis’ and under assault and in retreat.

In America, the restrictions on civil rights and liberties have been growing and deepening since 2001 and the Patriot Acts, institutionalized in annual NDAA legislation by Congress thereafter. Legislatures have been gerrymandered to protect the incumbents of both wings of the Corporate party of America. The US Supreme Court has expanded its authority to select presidents (Gore v. Bush in 2001), defined corporations as people with the right to spend unlimited money which it defines as free speech (Citizens United), and will likely next decide that Presidents (Trump) can pardon himself if indicted (thus ending the fiction that no one is above the law and endorsing Tyranny itself).

The two wings of the Corporate Party of America meanwhile engage in what is an internecine class war between factions of the American ruling class. More billionaires openly contest for office as it becomes clear millions and billions of dollars are now necessary to get elected.

Voter suppression spreads from state to state to disenfranchise millions, from Georgia to the Dakotas, to Texas and beyond. If one lacks a street number address, or an ID card, or has ever committed a felony, or hasn’t voted recently, or doesn’t sign a ballot according to their birth certificate name, or any other number of technical errors—they are denied their rights as citizens. What was formerly ‘Jim Crow’ for blacks in the South has become a de facto ‘Jim Crow Writ Large’ encompassing even more groups across a growing number of states in America.

A sense of growing political disenfranchisement adds to the feeling that the country is politically unraveling as well—adding to the concurrent fears about growing physical insecurity, worsening economic inequality and declining economic opportunities, and an America mired in never ending wars. An America in which it is evident that political elites are increasingly committed to policies of redistribution of national wealth to the wealthiest. An America where more fear that technology may be taking us too far too fast. An America where the culture grows meaner, nastier and more decadent, where lies are central to the political discourse, and where political institutions no longer serve the general welfare but rather a narrow social and economic elite who have bought and captured those institutions.

And, not least, an America where politicians seem intent on drifting toward a nationalism on behalf of a soon to be minority White America—i.e. politicians who are willing to endorse violence and oppression of the rest in order to opportunistically assume and exercise power by playing upon the fears, anxieties, and insecurities as the unraveling occurs.

(Watch for my follow-on analysis of the 2018 Midterm Elections results, and why now the polarization in the country will deepen and why Democratic Party strategies will lead to disaster in 2020).

Dr. Rasmus is author of the forthcoming book, ‘The Scourge of Neoliberalism: US Policy from Reagan to Trump’, forthcoming 2019 by Clarity Press. He hosts the weekly radio show, Alternative Visions, on the Progressive Radio Network and blogs at jackrasmus.com. His twitter handle is @drjackrasmus.

posted October 13, 2018
The Coming Post-US Midterm Elections Bombshell

Liberals and the left were shocked by the Kavanaugh confirmation this past weekend. They may experience an even greater shock to their political consciousness should the Democrats fail to take the House in the upcoming midterm elections.

The traditional media has been promoting the message that a ‘blue wave’ will occur on November 6. Polls as evidence are being published. The Democratic Party is pushing the same theme, to turn out the vote. But these are the same sources that in 2016, on the eve of that election, predicted Trump would get only 15% of the popular vote and experience the worse defeat ever in a presidential election! Should we believe their forecasting ability has somehow radically improved this time around?

Anecdotal examples, in New York City and elsewhere in deep Democrat constituencies, are not sufficient evidence of such a ‘wave’. Especially given the apparent successes underway of Republic-Right Wing efforts to suppress voter turnout elsewhere, where House seats must be ‘turned’ for Democrats to achieve a majority in the House once again. (See, for example, Greg Palast’s most recent revelation of voting roll purging going on in Georgia, which is no doubt replicated in many other locales).

Should the Democrats clearly win enough seats to take over control of the US House of Representatives on November 6, liberals and progressives may be further disappointed. Democrat party leaders will most likely talk about impeachment, make some safe committee moves toward it, but do little to actually bring it about in the coming year. What they want is to keep that pot boiling and leverage it for 2020 elections. Such prevarication and timidity, so typical of Democrat leadership in recent decades, will almost certainly have the opposite intended effect on liberal-left voter consciousness. Voters will likely retreat from voting Democrat even more in 2020 should Democrat Party leaders merely ‘talk the talk’ but not walk.

Conversely, should the Dems fail to take the House a month from now, an even deeper awareness will settle in that the Democratic Party is incapable of winning again in 2020. Even fewer still may therefore turn out to vote next time, assisted by an even more aggressive Republican-Trump effort to deny the right to vote than already underway.

In short, a Democrat party failure to recover the US House of Representatives next month will have a debilitating effect on consciousness for the Democrat base that will no doubt reverberate down the road again. So too will a timid, token effort to proceed toward impeachment should the Democrats win next month.

But a takeover of the House by Democrats will result in an even greater, parallel consciousness bombshell—only this time on the right. Bannon, Breitbart, and their billionaire money bags (Mercers et. al.) are already preparing to organize massive grass roots demonstrations and protests to scare the Democrats into inaction so far as impeachment proceedings are concerned. And it won’t take much to achieve that retreat by Democrat party leaders.

The recent Kavanaugh affair is right now being leveraged by Trump and the far right to launch a further attack on civil liberties and 1st amendment rights of assembly and protest. Trump tweets are providing the verbal ‘green light’ to go ahead. Kavanaugh has become an organizational ‘cause celebre’ to mobilize the right to turn out their vote. The plans are then to take that mobilization one step further, however, after the midterm elections.

Plans are in the works for Bannon and friends for a mobilization of the right to continue post November 6, should the Dems take the House. They’re just warming up with the Kavanaugh affair. Demonstrations celebrating Kavanaugh’s Supreme Court win are just a dress rehearsal—first to turn out the vote but then to defend Trump in the streets if the Democrats actually take the House.

The public protests and demonstrations on the right will aim to intimidate House Democrats, should they win, but will also serve as counter demonstrations to attack protestors demonstrating for impeachment.

Either way—should the Republicans retain the House or the Democrats take it—a sea change in US political consciousness will occur once again this November, as it did in November 2016. And should the Democrats take the House, political instability will almost certainly intensify in the US, as the developing political crisis will ‘move to the streets’.

The 2016 election and events of the past two years wrenched the consciousness of many Americans about how the US system works. The myths have fallen by the wayside, one by one in the intervening two years. The belief that somehow the sane leaders appointed to Trump’s initial cabinet would somehow control him or the Republicans in the Senate keep him in check have both dissipated.

Trump has purged them from his administration, or they have dropped out of running for Congress again as the well-financed, pro-Trump, right wing local machine has promoted right wing candidates to run against them. Trump has been successfully reconstituting the Republican party increasingly in his far right image. The myth that Trump will ‘tear up NAFTA’ and bring manufacturing jobs back is now debunked. Or that he will end the wars in the Middle East. The list is long.

Democrats in the meantime have continued to show their strategic ineffectiveness and tactical ineptness in dealing with Trump. Their party leaders have shown more concern, and success, in keeping Bernie Sanders and his supporters at bay, as witnessed by the recent Democrat Party measures that keep their ‘superdelegates’ barrier to party reform in place while giving the chair of the Democratic Party the power to veto any candidate to run on its ticket who may win a primary in the future. Nor have they adopted an effective program to win back the working class, the loss of which in key Midwestern states in 2016 cost them the 2016 election. The latter not surprising, given that the central committee of the party is composed of more than 100 corporate lobbyists and CEOs. Promoting ‘identity politics’ has become the mantra—not programs to restore good jobs, ensure wages, protect retirement, defend union rights, push Medicare for All, and similar class-based demands.

Whether right or ‘left’ prevails in the upcoming November midterms, a few things are certain:

First, political consciousness, both right and left, will likely undergo another major shift, and perhaps on a scale close to that which occurred in 2016.

Second, the midterm elections will be used by the Bannons, Breitbarts, Mercers and others on the far right as an opportunity to mobilize the grass roots into a more centralized right wing movement. Initially for purposes of voter turnout, that organization, centralization, and mobilization will expand into the post-midterm US political landscape.

Third, more intimidation, more threats, and even now confrontations between left and right in the streets is a real possibility in the years to come in Trump’s remaining two years in office. (And the Republicans and the right will now own the police and the courts and will thus have a decided advantage in protests and demonstrations).

Increasingly, US intellectuals, artists, and even experienced old-guard politicians, who were once eye-witnesses in their early years, have begun to see parallels about what’s happening now in the US with past origins of fascist movements. Up to now, however, one especially important element of fascist politics has been missing in the US, although its ugly head has been peering above the horizon since 2016. That element is a grass roots movement of fascist-like supporters, activists and sympathizers, whose main task is to confront, intimidate, and violently discourage demonstrations and protests against their leader (Trump) personally, and in support of democratic rights under attack and the exercise of civil liberties in general.

The emergence of just such a right wing grass roots movement, better organized and well financed, and willing to engage in violent confrontations against other protestors and demonstrators in the streets, may soon be upon us. Should the Democrats win in November and launch impeachment proceedings the phenomenon will quickly appear. But even if Democrats prevaricate (the more likely scenario), the right is preparing to mobilize nonetheless. Their response to the Kavanaugh affair shows how much they’re ‘itching’ to do so. And should the Democrats win the House, their development will become even more evident.

Jack Rasmus
October 8, 2018

Jack is author of the forthcoming book, ‘The Scourge of Neoliberalism: US Policy from Reagan to Trump’, Clarity Press, as well as ‘Central Bankers at the End of Their Ropes’, Clarity Press, August 2017. He blogs at jackrasmus.com and tweets at @drjackrasmus. His website is: http://kyklosproductions.com

posted October 13, 2018
Trump at the UN: Lies, Damn Lies & Statistics

This past week Donald Trump appeared before the United Nations Assembly in New York. In typical Trump style, he immediately launched into bragging about his accomplishments. Like most of his recent public appearances, it was a campaign speech directed to his political base. He proclaimed to the Assembly he had achieved more in his first two years than had any other president in a like period. The claim elicited laughs from the audience, which Trump would brush off later in a press conference saying ‘We were laughing together, they weren’t laughing at me”. Sure, Donald. That’s what happened!

In the course of his over-the-top, self-congratulatory announcement he said the US economy had grown faster in his first two years at the presidential helm than in any administration before during a like period, he had reduced unemployment to the lowest rate ever in the US, and his policies have produced record wage gains for American workers. The reality, however, is none of the above are true.

What’s somewhat ironic is that Trump’s lies and misrepresentations about the performance of the US economy are buttressed in part by official US statistics. He didn’t have to lie outright. It is often forgotten that statistics are not actual data. They are not numbers and facts that are actually observed, collected and reported in their original form. Statistics are ‘operations’ on and manipulation of the actual data, i.e. the real numbers. Statistics are created numbers. The operations and manipulations are often justified by arguing they improve the data, reveal it more accurately. Sometime this is so. But too often the manipulations are designed to boost the raw data to show the economy is doing better than it actually is (i.e. GDP and growth is better than it really is); or reduce the numbers to show the same effect (i.e. inflation is not as high as it really is); or that wages are rising for everyone when in fact they may not be for most.

In Trump’s UN speech, we therefore find an ironic congruence of typical Trump imagined facts that don’t actually exist and official government statistics that are not lies per se but are nonetheless distortions and misrepresentations created by the many complex, often convoluted operations and manipulations performed on the actual facts.

Who’s lying? There are different ways to lie. Trump does it crudely and blatantly. Official stats often do it cleverly and opaquely. The debunking of Trump claims before the UN about US GDP, US unemployment, and US wages in what follows shows how the crude and the clever often coincide.

Trump’s ‘US GDP Is Growing at Record Rate’ Claim

Let’s take US economic growth or GDP (Gross Domestic Product). Trump claims the last quarter’s GDP growth of 4.2% was the best ever. Apart from the fact that the US economy has grown quarterly faster many times before, the 4.2% is a misrepresentation—even if it’s the official US figure. Here’s why:

GDP is defined as the total goods and services produced in a given year that is sold in that year. So prices are associated with the output of actual goods and services produced. But real growth of the economy should not include prices. Therefore prices are adjusted out from what’s called the ‘nominal GDP’ number. Nominal GDP last quarter was 5.4%. Trump’s ‘real GDP’ number of 4.2% means inflation was 1.2% for the period, according to the ‘GDP Deflator’ price index that’s used to adjust GDP for inflation.

But does anyone really believe inflation was only 1.2%? No one that was paying for double digit hikes in insurance premiums and copays during the quarter, or a dollar plus more for a gallon of gasoline to get to work, or who has had to pay rent hikes by their landlord of 20% or more, or is paying higher local property taxes and fees, or has opened their utility bill envelopes lately. What wage earning household believes inflation is running at only 1.2%? And if inflation is higher than that, then the adjustment for inflation to the 5.4% nominal GDP results in a ‘real GDP’ of far less than Trump’s official 4.2%.

So why is inflation so underestimated, resulting in real GDP being over-estimated at 4.2%?

One reason actual inflation is much higher is that government statisticians arbitrarily assume that consumers are buying more online where goods are cheaper, even though the government itself has said its procedure for estimating online sales is a ‘work in progress’ and at best a guesstimate.

Another reason inflation is underestimated at 1.2% is government bureaucrats at the Commerce Dept. (responsible for estimating GDP) assume that the quality of goods sold today is better than in the past. So they reduce the actual price that households really pay for the product in the marketplace and assign a lower, fictional price when they calculate the 1.2% GDP Deflator.

Or they assume that rents aren’t really rising as fast as they are in fact, because their models definition of rent includes homeowners with mortgages supposedly paying a ‘rent’ to themselves as well. That’s called ‘imputed rents’. Of course it’s nonsense. Homeowners don’t pay themselves rents. But when you assume they do, it means 100 million homeowners pay rents to themselves that barely changes year to year, while true renters keep paying 20% or more. When rents are then ‘averaged out’ for both homeowners and real renters, the actual rent inflation comes out much lower as a contribution to total GDP inflation. There are dozens of other techniques by which the ‘GDP Deflator price index’ is manipulated to come up with only 1.2% inflation—and thus overstate real GDP to 4.2%.

The US has other inflation indexes it could use to adjust for real GDP more accurately, but it doesn’t use them. It prefers the ‘lowball’ GDP Deflator price index. The Consumer Price Index, CPI, is closer to the actual inflation, at 2.7%. If the CPI were used to adjust nominal GDP, the 4.2% real GDP would be only 2.7%. The US Central Bank, the Fed, uses yet another index called the Personal Consumption Expenditure or PCE. That’s at 2.2%, also much higher than 1.2%. If the PCE was used real GDP would be 3.2% not 4.2%. So the most conservative and lowest inflation indicator is used to estimate real GDP. And that’s how Trump gets his phony 4.2% real GDP—i.e. his ‘greatest in history’ US growth number.

But even the CPI, at 2.7%, underestimates inflation. It uses what’s called the ‘chained index’ method for calculating annual inflation rates. That simply takes the actual current year CP inflation and averages, or ‘smooths’, it out with the preceding years of inflation. The resulting ‘averaging of averages’ is a lower than actual annual rate of inflation.

There are other problems with GDP that further reduce the 4.2% assumed real growth rate. Periodically the government changes its definition of what makes up the GDP. The re-definitioning often results in a higher GDP than previous. It’s not a real growth increase, just growth by definition. This redefining GDP is going on globally as well. In Europe for example they now include drug smuggling and services from brothels as contributing to GDP. Of course, to estimate these ‘services’ contributions to total GDP one needs to get a price. Drug peddlers don’t tell the government what they’re selling their heroin or cocaine for. And it’s doubtful that government statisticians stand outside the brothels or interview street walkers to determine the price they charged their ‘johns’. So government statisticians simply make up the numbers and plug them into their GDP calculations. One of the most egregious examples of GDP growth by definition occurred in recent years in India. By redefining GDP it doubled its value overnight. The US engaged in its own form of GDP redefinition a few years back as well, when the economy recovery just couldn’t get off the ground and stagnated in late 2012.

Back in 2013 US GDP was arbitrarily redefined to include categories that had never been included—like the estimation of the value of company logos, trademarks, and intellectual property that never gets sold. What was for decades considered a business cost and not an investment—i.e. research and development—was now added to GDP figures. This change to GDP raised it by $500 billion annually starting in 2013. It’s no doubt higher today. That’s about 0.2% to 0.3% artificial boost to GDP just by redefining it. The point is no one knows the price of new categories like logos, trademarks, and the like. Government bureaucrats simply make them up (like they do ‘imputed rents’) and add them to the GDP totals.

What this all means is that Trump’s boast of his record 4.2% GDP is not really 4.2%, but something far lower, probably around 2%. That’s only a few tenths of one percent higher than under Obama, when GDP averaged around 1.7%-1.8% annually.

Trump’s bragging of historic growth misses another really important problem with GDP: It avoids the question of who benefits from the 4.2% (or 2% in fact). Who gets the income generated from the 4.2%, or 2.7%, or 2%, or whatever. The flip side of the 4.2% GDP is what is called National Income. National Income is what the GDP creates for businesses, investors, wage earners, etc. who make the goods and services that create the National Income. But to whom is the 4.2% national income equivalent of GDP really benefitting? Is it the roughly 130 million wage earners? Or is it the owners of capital, their shareholders and managers, the self-employed? How much do those who make the goods and services—i.e. wage earners—get of the National Income? And is the share of total National Income they are getting distributed more or less equally among the 130 million, or is it skewed to the high end of the wage and salary structure, i.e. the top 10% of wage and salary earners—i.e. the business professionals, tech sector engineers, high paid health professionals, etc.?

Trump’s ‘Wages Are Rising Fast’ Claim

Trump brags that wages are rising at 2.9% a year now. However, that 2.9% is for full time permanent employed workers only. (Read the fine print in the Labor dept. definitions). Excluded are the roughly 50 million part time, temp, on call, under-employed and unemployed. And the wages are rising nicely claim may include extra hours worked—i.e. more overtime for the full time employed and extra part time jobs and gig jobs for the part time and temp employed. Workers’ earnings may thus rise due to more hours worked, not actual wage rate increases. Independent reports show, moreover, that employers are giving raises mostly in lump sum and bonus payments instead of wage rate per hour hikes. That way they can discontinue paying the lump sums and bonuses more easily in the future.

Apart from applying only to full time permanent employed, the 2.9% is a distortion for tens of millions of workers as well because it is an average. It represents those at the top of wages and salary—the best off 10% of tech, healthcare, and select other occupations getting most of the 2.9%. They may be getting 4% and more. Those in the less preferred occupations get far less than 2.9%, or nothing at all in wage hikes. The average is 2.9%. So at least 100 million wage earners are getting far less than 2.9%–which then needs adjusting for a much higher than reported inflation rate. The result is a real wage gain for 100 million or more that is negative, not 2.9%. But Trump doesn’t bother to explain that. The devil is in the details, as they say.

Here’s another problem with the official government wage data reported in the GDP-National Income numbers you probably never heard of. It reduces the share of wages in National Income even more than is reported officially. According to GDP rules, 65% of the profits of unincorporated businesses (i.e. sole proprietorships, partnerships, S-corps, etc.) are considered wages in the National Income data. That’s right. Business Income—aka profits of non-corporate business—is considered ‘wages’ and added to the totals for wages in the GDP-National Income calculations.

The biggest misrepresentation of wage gains, however, is due to the underestimating of true inflation. What matters is ‘real wages’, what wages can actually buy. Trump’s 2.9% wage increase is not adjusted for inflation. It’s not ‘real’. If CPI inflation is 2.7% and nominal wages are rising at 2.9%, then real wages are actually stagnant at best at 0.2%. And if inflation for the more than 100 million primarily wage earning households is really around 3.5%–given recent hikes in oil and gas prices, rents, healthcare costs, utilities costs, local taxes and fees, etc.—then real wages for the 100 million or so are actually falling by 0.6% or more. Just as they have been falling every year since 2009.

Trump’s ‘Unemployment is at an Historic Low 3.9%’ Claim

Like the numbers for GDP, inflation, and wages there are problems associated as well with Trump’s jobs data claim in his UN Speech. The 3.9% unemployment rate Trump declared as ‘the lowest it’s ever been’ refers to the unemployment rate for only former full time permanently employed workers. (The lowest ever rate was 1.9% in 1944, by the way). The 3.9% excludes the 50 million part time, temps, on call, i.e. what’s called the underemployed. If the underemployed are included the unemployment rate rises to about 8%–in other words more than double the 3.9% for full time permanent workers only.

But both the 3.9% and 8% are still underestimates of the true unemployment in the US at present. In the US, someone is considered unemployed only if they are ‘out of work and looked for work in the preceding 4 weeks’. Otherwise, they’re considered part of what’s called the ‘missing labor force’ and not counted in the 3.9% (or 8%). (Note that being unemployed in the US also has nothing at all to do with whether or not you’re getting unemployment benefits).

Another problem with the 3.9% is that it is based in large part on gross and arbitrary assumptions by government statisticians as to the number of new jobs that were created due to ‘new businesses being formed’. The government assumes hundreds of thousands of net new businesses are created every month, each with a number of employees. But the government just makes an assumption of how many businesses and number of employees. It then adds these assumed numbers to the actual numbers of unemployed counted for a recent month. Worse still, this assumed number of new jobs is based on businesses and jobs created nine months prior to the present. For example, assumed new business formations and jobs back in January 2018 are then plugged into current September 2018 job numbers. That boosts the number of jobs in September, to get the lower, 3.9% unemployment rate. And we’re talking about tens and sometimes hundreds of thousands of net jobs from nine months ago being added to current unemployed totals in the present. In short, boosting job numbers (and thus reducing unemployment to 3.9%) from ‘New Business Formation’ assumptions nine months prior is a way of padding the numbers.

Another set of problems in estimating the 3.9% occurs due to how the Labor Dept.’s household surveys are conducted to provide the 3.9% unemployment rate. The government surveys 60,000 households a month by telephone. But not everyone has a telephone or responds to a government call to participate in the survey. Typically refusing to participate in such government surveys are inner city youth, workers ‘working off the books’ and receiving cash instead of wages, most of the 10 million undocumented workers in the US, itinerant workers without cellphones, and others. In other words, how the government surveys to get its estimated 3.9% unemployment rate is not sufficiently accurate either.

There’s an even greater gap in government estimations of unemployment. There’s still millions more who are not counted at all. Millions of workers in recent years have dropped out of the labor force altogether. Remember, if you’re not working or looking actively for work you’re not even in the labor force. Your ‘joblessness’ is therefore not even considered in calculating the unemployment rate. You may be jobless but you’re not unemployed, given the oxymoron US definition of unemployed. And the number of those who have dropped out of the labor force altogether, and thus not considered in calculating the unemployment rate, in the past decade number in the millions!

There’s what’s called the ‘Labor Force Participation Rate’ (LFPR). It is the percentage of the working age population that is employed or else unemployed and actively looking for work. That’s about 58% of the potential working age workforce in the US at present. But before the 2008 crash the percentage or LFPR was 63%. So 5% of the labor force has somehow ‘disappeared’ during the last decade. They’re not factored in the unemployment rate calculations. They may be without jobs, but they’re not considered unemployed. That 5% decline in the LFPR represents 5% of the total civilian labor force, which is about 165 million. So 5% of 165 million is a massive number of another 8.25 million. Having dropped out of the labor force, it is safe to assume most are unemployed or only temporarily or partially employed. About a million of them were able to arrange permanent social security disability benefits.

Mainstream and government economists try to explain away this massive drop out of the labor force by saying it reflects a growing number of retiring baby boomers. But that’s questionable, since the fastest growing numbers of people entering the labor force today (not dropping out) are workers older than 65 and 70, who are returning to work because they cannot afford to retire on the paltry benefits, 401k pensions, and IRAs they have, or the minimal savings they were able to accumulate since the 2008 crash.

To sum up: If to the ranks to the roughly 6.5 million full time permanent unemployed (the 3.9%) are added the 4% or so underemployed and discouraged, there are officially about 8% of the 165 million that are unemployed. That rate is double Trump’s claim of only 3.9%. But add a further 2%–i.e. the ‘hidden’ unemployed not counted in the underground economy, plus the mis-estimation of unemployment due to government survey methods, plus the million or so who have gone on social security disability, plus the 8 million more who have dropped out of the labor force altogether—and the true unemployment rate is somewhere between 15% and 18%, not 3.9%. But you won’t hear that from Trump, or for that matter from government bureaucrats that create the low ball number, or from the media and press that favorably promote the lowest possible number.

Trump’s ‘Stock Markets are at Record Highs’ Claim

In this case Trump is also lying. He claims that he is totally responsible for the current record highs in the Dow, S&P 500, and Nasdaq stock markets in the USA. Record levels in all the three major stock markets are of course fact. That is not the locus of Trump’s lying. The lie is he claims his economic policies, especially tax cuts and military spending and business deregulation are the direct cause of the record stock market levels. While it is true that Trump’s investor-business tax cuts have contributed in 2018 to boosting stocks. The cuts have reduced US budget revenues by more than $300 billion in just the first half of 2018. The tax cuts have thus far provided an artificial windfall to corporate profits of at least 20%, according to numerous studies. Other studies show that 49% of the tax-profits windfall has gone into corporations buying back their stock and paying more dividends to shareholders. Estimates by Goldman Sachs bank research and other sources are that $1.3 trillion will be spent by corporations on buybacks and dividends. That is a major factor why stocks just keep rising this year regardless of concern about trade wars, emerging markets’ currency collapse, Fed raising rates, the spread and deepening of recessions in key global economies, etc. Trump’s lie, however, is his taking credit for the entire stock bubble, when in fact a wall of money has been handed to investors and corporations ever since 2009 by continuous tax cutting under Obama, free low interest money provided by the Federal Reserve for six years, and other forms of subsidization or business by the US government, which is now the hallmark of 21st century capitalism in America.

Trump’s tax cuts and spending may be boosting stock buybacks and dividends—that in turn keep driving stock prices ever higher. But this policy has been going on since 2010. Every year since 2010, buybacks and dividend payouts have on average exceeded $1 trillion a year. Corporate profits have almost tripled. The Fed kept interest rates so low for so long that corporations, like Apple, borrowed billions by issuing new corporate bonds, with which to buy back its stock, increase its dividends, and invest massive sums directly itself in the stock market—even as it hoarded 97% of its $252 billion in cash offshore.

Trump thus lies when he takes full credit for the stock market at record highs. Obama and George W. Bush before him actually are even more responsible than he is.

Jack Rasmus
September 28, 2018

Jack is author of the book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017, and the forthcoming book, ‘The Scourge of Neoliberalism: US policy from Reagan to Trump’, 2019, also by Clarity Press. He blogs at jackrasmus.com, hosts the weekly radio show, Alternative Visions, on the Progressive Radio network, and tweets at @drjackrasmus.

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posted September 26, 2018
Comparing Crises: 1929 with 2008 and the Next

The business and mainstream press this month, September 2018, has been publishing numerous accounts of the 2008 financial crash on its tenth anniversary. This month attention has been focused on the Lehman Brothers investment bank crash that accelerated the general financial system implosion in the US, and worldwide, ten years ago. Next month, October, we’ll no doubt hear more about the crash as it spread to the giant insurance company, AIG, and beyond that to other brokerages (Merrill Lynch), mid-sized banks (Washington Mutual), to the finance arms of the auto companies (GMAC) and big conglomerates (GE Credit), to the ‘too big to fail’ banks like Bank of America and Citigroup and beyond. These ‘reports’ are typically narrative in nature, however, and provide little in the way of deeper historical and theoretical analysis.

Parallels & Comparisons 1929 & 2008

It is often said that the initial months of the 2008-09 crash set the US economy on a trajectory of collapse eerily similar to that of 1929-30. Job losses were occurring at a rate of 1 million a month on average from October 2008 through March 2009. One might therefore think that mainstream economists would look closely at the two time periods—i.e. 1929-30 and 2008-09—to determine with patterns or similar causes were occurring. Or to a deep analysis of the periods immediately preceding 1929 and 2008 to see what similarities prevailed. But they haven’t.

What we got post-2009 from the economic establishment was a declaration simply that the 2008-09 crash was a ‘great recession’, and not a ‘normal’ recession as had been occurring from 1947 to 2007 in the US. But they provide no clarification quantitatively or qualitatively as to what distinguished a ‘great’ from ‘normal’ recession was provided. Paul Krugman coined the term, ‘great’, but then failed to explain how great was different than normal. It was somehow just worse than a normal recession and not as bad as a bonafide depression. But that’s just economic analysis by adverbs.

It would be important to provide a better, more detailed explanation of 1929 vs. 2008, since the 1929-30 crash eventually led to a bona fide great depression as the US economy continued to descend further and deeper from October 1929 through the summer of 1933, driven by a series of four banking crashes from late 1930 through spring 1933 after the initial stock market crash of October 1929. In contrast, the 2008-09 financial crash leveled off after mid-2009.

Another similarity between 1929 and 2008 was the US economy stagnated 1933-34—neither robustly recovering nor collapsing further—and the US economy stagnated as well 2009-12. Upon assuming office in March 1933 President Roosevelt introduced a pro-business recovery program, 1933-34, focused on raising business prices, plus initiated a massive bank bailout. That bailout stopped further financial collapse but didn’t generate much real economic recovery. Similarly, Obama bailed out the banks (actually the Federal Reserve did) in 2009 but his recovery program of 2009-10, much like Roosevelt’s 1933-34, didn’t generate real economic recovery much as well.

After the failed business-focused recoveries, the differences between Roosevelt and Obama begin to show. Roosevelt during the 1934 midterm elections shifted policies to promising, then introducing, the New Deal programs. The economy thereafter sharply recovered 1935-37. In contrast, Obama stayed the course and doubled down on his business focused recovery program in 2010. He provided $800 billion more business tax cuts, paid for by $1 trillion in austerity programs for the rest of us in August 2011.

Not surprising, unlike Roosevelt’s ‘New Deal’, which boosted the economy significantly starting in 1935 after the midterms, Obama’s ‘Phony Deal’ recovery of 2009-11 resulted in the US real economy continuing to stagnate after 2009.

The historical comparisons suggest that both the great depression of 1929-33 (a phase of continuous collapse) and the so-called ‘great’ recession of 2008-09 share interesting similarities. Both the initial period of the 1930s depression—October 1929 through fall of 1930—and the roughly nine month period of October September 2008 through May 2009 appear very similar: A financial crash led in both cases to a dramatic follow on collapse of the real economy and employment.

But the 1929 event continues on, deepening for another four years, while the latter post 2009 event levels off in terms of economic decline. Thereafter, similar pro-business subsidy policies (1933-34) and (2009-11) lead to a similar period of stagnation. Obama continues the pro-business policies and stagnation, while Roosevelt breaks from the business policies and focuses on the New Deal to restore jobs, wages, and family incomes and recovery accelerates. Unlike Roosevelt who stimulates fiscal spending targeting household incomes, Obama focuses on further business tax cutting—i.e. another $1.7 trillion ($800 billion December 2010 plus another $900 billion in extending George W. Bush’s tax cuts for another two years—thereafter cutting social programs by $1 trillion in August 2011 to pay for the business tax cuts of 2010-11.

The policy comparisons associated with the recovery and non-recovery are clearly determinative of the comparative outcomes of 1935-37 and 2010-11, as are the comparisons of the business-focused strategies 1933-34 and 2009-10 that resulted in stagnant recoveries. But the political outcomes of the policy differences are especially divergent and interesting.

No less interesting are the political consequences for the Democratic Party. Roosevelt’s 1934 campaigning on the promise of a New Deal resulted in the Democrats sweeping Congress further than they did even in 1932. They gained seats in 1934 so that by 1935 they could push through the New Deal that Roosevelt proposed despite Republican opposition. In contrast, Obama retained, and even deepened, his pro-business programs before the 2010 midterms which resulted in the Democrats experiencing a massive loss in Congress in the 2010 midterm elections. Thereafter, the Democrats were stymied by a Republican House and Senate that blocked everything. Obama nonetheless kept reaching out and asking for a compromise with Republicans, but the Republican dog bit his hand with every overture.

Obama pleaded with American voters for one more chance in 2012 and they gave it to him. The outcome was more of the same of naïve requests for compromise, rejection, and a continued stagnation of the US economy. Republicans meanwhile also deepened their control of state and local level governorships, legislatures, and local judiciary throughout the Obama period.

The final consequence of all this was Trump in 2016 as the Obama Democrats promised more of the same in the 2016 presidential election. We know what happened after that.

Consequences for US Midterm 2018 Election
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As yet another midterm election approaches, November 2018, we are once again inundated with mainstream media projections of a ‘blue (Democrat) wave’ coming. But they are today the same pollsters of that same media that were proclaiming in October 2016 that Trump had only a 15% chance of winning the 2016 election. What’s changed that we should believe the pollsters, the media, and the Democrats this time around again that Democrats have the big lead?

Granted, there have been a few notable progressive victories in solid, highly urban constituencies But this does not necessarily ensure their optimistic projections. A likely greater voter turnout in these urban Congressional districts must be weighed against the continued Republican-Trump efforts to deny millions of their voting rights, the continued gerrymandered reality of Republican-led governorships and legislatures, and the massive money machine of ultra-right wing billionaires like the Koch brothers, the Mercers, the Adelmans and other radical right billionaire families behind Trump that is now cranking up to provide a wall of money for Trump sycophants running for office. And let’s not forget those millions of phony religious-moral Americans who support Trump regardless of his misogyny, racism, attacks on the press and immigrants, or his obvious disregard for the even limited democratic institutions and precedents that barely still prevail today in the US. Like Germans who loved Hitler, but not necessarily the Nazi philosophy, they will follow him over any cliff.

Will Millenials now turn out to vote in 2018 when they didn’t in 2016? What have Democrats promised to them this time that they will believe? Why should they think Democrats are any different now? Will Latinos and Hispanics turn out this time, when the Democrats promised last February a ‘line in the sand’ for a Dreamers bill or no approval of the US debt ceiling extension—and then caved in once again? Women and professionals (independents) tired of Trump’s antics and misogyny may come back to vote for the Dems. Maybe some union workers in the Midwest this time, who abandoned Hillary in 2016, as well. But will that be enough?

What will the public think and feel should Trump and his now converted radical Republican party maintain control of the House and Senate for another two years? They’ve been told of the coming ‘blue wave’. But what if that wave dissipates on the reactionary shore that has been deepening in America now for decades? What will the anti-Trump camp do? Say ‘Ok, let’s try again in 2020’? And go away further demoralized?

The opposite outcome in November—a defeat for Trump in the House—will have a similar ‘shock’ to public consciousness, only this time on the right. What will the far right do should it appear that the Dems win the House and announce Trump impeachment proceedings? Trump’s 30% of the electorate are beholden to him only—and not to the remaining, limited democratic institutions of America. He can do no wrong, even if it means dismantling the vestiges of democracy in America.

Should Trump lose the House and face the threat of impeachment, or even an indictment by special prosecutor Mueller, the radical right will mobilize at the grass roots. Bannon at his ilk, fueled by the money of the Mercers et. al., may well shift to popular right wing mass protests and demonstrations. They will want to ‘warn’ the Dems and others to proceed with caution toward impeachment or face the advent of a proto-civil war in the country. A threat of such, if not actual.

The linking of Trump, his wealthy backers, and releasing grass roots Trump supporters into a real street movement will mean yet another step toward a US fascist-like phenomenon. We are not there yet. Trump is not a fascist. To throw around the charge, as a part of the progressive left does, is like crying ‘wolf’ before it actually appears’. If and when it does appear, what should the real wolf then be called?

If Trump is not a fascist he clearly has proclivities toward tyranny and dictatorship: he obviously considers himself above the law (definition of Tyrant), as he has already declared he would pardon himself if indicted. And he clearly identifies with, and is fond of other, authoritarian strong men like Kim, Duterte, and others who rule by dictate. A crisis period Trump administration might be expected to ‘rule by executive order’, with the permission of Congress perhaps. But he is not yet a fascist (as so many progressives mistakenly declare). For that he needs a movement in the streets. Bannon, the Mercers and friends may yet give him that should he be actually impeached.

That street movement may be sufficient to scare the timid liberals and Democrats in Congress from proceeding with impeachment in all but talk should they win the House in November. The leadership of the Democrats will likely back off, once again, should Trump-Bannon turn to the streets. Therefore Democrats, should they win the House, will be all talk and no action. We’ll hear instead the real message, the real strategy: “complete the anti-Trump change by electing a Democrat president in 2020.” Once again, as Trump and the right leverage grass roots movements, the Dems try to funnel all discontent into their re-elections. Trump spends most of his time at rallies in the field. Obama sat on his butt in the White House and was rarely seen or heard.

But hasn’t that been the problem of the last several decades? Republicans link up with the Teaparty, go for the juggler, release the political demons in America always simmering below the surface, mobilize right wing money bags, pervert what remains of democratic institutions, block and thwart all progressive legislation, and ‘kick ass and take names’ of the Democrats—who respond timidly, try to play by the old rules, mouth bipartisanship ad infinitum, and continually retreat in the face of the right wing onslaught

With more than 100 of its Democrat National Committee, DNC, composed of business CEOs and business lobbyists, there’s little chance the Democratic Party will really directly confront Trump and his minions. Should the Democrats even win the House in November, it will be mostly talk of impeachment and token moves for the media, while re-directing discontent to electing still more Dems in 2020 as the real strategy. Meanwhile, Trump and the radical right will continue to mobilize in defense—legislatively, financially, and at the grass roots in increasingly confrontational ways.

To sum up: 1929 gave us Roosevelt and the ‘New Deal’. 2008 gave us Obama and a ‘Phony Deal’. The 2018 midterm elections and the next financial crisis, which is no more than 2-3 years away, may give us Trump’s ‘Final Deal’.

Whether Trump survives November, and his now transformed in-his- image Republican party continues to shield him and allow him to deepen his radical policies, or whether the Democrats take the House and commence talking impeachment proceedings—the result in either case will be a shattering of public consciousness from its prevailing mode once again, as occurred in November 2016. Either way, the next two years will undoubtedly prove more politically unsettling and economically destabilizing than the last.

The Next Crisis

The next financial crisis—and subsequent severe contraction of the real economy once again—is inevitable. And it is closer than many think, mesmerized by all the talk of a robust US economy that is benefiting the top 10% and not the rest. Why so soon?

The answer to that question will not be provided by mainstream economics. They are too busy heralding the current US economic expansion—which is being grossly over-estimated by GDP and other data and which fails to capture the fundamental forces underlying the US and global economy today, a global economy that is growing more fragile and thus prone to another major financial instability event.

The forces which led to the 2008 banking crash were associated with property bubbles (US and global) and the derivatives markets which allowed the bubbles to expand to unsustainable levels, derivatives which then propagated and accelerated the contagion across financial markets in general once the property bubbles began to collapse.

The 2008 crash was thus not simply a subprime housing crisis, as most economists declare. It was just as much, perhaps more so, a derivatives financial asset (MBS, CMBs, CDOs, CDSs, etc.) crisis.

More fundamentally than the appearance of a collapse in prices of subprime mortgages, and even derivatives thereafter, 2008 was a crisis of excess credit and debt that enabled the boom in subprimes and derivatives to escalate to bubble proportions.

But subprimes and derivatives were still the appearance, the symptoms of the crisis. Even more fundamentally causative, the 2008 crash had its most basic origins in the massive liquidity injections by the central banks, led by the US Fed, that has occurred from the mid-1980s to the present. The massive liquidity provided the cheap credit that fueled the excess debt that flowed into subprimes and derivatives by 2008. (And before than into tech stocks in 1998-2000, and before that into Asian currencies (1996-97), and into Japanese banks and financial markets and US junk bonds and savings & loans in the 1980s, and so forth).

Excessive debt accumulation is not the sole cause of financial crises, however. It is an enabling precondition. Enabling the debt in the first place is the excess liquidity and credit. That liquidity-credit-debt buildup is what occurred in the 1920s decade leading up to the October 1929 stock crash. It’s what occurred in the decades preceding 2008, especially accelerating after the escalation of financial derivatives in the 1990s.

Excessive debt creates the preconditions for the crisis, but the collapse of financial asset prices is what precipitates the crisis, as the excessive debt built up cannot be repaid (i.e. principal and interest payments ‘serviced). So if liquidity provides the debt fuel for the crisis, what sets off the conflagration is the collapse of prices that lights the flame.

The collapse of stock prices in October 1929 precipitated the subsequent four banking crashes of 1930-33. The collapse of property prices (residential subprime and also commercial) in 2006-07 precipitated the collapse of investment banks in 2008, thereafter quickly spilling over to other financial institutions (brokerages, insurance companies, mutual funds, auto finance companies, etc.) after the collapse of Lehman Brothers investment bank in September 2008.

Today in 2018 we have had a continued debt acceleration since 2008. As estimated by the Bank of International Settlements (BIS) in Geneva, Switzerland, total US debt has risen from roughly $50 trillion in 2008 to $70 trillion at end of 2017. The majority of this is business debt, and especially non-financial business debt. That’s different from 2008 when it was centered on mortgage debt. It is also potentially more dangerous.

The US government since 2008 has also increased its federal debt by trillions, as it continued to borrow from investors worldwide in order to ‘finance’ and cut business-investor taxes and continue escalation of war spending since 2008. US household debt also rose further after 2008, as the lack of real wage and income growth over the post-2008 decade has resulted in $1.5 trillion student debt, $1 trillion plus in auto and in credit card debt, and $7-$8 trillion more in mortgage debt. Globally, according to the BIS, non-financial business debt has also been the major element responsible for accelerating global debt levels—especially borrowing in dollars from US banks and investors (i.e. dollarized debt) by emerging market economies, as well as business debt in China issued to maintain state owned enterprises and to finance local building construction.

So the debt driver has continued unabated as a problem since 2008, and has even accelerated. Financial asset bubbles have appeared worldwide as a result—not least of which is the current bubble in US stocks. This time it’s not real estate mortgages. It’s non-financial business and corporate debt that is the likely locus of the next crisis, whether in the US or globally or both.

Since 2008 US and global debt bubbles have been fueled once again—as in the 1920s and after 1985 by the excess liquidity provided by the US central bank, and other advanced economy central banks. The central bank, the Fed, alone has subsidized US banks and investors to the tune of $6 trillion from 2009 to 2016, as a consequence of its QE and near zero interest rate policies.

Since 2008, excessive and sustained low interest rates for investors and business have resulted in at least $1 trillion a year in corporate debt buildup, as corporate bond issues have accelerated due to ultra cheap Fed money. The easy money has allowed countless ‘junk’ grade US companies to survive the past decade, as they piled debt on debt to service old debt. Cheap money has also fueled corporate stock buybacks and dividend payouts to investors, which have been re-funneled back into stock prices and bubbles. So has the doubling and tripling of corporate profits from 2008 to 2017 enabled record buybacks and dividend distributions to shareholders.

Most recently, in 2017-18 the subsidization locus has shifted to Trump tax cuts that have artificially boosted US profits by a further 20% and more. As data has begun showing in 2018, most of that is now being re-plowed back into stock buybacks and dividend payouts—this year totaling more than $1.4 trillion, after six years of already $1 trillion a year in buybacks and payouts. That’s more than $7 trillion in distribution by corporate America in buybacks and dividends to its wealthy shareholders.

Where’s the mountain of money provided investors all gone? Certainly not in raising wages for workers. Certainly not in paying more taxes to government. It’s been diverted into financial markets in the US and globally—stocks, bonds, derivatives, currency, property, etc.—into mergers & acquisitions in the US, or just hoarded on balance sheets in anticipation of the next crisis approaching. Or sent into emerging markets (financial markets, mergers & acquisitions, joint ventures, expanding production, etc.) when they were booming 2010-2016.

So where will the financial asset prices start collapsing in the many bubbles that have been created globally and in the US so far—and thus precipitating once again the next financial crisis? The BIS has been warning to watch US corporate junk bonds and leveraged loan markets. Watch out for the new derivatives replacing the old ‘subprimes’ and CDSs—i.e. the Exchange Traded Funds, ETFs, passive index funds, dark pools, etc. Watch also the US stock markets responding to US political events, to a real trade war with China perhaps in 2019, a continuing collapse of emerging market economies and currencies, to a crisis in repayment of non-performing bank loans in Italy, India and elsewhere, or a tanking of the British economy in the wake of a ‘hard’ Brexit next spring, or Asian economies contracting in response to China slowing or its currency devaluing, or to any yet unseen development. Collapsing prices in any of the above may be the origin of the next financial asset contraction that will spread by contagion of derivatives across global markets. And the even larger debt magnitudes built up since 2008 may make the eventual price deflation even more rapid and deeper. And the new derivatives may accelerate the contagion across markets even faster.

The financial kindling is there. All it now takes is a spark to set it off. The next financial crisis is coming. The last decade, 2008-18, is eerily similar to the periods 1921-1929 and 1996-2007.

Only now it will come with the US challenging foreign competitors and former allies alike as it tries to retain its share of slowing global trade; with a US economy having devastated households economically for a decade; with a massive US federal debt now $21 trillion and going to $33 trillion due to Trump tax cuts; with a US crisis in retirement income, healthcare access and costs, and a crumbling education system; with an economy having created only low pay and mostly contingent service jobs; with a virtually destroyed union movement; with a big Pharma initiated opioid crisis killing more Americans per year than lost during the entire 9 year Vietnam war; with a culture allowing 40,000 of its citizens a year killed by guns and doing nothing; with an internal transformation and retreat of the two established political parties; and with a Trump and right wing radical movement ascendant and poised to move to the streets to defend itself.

Jack Rasmus
September 24, 2018

Dr. Rasmus is author of the forthcoming book ‘The Scourge of Neoliberalism: US Policy from Reagan to Trump’, Clarity Press, 2019. He blogs at jackrasmus.com and his twitter handle is @drjackrasmus. (For a more detailed analysis of the similarities and differences between 1929 and 2008, and how Roosevelt and Obama treated the crisis differently, read the except from Dr. Rasmus’s 2010 book, ‘Epic Recession: Prelude to Global Depression’, Plutobooks, now posted on his website, http://kyklosproductions.com).

posted September 16, 2018
Anniversary of the 2008 Lehman Brothers: Did the Fed and Treasury Engineer the Banking Crash?

(Excerpt from ‘Epic Recession: Prelude to Global Depression’, by Dr. Jack Rasmus, Pluto books, 2010

DID JP MORGAN CHASE AND THE FED ENGINEER THE COLLAPSE OF BEAR STEARNS?

Bear Stearns was especially dependent on day to day funding from the big commercial banks like JP Morgan Chase and others. As Bear Stearns’ stock plummeted it had to use up virtually all its capital. As it did, other commercial banks began to refuse to loan it overnight funds in order to keep operating. Other shadow bank investors like Hedge Funds with money in Bear Stearns began pulling out their funds. What this represented was a kind of ‘wholesale’ or institutional run on the bank in the case of Bear Stearns. It was about to go bankrupt. Were Bear Stearns a commercial bank and thus a member of the Federal Reserve system, the Fed could have provided funds to it through its recent TAF auction or by other direct means. But at this time the shadow investment banks like Bear were not members of the Fed system and could not join even if they wanted. Bear Stearns also ‘owed’ other banks and financial institutions. Had it simply gone bankrupt, that would have resulted in additional major losses of those other institutions at a time during which their losses were growing rapidly for other reasons. The chain-reaction of losses and bank defaults might have been serious.

The Fed at this point, in mid-March 2008, intervened unilaterally, redefining its own charter to cover the investment bank segment of the shadow banking sector. It ‘arranged’ for the sale of Bear Stearns to JP Morgan Chase at firesale $2 per share prices, or about $236 million, a total value more than a billion less than Bear Stearns’ Manhattan, New York, office building. The Fed gave JP Morgan $29 billion to ensure the deal. Morgan would not even have to put up its own collateral, the Fed allowing it to use Bear Stearns assets instead. In short, JP Morgan Chase was given Bear Stearns virtually free, hand-delivered by the Federal Reserve. In arranging the firesale of Bear Stearns to Chase, the Fed entered new territory as ‘lender of last resort’. It gave the signal that banks, even shadow banks, henceforth would not be allowed to fail. Morale hazard was no longer a factor to the Fed.

The bankruptcy of Bear Stearns set off instability in other areas, including globally. In addition to the $29 billion Bear bailout, the Fed instituted new emergency lending facilities for primary dealers-investment banks-brokers and put up another $300 billion in funding. It also arranged $36 billion in swap loans to European central banks.

With the Bear Stearns bailout, the Fed had used up half of its available $850 billion of resources on hand. Having ‘shot off its big gun’ it retreated temporarily to the sidelines. Bernanke’s public position at this point was that banks and shadow banks still experiencing growing losses should now raise private capital on their own and not expect a bailout. But failing banks tend to have trouble raising capital, to say the least. And the new Fed policy of mass liquidity injection and bailout had now been set in motion. Market speculators were not fooled by talk of banks’ raising capital on their own. and would soon test the limits of the Fed’s new liquidity policy.

For a few months, in April-May 2008, it appeared the financial crisis had somewhat stabilized. The temporary effects from the fiscal stimulus bill passed in February were also entering the economy. That stimulus and continuing expansion in world trade, and thus exports, together appeared to prop up the real economy, which recorded a moderate rise in GDP. But it was a weakest of recoveries, and sustaining it was never a question. It had dissipated in three months. The real economy continued to deteriorate below the surface throughout the spring of 2008 and into the summer. Nearly a year of credit tightening, slowing industrial production, and steadily rising jobless for seven straight months was taking a deeper toll on the real economy.

By June 2008 the decline of the real economy began to reappear. Debt loads were rising for banks, consumers and businesses alike. Prices were beginning to slow and level off. The exports and commodities boom was over. Unemployment was rising faster. Signs were growing the fiscal stimulus package passed in February was beginning to run out of steam. Oil, commodity, and export prices were starting to unwind. Bank lending to non-financial businesses was falling at a 9.1% annual rate—the fastest since 1973. Rates on corporate loans, investment grade bonds, and residential mortgages were rising—a reflection of the growing financial fragility of borrowers. Financial fragility and consumption fragility were both continuing to deteriorate. Meanwhile, short sellers and speculators were sharpening their knives, preparing to go after the next subprime burdened financial institution. By late June 2008 their next target was clear: the quasi government agencies, Fannie Mae and Freddie Mac, who were required by law to buy up bad mortgages and were now becoming overloaded as private sector lenders in effect transferred their debt and falling financial assets to the government quasi agencies, Fannie and Freddie.

In July 2008, the renewed financial instability focused on Fannie/Freddie. A new phase in the financial crisis was about to emerge. In July the lead role as ‘lender of last resort’ shifted from the Fed—now on the sidelines trying to absorb the Bear Stearns bailout and the other emergency auctions initiated in March—to the U.S. Treasury and its Secretary, Henry Paulson.

HANK PAULSON & GOLDMAN SACHS ‘CASH-IN’ on LEHMAN BROTHERS

Former CEO and Chairman of the largest Investment Bank, Goldman Sachs, and billionaire banker, Henry Paulson, was brought into the Bush administration at the end of June 2006. His prime task was to complete the deregulation of the financial sector. Initiated under Reagan, financial deregulation accelerated into high gear under Clinton in 1999-2000 with the repeal of the 1930s Glass-Steagal Act and its replacement with Gramm-Bliley in 1999 and the passage of the Commodities Modernization Act soon after. The federal regulatory structure for banks and shadow banks was largely eviscerated by 1999-2000. Investment banks like Goldman were removed altogether from Securities and Exchange Commission (SEC) oversight. But state-level regulators were still an obstacle and annoyance.

Paulson’s first task was to clear the decks of this remaining obstacle on the road to total and complete financial deregulation. One of his first efforts in office was to form a Committee on Capital Markets Regulation (CCMR) along with other big financial institution players. The CCMR issued its 148 page report in November 2006. At the same time Paulson addressed the Economic Club of New York explaining the objectives of the report was to put in place curbs on state regulators, like New York’s Eliot Spitzer and others. The report came up with 32 specific recommendations for legislation, and called for a basic change in financial regulatory policy that would focus on “the soundness of the financial system” instead of individual institution’s acts of wrongdoing. Regulators at the SEC and elsewhere would henceforth have to do cost benefit analyses for every rule, economists would replace lawyers on the staff, and the federal government would be given power to block indictments by state regulators. Paulson and the Treasury held a conference in early 2007 to push the proposals further toward legislative enactment. It was followed by a recommendation by the Paulson-headed ‘President’s Working Group on Financial Markets’ that the hedge fund industry, now with nearly $2 trillion in assets, should not be regulated. Nor should the government levy taxes on hedge funds and private equity firms, another new form of shadow banking. Such was the mindset of the man who the Bush administration would call on to bring discipline and regulation to the banking system once it began to collapse.

A final ‘coup de grace’ for financial regulation, the Supreme Court added its weight to efforts to silence state regulators who were now increasingly warning of growing financial irregularities and pending crisis. The Court ruled in April 2007 that mortgage subsidiaries of national banks were no longer subject to state regulators. States were thus stripped of the authority they had exercised for thirty-five years.

Once the subprime mortgage bust occurred in early August 2007, Paulson had little to say and did even less, leaving action to the Fed. In October 2007 in another speech he called for better monitoring of mortgage brokers, but added a new ‘regulatory blueprint’ would take years to develop and implement.

Paulson, like Bernanke at the time, was deeply committed to ‘voluntary’ solutions to the crisis, advocating that banks ‘pool’ their remaining assets as a defense to the crisis. Some of the larger banks attempted to do so, forming a ‘superconduit fund’, called the Master Liquidity Enhancement Conduit, or MLEC. As for homeowners, now beginning to default in increasing numbers and foreclose, Paulson’s answer was ‘voluntary action’ by lenders in which they would renegotiate loans. When Sheila Bair, head of the FDIC, proposed to freeze interest rates temporarily on 2 million mortgages, Paulson opposed vigorously. Instead, he led Bush efforts to launch what was called the ‘HOPE NOW Alliance Plan’ for voluntary mortgage relief. The New York Times called the Paulson plan “too little, too late, too voluntary”, designed to create the appearance of action to undercut more aggressive proposals pending U.S. House of Representatives bills introduced in November-December 2007. Outside experts, like Harvard University bankruptcy expert, Elizabeth Warren, called the Paulson proposal “the bank lobby’s dream”.

Paulson continued to sit on the sidelines in early 2008 as the Fed struggled to get ahead of the crisis curve in the weeks leading up to the Bear Stearns collapse in mid-March 2008. In March the Fed originally requested that Paulson and the Treasury bail out Bear Stearns, but Paulson refused, putting forward the excuse the Treasury could do nothing without an Act of Congress.

In a U.S. Chamber of Commerce speech in March after the Fed’s bailout, Paulson continued to argue that Investment banks should not be regulated like commercial banks, adding “recent market conditions are an exception to the norm” and it was premature to attempt a system-wide bank stabilization effort. Instead he referred to his ‘Blueprint’ for a new deregulated system and proposed that oversight of state banks should be reassigned from the FDIC to the Federal Reserve and Bernanke. That blueprint also proposed replacing the Securities and Exchange Commission, SEC, tasked with bank regulation since the 1930s, with a “self regulating organization, an industry group that develops and enforces rules of conduct and business standards…”

In other words, even after the collapse of Bear Stearns—an event which clearly signaled that other Investment banks, many hedge funds, and mortgage lenders were in deep trouble and were already technically insolvent—Paulson kept pushing the Bush party line of financial deregulation as he had from first entering office as Treasury Secretary a year earlier. He pushed for voluntary self-rescue by the banks and voluntary renegotiation of mortgages—neither of which remotely happened. Paulson’s main proposal for dealing with the growing financial crisis was for the banks to ‘raise capital’ on their own to offset the deepening losses on their balance sheets.

Paulson the champion of financial deregulation, of hands off and voluntary solutions, and of the view banks should rescue themselves was, in a matter of days, thrust into the opposite role, in which he would perform even more questionably. It all began with the crisis of the quasi-government mortgage agencies, Fannie Mae and Freddie Mac, in early July 2008. That date marks the beginning of the road to the banking panic of 2008 in September-October and to a subsequent virtual shutdown of the financial system.

By law Fannie and Freddie are required to buy up mortgages. Before the crisis erupted, they were limited to buying no more than 40% of mortgages issued. By June 2008 that had risen to more than 80%. Like private mortgage lenders and financial institutions, Fannie/Freddie resold $1.7 trillion bundled mortgages, but in their case directly as U.S. securities to investors, banks, and central banks around the world. Thus bad subprimes bought by the agencies were recycled globally, tying financial institutions worldwide into the web of bad mortgage debt. By summer 2008 the two agencies found themselves with a total of $5.3 trillion in liabilities, but with only $81 billion in reserves. That meant reserves equal to only 1.6% of the mortgage liabilities they owned or guaranteed. It was a classic case of severe and sharply deteriorating financial fragility.

As it became increasingly apparent Fannie/Freddie were taking on more and more ‘bad’ debt investors became more concerned the two agencies could not cover their multi-trillion dollar liabilities with their miniscule liquid funds on hand. With housing prices continuing to fall and foreclosures rise, in early July analysts estimated losses by Fannie/Freddie over the coming year ranging from $100 to $300 billion. It was a perfect scenario for speculators and short sellers to jump in and repeat the process that drove Bear Stearns into financial oblivion, and which was now eating away at other I-banks like Lehman Brothers, Morgan Stanley and others. The big attack came the week of July 7-11 as speculators began aggressively short selling their stock. The commodities speculation boom was now over; there was even more available liquidity now with which to speculate by short selling. Fannie/Freddie was the target.

In the days immediately leading up to July 11, Paulson repeatedly proclaimed that the two agencies had sufficient capital, were voluntarily raising more, and that no rescue of the agencies was necessary. Of course, Paulson never bothered to explain how companies with such a collapse in stock prices might be able to ‘raise capital’. By the end of the week of July 7-11, Fannie Mae’s stock price was down 76% over the previous year, and Freddie’s had fallen 83%. Nevertheless, as late as July 10 Paulson was publicly stating there was no anticipation of the need for a bailout. As he publicly declared, “For market discipline to effectively constrain risk financial institutions must be allowed to fail.”

Over the weekend of July 12-13, Paulson did an about-face. When markets opened on Monday, July 14, Paulson and Bernanke together announced a plan that guaranteed the government would not allow Fannie/Freddie to fail. The plan required that Congress provide $300 billion of bailout funding. Paulson graphically explained he wouldn’t need to use the $300. It was just his ‘bazooka’, he said, the threat of which would prove sufficient to deter collapse of the agencies. Until Congress passed the funding, the Fed provided interim emergency loans to the two agencies from its ‘discount’ window and the newly established Fed special auction. Paulson also proposed the U.S. Treasury buy the two agencies’ public stock, thus propping up their stock prices, if necessary.

Congress passed an emergency housing industry law in late July. In it were provisions for $100 billion immediately and up to $300 billion later to bailout Fannie/Freddie if needed. Paulson said he wouldn’t need to use it; that the mere option of its availability would prove sufficient to calm the speculators, markets and investors. He was wrong again. Throughout August short sellers were driving the agencies’ stock prices down to record lows. Sometime in August Paulson shifted to bailout. At the end of the first week of September, he shot off his bazooka and bailed out Fannie/Freddie. The shot was heard ‘round the financial world. Now it was crystal clear the Fed and Treasury policy was to bail out whatever financial institution was in trouble. Bear Stearns was not an aberration, one time event. It was now all about helicopters and bazookas.

What explains the 180 degree shift by Paulson? One plausible interpretation is that foreign investors, banks, and central banks that had accumulated $1.7 trillion in Fannie/Freddie agency debt began to panic and demand Paulson take action to ensure Fannie/Freddie wouldn’t collapse. As the two agencies’ stock prices fell to single digits, Paulson stepped in to protect foreign bond holders. Failure to placate foreign bond holders could well mean a sharp decline in their purchase of U.S. bonds needed to finance the continually rising U.S. budget deficit, which was about to accelerate by trillions in the next year. But by protecting bondholders in the Fannie/Freddie bailout and allowing preferred and common stockholders to lose everything, Paulson doomed the rest of the investment banks to the short seller wolves. With stockholders seeing the writing on the wall, they were now more than ever willing to sell their stock, creating the perfect situation for short sellers. It also made it virtually impossible for Fannie/Freddie or any investment bank to voluntarily raise equity capital. The manner in which Paulson handled the Fannie/Freddie bailout exacerbated the pressures on the investment banks. Then bailing out just the bondholders worsened the situation. In short, Paulson bungled the process.

By the Fed bailing out Bear Stearns and the Treasury Fannie and Freddie, Bernanke and Paulson thought it would restore confidence in the institutions and the financial system in general. All it did was encourage speculators to go after the remaining I-banks more aggressively. It was now the end of the first week of September and the worse was yet to come.

Between the first and second weeks of September the stock prices of all the remaining investment banks went into freefall. The ‘raise capital voluntarily’ strategy of the preceding three months thus collapsed with the collapse of banks’ stock. In other words, financial fragility was rapidly worsening as a consequence of the bailouts of Bear Stearns and Fannie-Freddie. The remaining large investment banks—Merrill Lynch, Morgan Stanley, Goldman Sachs, Lehman Brothers, and others—were also in big trouble by September. The most serious was Lehman Brothers, an investment bank with $639 billion in assets but with leveraged debt of 30 to 1 and most of that in subprimes, commercial property, and leveraged buyout loans. Of all the investment banks, Lehman was also the most exposed to securitized assets in general. Between 2003-2007, Lehman had securitized $700 billion in assets—85% of which ($600 billion) were residential. 40% of its subprimes were delinquent. And by September Lehman had less than $20 billion in liquid resources on hand and couldn’t raise capital despite multiple attempts to do so. Lehman sought desperately to sell its best assets at firesale prices to raise capital, even seeking buyers in Korea, Japan and China. But all walked away from deals. It then tried to get the Fed to extend it status as a bank holding company (as the Fed did for Bear Stearns) to allow it access to emergency Fed auctions and funding. But the Fed refused.

One might reasonably ask why were short sellers and other speculators intent on driving down stock prices of I-banks like Lehman when it might result in the latter’s collapse? The answer is yet another example of speculation in financial assets running rampant. Investors after 2000 were able to purchase derivatives called ‘Credit Default Swaps’, or CDSs. This was originally conceived as insurance against the collapse of a company. If the collapse occurred, those who bought CDS contracts as insurance would be paid off. But CDSs soon evolved into more than insurance contracts. They became a form of investment gambling. CDS contracts had zoomed to $60 trillion worldwide in less than a decade. Speculators were increasingly buying CDS contracts as a ‘bet’ that a company would in fact fail and they’d receive a payoff. CDS purchases typically totaled even more than a company was worth. CDS betting thus presented an incentive for speculators to drive a company into bankruptcy by short selling. Speculators could make money as the stock price fell, and then again when the company collapsed Short sellers made money on driving down stock prices. But as stock prices fell, CDS prices escalating in value. Speculative profits were thus possible in both directions simultaneously—on stock asset price collapse and CDS asset price inflation—in a dual kind of betting. All this amounted to speculating on speculation—i.e. ‘casino investing’.

The Bush administration for years resisted any effort to regulate CDS trades. There was no public market for CDSs and thus no regulation possible. Trades were conducted privately and no one knew for certain, least so the government, where the trades were made and for how much or how many parties there were to a trade. Nor was the Bush administration willing to do much about the growing number, weight and influence of short sellers. Once the commodities boom ended in the spring of 2008, more short sellers entered the market attacking the investment banks’ stock prices. The Bush SEC had placed token limits on short selling earlier in the year. The SEC then allowed those limits to expire in mid-August, which resulted in even more intensified short selling of Fannie, Freddie, Lehman and other banks’ stock. Lehman stock in particular came under massive short selling pressure between September 8 and 12.

On September 15 the Treasury held an emergency meeting to which 30 top banks globally were invited to try to arrange a buyer for Lehman. At first Bank of America appeared interested. But Merrill Lynch quickly offered itself to B of A on terms the latter could not refuse, and B of A bought Merrill instead of Lehman. There were potential buyers for Lehman and it could have been bought. The lynchpin of the problem was the Treasury refusal to ‘insure’ the deal for any of the buyers—just the opposite of the insured deal JP Morgan Chase got from the Fed with the Bear Stearns bailout. Lehman in contrast was allowed to go bankrupt. But before it was announced the following Monday, the banks were allowed a special four hour trading session to hedge their possible losses with CDSs and other derivatives. Lehman was history that following Monday. Within days the fall of Lehman set off a collapse of a string of financial institutions. Biggest was the insurance giant, AIG, which the government then bailed out quickly for $123 billion (later extended to more than $180 billion).

A key, still unanswered question is why Paulson supported the Fed bailout of Bear Stearns prior to Lehman’s collapse and AIG immediately after, but allowed Lehman itself to collapse? One possible answer is that Bear Stearns and AIG were both heavily involved with CDSs, while Lehman was overexposed to subprime and commercial mortgages and leveraged loans but not particularly exposed to CDSs. Could it be then that the problem wasn’t that AIG and Bear were ‘too big to fail’ but that the CDS derivatives market was ‘too big’?

Another explanation is that Goldman Sachs, Paulson’s old company where he was previously chairman, had heavily invested in Bear and stood to lose billions if it went under, whereas Lehman was Goldman Sachs’ main competitor. But estimates of a Lehman bail out were no more than $85 billion, less than half that spent on AIG a few days later. Then again, AIG was one of the biggest players in CDSs. Arguments by Paulson that bailing out Lehman would have created a ‘bailout culture’ are simply not convincing; that culture had already been created with Bear Stearns and Fannie/Freddie.

The decision to let Lehman collapse was, in the last analysis, Paulson’s. To his bungled handling of the Fannie and Freddie bailouts was thus added his even greater misstep with Lehman. But it would not be his last. Lehman’s mid-September failure set off the banking panic of 2008. Unlike Fannie/Freddie, where stockholders lost everything but bondholders were protected, with Lehman bondholders also lost everything, months later only recovering 8 cents on the dollar. Only those who held derivatives on Lehman were first in line to claim whatever assets were left—i.e. to recall, the big 30 banks that Paulson brought together on the eve of the Lehman collapse whom Paulson allowed 4 hours to buy CDS claims to hedge their losses before the Lehman bankruptcy announcement. They lost little, if anything. In contrast to bonds and stocks, CDS claims delivered 91 cents on the dollar. But of course that’s not ‘insider trading’.

The Lehman collapse and how it was allowed to unwind exacerbated an already deteriorating state of confidence in the banking system’s future. Now no one knew for certain what the government’s policy was—bailout if ‘too big’ or let them fail if too big. Paulson’s handing of it in effect created the worse of both worlds.

In quick succession a series of other banks either folded or were absorbed into others. Washington Mutual, Wachovia, Merrill Lynch, AIG—all quickly imploded. The case of AIG is of particular interest. This time Paulson didn’t call in the CEOs of the leading banks to his office to mutually decide. He brought in only his old alma mater, Goldman Sachs. To recall, AIG was deeply exposed to CDSs. And Goldman Sachs was deeply exposed to AIG. Paulson not only bailed out AIG—he bought them out! AIG was bought by the government, the U.S. Treasury, for 100 cents on the dollar! Full price. No negotiations and no ‘’haircuts’ for those exposed to AIG—one of the most exposed of which was Goldman Sachs, the only bank allowed in the decision with Paulson the weekend before the AIG announcement. Initially the cost of the AIG bailout was $123 billion for taxpayers. Shortly thereafter the terms were adjusted more favorably to AIG and even more money was doled out to them. Still another dose followed. The sharp contrasts between the way Lehman was handled and the way Paulson ‘resolved’ the much larger AIG crisis raise interesting questions—especially given the presence of Goldman as the only bank present in the decision to take over and bail out AIG.

Following the collapse of AIG and the big banks, the run by institutions and ‘wholesalers’ on shadow banks spread rapidly to other financial institutions and markets. Hedge funds were hard hit by the Lehman failure. They held 32% of the entire $60 trillion CDS market. Withdrawals of investors from the funds accelerated, forcing the funds to freeze withdrawals. They would quickly lose $600 billion in withdrawals. Almost immediately hedge funds therefore began selling their assets. The prices for loans for leveraged buyouts also began to collapse. Money Market Funds with their $4 trillion in assets began experiencing withdrawals and one of the largest funds, Primary Reserve, nearly went bust. The Commercial Paper market shut down. Nearly all securitized consumer credit markets collapsed. The stock market plummeted with the Dow Jones experiencing a series of its worst days on record.

In other words, asset price deflation was rapidly spreading to other sectors of the shadow banking system. In contrast, prices of CDSs soared, delivering super-profits to gamblers and speculators that bought. Foreign banks began withdrawing funds from the U.S. banking system as well, as the banking crisis spread rapidly in Europe with failures of British, Belgian and Iceland banks. Registering massive losses, U.S. banks, traditional and shadow, began freezing credit. No longer a credit crunch, the system entered a phase of virtual credit crash after September 19, 2008. The credit crash accelerated the transmission of the financial crisis to the real economy. Mass layoffs quickly followed in November and December, continuing through the first half of 2009. Financial fragility had ‘fractured’ seriously with the events of September-October 2008. Mass layoffs meant consumption fragility was now about to deteriorate further as well, as credit to households collapsed while disposable income fell.

On September 19 Paulson proposed to Congress that it give the Treasury $700 billion to use to buy up bad assets of the banks in order to resolve the crisis. At first Congress balked and rejected the bill. Paulson’s proposal was a simple one page request, saying nothing about how or where the $700 billion was to be spent. It was essentially a blank check for him to sign and spend as he alone determined. After the ‘no vote’, it was revised. Between the first and second votes a massive business lobbying campaign descended on Capitol Hill. Legislators were threatened with a financial Armageddon, for which they would be solely responsible should the bill not pass. The $700 billion was all necessary, Paulson argued, in order to buy the ‘bad assets’ on the balance sheets of banks. Cleaning up the bad assets was necessary, he argued, in order to get the banks to begin lending again—both to homeowners and the mortgage markets and to general business. The government relented and gave him his $700 billion check, with the understanding he would buy the bad assets on banks’ books and thereby end the credit crash.

With the money in hand he set out to purchase the assets. He soon found that $700 billion was far too little. The value of the assets on banks’ balance sheets that had collapsed were worth at least $4 trillion, as was later revealed by IMF and other independent estimates. Worse, the banks themselves didn’t want to sell them! That is, unless Paulson and the government was interested in buying them at the prior, full purchase market value! The banks were keeping the assets on their books at inflated, above market price. They had no incentive to sell them at market prices and register even greater losses in doing so. They wanted Paulson to buy them at above market price.

This of course posed a serious problem for Paulson. If he purchased assets worth 50 cents or even 10 cents on the dollar he would be charged with providing a windfall profit to the banks purchasing the assets well above what they were worth. Besides, the $700 billion would hardly dent the $4 trillion, and the problem would still remain. But the banks wouldn’t sell at the true market value of the assets. If they did, then they would have to write down trillions $ more on their balance sheets, which were already deep in the red. There would be no doubt they were insolvent in that case. So it was a standoff. Banks wouldn’t sell at true market value; Paulson couldn’t buy at their inflated initial purchase value. The bad assets remained on the books—and continued to grow. Bank balance sheets continued to deteriorate as the value of housing prices, mortgage bonds, and other securities continued to collapse in value as housing, stock market, and various securitized asset prices continued to fall.

Congress repeatedly requested information what he was doing with the $700 billion in the weeks following the passage of the $700 billion, now called the Term Asset Relief Program, or TARP for short. Unable to buy the assets and clean up the banks’ balance sheets—which all agreed was the necessary first step to get ‘credit flowing again’ as the bankers’ favorite phrase goes—Paulson instead threw $125 billion at the nine biggest banks. He called their CEOs to his office and told they had to take the money whether they wanted to or not. He followed the disbursement by another roughly $125 billion to scores of regional and smaller banks. None of the $250 billion was used to purchase bad assets. Another $80 billion or so went to AIG in several installments. Tens of billions more to Citigroup and Bank of America in November. Nearly $20 billion to auto companies. By February 2009 less than $190 billion of the $700 remained. Once again, none of it expended to purchase ‘bad assets’.

To sum up his performance, Paulson’s term in office amounted to a series of actions that did nothing to address or correct the crisis, and actually served to exacerbate it. His errors were both strategic and tactical. Right up to August 2007 he continued to push financial deregulation, when it was clear deregulation was contributing to the problem of financial fragility and instability. He then did virtually nothing for nine months after the crisis evolved, deferring to Bernanke and the Fed. His one weak foray into the crisis in 2007 was to push Bush’s plan to get banks and mortgage lenders to voluntarily renegotiate mortgages, announced in December 2007. Reportedly that no more than 50 such mortgages were ever reset under this plan. He stood by and played cheerleader to Bernanke as the Fed bailed out Bear Stearns distributed $400 billion to banks, including those offshore, in March 2008. After March he pushed once again for banks to voluntarily raise capital on their own, even as speculators were hammering their stock prices throughout the summer of 2008. He did nothing to limit short sellers, and in fact opposed measures that would have reduced their impact. When thrust to the fore in the case of Fannie Mae and Freddie Mac in July, he repeatedly denied they needed government bailout, said publicly he would not use the $300 billion allocated by Congress if it were given to him, publicly signaled if he did bail them out, he would protect bondholders only, which accelerated the dumping of their stock and the short selling. He then totally reversed himself and bailed out the agencies in early September. The flip-flopping and dragging out of the bailout decision fueled the speculation in their stock that doomed Fannie/Freddie. It also fueled speculation in the stocks of investment banks like Lehman and others, pushing them past the point of no return in September.

Bailing out Fannie/Freddie after insisting no more bailouts would occur, then switching 180 degrees and refusing to bail out Lehman destroyed whatever confidence might have been restored by consistent Fed-Treasury policy action. After letting Lehman collapse he then reversed a second time and bailed out AIG, in a process that was highly suspect given the presence of only one bank, Goldman Sachs, participating in the decision. Paulson thereafter panicked Congress into providing the $700 billion TARP, which he never put to the use authorized, but instead partially dissipated on a string of piecemeal rescue efforts. As former IMF economist, Simon Johnson, commented in January 2009, “How cold a person with so much market experience be repeatedly at the center of such major misunderstandings regarding the markets…”. Following the TARP fiasco, Paulson steadily slipped into policy oblivion, as Bernanke and the Fed came assumed center stage once again in bailing out the banks.

While Paulson would not spend the full TARP $700b allocated by Congress, and eventually restore $300b of it back to the US Treasury in 2009, the Fed’s Bernanke would expend $6 trillion in Quantitative Easing (QE) Fed direct buying of bad assets from banks and investors (and above their market prices) from 2009 through 2016. The Democrat Party controlled Congress in 2009 would help as well–by allowing banks to suspend normal ‘mark to market’ accounting practices to cover up their then serious losses (to make the banks appear better off than they were in fact in order to get investors to start re-buying collapsed bank stocks). Phony Fed bank ’stress tests’ would serve the same purpose, to encourage bank equity price recovery. Paulson achieved nothing–except ensuring a massive tens of billion of dollars for his former company, Goldman Sachs, by bailing out AIG and ensuring the latter paid off the CDSs it sold to Goldman Sachs.

posted September 8, 2018
The Myth of Rising Wages in America

This Labor Day 2018 marks yet another year of declining living standards for American workers. If one were to believe the media and press, rising wages belie that statement. The Wall St. Journal, August 1, 2018 trumpeted ‘US Workers Get Biggest Pay Raise in Nearly Ten Years’.

But here’s why that media spin is a misrepresentation of reality.

Labor’s Falling Income Share

If wages were rising, why is it that labor’s share of total national income has continued to fall for nearly 20 years, including this past year? At about 64% of total national income in 2000, it has steadily plummeted to around 56% of today’s roughly $16 trillion national income. That decline has not just been a result of the 2008-09 great recession; half of it occurred between 2000 and 2008. So it is a long term secular trend, rooted in today’s 21st century US capitalist system and not a recent phenomenon.

A drop of 8% in income share for Labor might not seem much in simple percent terms. But 8% of $16 trillion is just short of $1.5 trillion a year. In other words, workers have come up short $1.5 trillion in 2017-18; if their share had remained at 64% they would have $1.5 trillion more in their pockets today than they actually have. That $1.5 trillion of Labor Share decline represents a loss, at minimum, of $8,000 a year or more per worker. But the $1.5 is also an underestimation.

‘Labor’s Share’ as defined by the government (Labor Dept. and Congressional Budget Office) includes the salaries of managers and senior executives, year-end bonuses of bankers, lump sum payments to executives, and other forms of non-wage income. True wages income—i.e. of non-management, non-supervisory worker—is a subset of this expanded official definition of Labor’s Share. But if executives, managers and bankers’ forms of salary and pay categories of Labor’s Share have been rising rapidly—which they have—in net terms then true wage incomes have fallen even more than the $1.5 trillion. Take out the executives’ and managers’ share of the Labor Share of national income, and the lost per year per worker likely exceeds $10,000.

But that’s not all. Even when considering true wage incomes of non-management, non-supervisory workers (about 82% of the total labor force), wage gains that have occurred have been skewed strongly to the top 10% of the remaining working class households—i.e. professionals in tech, health care and finance, those with advanced college degrees, etc. By averaging in the wage gains of the top 10% of the working class with the rest, the wage gains of the 10% offset the wage stagnation of the rest. The true negative wage stagnation and decline for the ‘bottom’ 90% wage earners is thus even greater. That’s about 133 million of the 162 million labor force. In other words, the wage incomes of the 133 million have lost even more than the $1.5 trillion of Labor’s Share decline, when excluding the net wage gains of the top 10% of the working class. That means the 133 million have lost even more than $10,000 a year per worker.

And here’s another reason why even the $1.5 trillion is an underestimation: the US National Income Accounts from which Labor v. Capital shares of total US income are calculated, overstates the ‘Wages and Compensation’ category of national income. Other major categories are corporate profits, interest, rent, and what’s called ‘business income’. Business income is really profits for non-incorporated businesses (sole proprietorships, partnerships, etc.). Business income should be included in calculations of profits but isn’t. More important, 65% of business income/profits is instead defined as ‘wage income’ in the US National Income accounts. That means, in effect, profits are defined as wages, thus over-stating wages, while under-stating profits. Both the under- and over-stating results in a lesser share of total National Income going to capital incomes and, simultaneously, a larger share registered as wages. And that means a significant greater magnitude of decline for Labor’s Share of Income than even the $1.5 trillion annual official estimate.

Weekly Earnings v. Wages

Media conflating of weekly earnings with wages is yet another way that wage gains are typically over-reported. Wages are not the same as ‘workers weekly earnings’, which the media often refers to as wages in order to overstate wage gains. Official government sources indicate weekly earnings have been rising at 2.7% annual rate. But weekly earnings are volatile and upswing widely with the business cycle, reflecting hours worked and second jobs. And business cycle upswings since 2001 have been short and shallow. Nevertheless, the press and media often, and purposely, confuse wages with weekly earnings (or with household personal income) in order to make it appear that gains for America’s working class are greater than they are in fact. US Labor Dept. data as of mid-year estimated wage gains at 2.5% over the preceding 17 months to July 2018, according to the Wall St. Journal, and therefore less than the 2.7% figure for weekly earnings.

Wages: The Real Numbers

Even when properly considering just wages for non-management and non-supervisory workers, official government stats still distort to the upside the true picture with regard wages as well. This upside overestimation is due largely to five causes:

• 1) reporting wages for full time employed workers only;
• 2) reporting nominal wages instead of real wages;
• 3) ignoring the claims on future wage payments due to rising worker household debt in the present and therefore future interest payments;
• 4) not considering the decline in ‘deferred wages’ which are represented in pension and retirement benefit payments decline;
• 5) disregarding declines in ‘social wages’ represented in falling real social security benefits payments;

1) While official government data report that wages are now rising at a 2.5% annual rate, what that stat fails to mention is that the 2.5% is for full time permanent workers only. It thus leaves out the lower, if any, wage increases for the current 40-50 million workers who are not full time and are employed in what is sometimes called ‘contingent’ or ‘precarious’ work.

Their lower wage gains would reduce the 2.5% for the total wage earning labor force to less than 2.5%. A similar adjustment should be made for the 8 million or full time workers who have become unemployed and whose “wages”, in the form of unemployment benefits and food stamps, are certainly not rising or being cut. Add the millions more of undocumented workers, and still millions more youth and others working in the ‘underground’ economy (estimated now at 12% of US GDP)—neither of whom whose wages are estimated accurately by official government wage stats—and the wage gains are still further reduced from the official 2.5%. When adjustments are made to include these latter categories of wage earners, and consider contingent workers’ wages, it is this writer’s estimate that the true net rise in nominal wages the past year is no more than 1.7% to 2.0% overall and closer to 1% for the 133 million and the ‘bottom’ 90% of the wage earning labor force.

To sum up thus far, when excluding salaries of executives and managers, exempting the top 10% of the wage earning labor force, adding in the wage-less unemployed, and correcting for undocumented and underground economy labor force—the net result for even nominal wages is far less than the official 2.5%.

Nominal wage gains for 133 million are thus no more than 1.5%; that is, or one percent less than the official 2.5%.

2) The 2.5% official wage gain stat reported by the government is what’s called the nominal wage, not the real wage. The real wage—or what workers have actually to spend—is the nominal wage adjusted for the rate of inflation. So what has been the inflation rate? And how accurate is it?

There are various price indices against which wage gains may be adjusted: the consumer price index (CPI), the personal consumption expenditures index (PCE), GDP deflator index, and others. However, most often reported by the media is the CPI. The CPI at mid-year had officially risen 2.9% over the previous year. So if one applied the CPI to the official hourly wage gain of 2.5%, it would mean that workers’ real wages declined by- 0.4% over the past year. (Or fell by -1.4% if the above adjustments to the nominal wage are considered).

But both the -0.4% and -1.4% are also underestimations. Here’s why: The CPI purposely underestimates the true rate of inflation. (And the higher the rate of inflation, the lower the real wage). First, it smooths out year to year inflation by averaging annual inflation rates by means of what is called ‘chained indexing’. Furthermore, the CPI does not look at all prices, but at a ‘basket’ of the most likely purchases of goods and services by households. It then assigns ‘weights’ to the items in this basket. For working class households, the weights should be greater for housing, healthcare, education, insurance and other basics but they’re not. The weights therefore do not reflect the true impact of inflation on reducing real wages. There’s another problem. The Labor Dept. arbitrarily assumes increases in quality of a particular good or service in the basket reduces the price for that product. The price for the product in the CPI is often far lower than what a household actually pays for it in the market place. For example, a student may pay $800 for a computer laptop for back to school use, but the Labor Dept. reports it in the CPI as only $500 since it assumes the quality of that laptop is greater than an $800 laptop three years ago. But this is a distortion of the actual price paid in the market by the working class household. Inflation is under-estimated. Another problem in the CPI is the government’s bias toward underestimating prices for online ecommerce goods purchases by households.

These arbitrary assumptions baked into the CPI serve to reduce the actual rate of CPI inflation. And if the CPI is underestimated, the real wage gain is estimated higher than it actually is. The true inflation rate is therefore undoubtedly well above the official 2.9% and real wages consequently even lower than officially reported.

While mainstream economists typically argue households don’t really know how much inflation is really rising, the truth is they know far better than the economists who rely on faulty, arbitrary government statistical estimations of consumer inflation. Ask any median working class worker if their household costs have been increasing by only 2.9% the past year—when rent costs are escalating rapidly (often at double digit rates), health insurance premiums and doctor-hospital deductible and copay costs rising 20%-50%, auto insurance, gasoline costs per gallon up sharply over the past year, education & utility and transport costs, etc. And in the last six months, prices have begun to rise even more broadly, as a large array of goods prices are being hiked by US businesses in anticipation of Trump’s tariff wars starting to bite.

With official CPI inflation at 2.9% and official nominal wages at 2.5%, the government real wage adjustment is only -0.4%. But if the real CPI were around 3.5%, and nominal wages still assumed at the official 2.5%, then the real wage gain would be only 1.5%.
But that 1.5% real wage still does not factor in the corrections to the nominal wage noted in 1) above—i.e. for excluding executive-managers’ salaries as wages, for including contingent part time and temp workers’ wages, including the lost wages of the unemployed, and correcting for the undocumented and underground economy labor force, etc. Those adjustments reduced the nominal wage from 2.5% to 1.5%.

When these downward adjustments are made to the official 2.5% nominal wage (reducing it to 1.5%), combined with an upward adjustment of the CPI inflation rate to 3.5% (from 2.9%), what results is a real wage decline of -2.0% for the 133 million wage earners in the labor force.

The media and the press consistently report that real wages have stagnated this past year. The nominal wage gains have been roughly equal to the rate of inflation. But by properly estimating nominal wages (with the adjustments) and properly estimating a somewhat higher CPI rate, real wages have not been stagnating but have continued to decline—at least for the 133 million.

But the ‘wage story’ is still not complete, even when properly defining and adjusting for nominal wages, inflation, and real wages. Neither the media or government give any consideration in their calculations of wage changes to deferred wages or social wages or to the impact of interest and debt on future wages.

3) Future Wages represent a category never considered by official government statistics. What’s ‘future wages’? They represent nominal and real wages adjusted downward to reflect the cost of credit, and thus interest payments on debt, incurred in the present but due to impact wages in the future as the interest on debt is repaid. It is no secret that US working class households are increasingly in debt since 2000, as they take on credit in order to finance household consumption as their real wages and incomes have steadily stagnated or declined. Credit, and therefore debt, has been a primary way they have tried to maintain their standard of living the past two decades. (Before that it was adding more hours of work to the family income by having spouses enter the workforce. But this leveled off by 1999). Adding second and third jobs has been another way to add wage income to the household, as wages for primary worker in the household have declined.

But interest on debt is a claim on wages to be paid in the future. It is spending future wage income in the present. And US capital is more than glad to finance household consumption by extending more and more credit and debt to households in lieu of paying more wages. Another method by which wage decline has been ‘offset’ is to provide cheap imports of basic goods like clothing, household items, even some food categories. But the cheap imports come at the cost of lost high paying manufacturing jobs. So lack of wage gains is in part offset by cheap imports and a massive increase in available credit to households. US household debt is now at historic levels, higher than in 2007. More than $13 trillion in debt, including $1.5 trillion in student debt, more than $1 trillion in credit cards, $1.2 trillion in auto debt, and the rest in mortgage debt. The average household credit card debt interest payments alone are estimated at no less than $1,300 per year. Debt costs, moreover, are rising rapidly as the US central bank continues to steadily hikes its rates.

The debt-interest to wage change relationship has become a vicious cycle, moreover. Employers give little in the way of wage hikes and households resort to more credit-debt and in turn demand less wage increases. This cycle appears in some areas to be breaking down, however, as teachers, minimum wage service workers, and others agitate for higher wages. But he overall problem will likely continue, as the vehicle for achieving wage gains in good economic times—i.e. Unions—decline further and no longer play their historic role. Knowing this, and burying households in credit card offers and other credit, businesses refuse to grant wage hikes except in isolated cases.

4) and 5): Another area that should be considered ‘wage’ but is not by government agencies reporting on wage changes is pensions and social security benefits. These too are in effect ‘wages’. Pensions are deferred wage payments. Workers forego actual wage increases in order to have employers provide contributions, in lieu of actual wages, into their pension plans. Upon retirement, they are then paid these ‘deferred wages’ from their pension plans.

But true pension plans, called defined benefit pensions, have been steadily destroyed—with the assistance of the government run by both Republican and Democrat parties—by employers since the 1980s. The destruction has accelerated since 2001 and continues in its final stages. Defined benefit pensions have been progressively replaced with privatized, ‘401k’ and ‘IRA’ plans—reducing employer costs and liabilities dramatically. 401k plan substitutes have proven a disaster and grossly insufficient for providing ‘deferred wages’ for retirees. Workers within 10 years of retirement on average have barely $50k in 401ks with which to retire on. The average 401k balance for all households is less than $18k. Not surprising, the fastest segment of US labor force growth is workers over age 67 having to re-enter the work force in order to survive. And retiree bankruptcy filing rates are at record levels and rising rapidly. Before 2000, only 2.1% of the over 65 age group filed for bankruptcy; today the rate is 12.2%, a more than fivefold increase even as their population share has risen by only 2.3%. Median household indebtedness for retirees is now $101,000.

Much of the rising debt for retirees is due to the collapse of the ‘wage’ in the form of monthly pension benefit payments, as defined benefit plans have been destroyed by employers and government in collusion and replaced by lower benefit 401k privatized pensions. Bankruptcies, rise of part time contingent work by retirees, and senior citizen poverty rate escalation have been the consequences. None of this deferred wage decline has been accounted for in the general wage statistics by US government agencies, however.

A similar retirement household wage decline is associated with monthly social security benefit payments—i.e. what might be called a ‘social wage’ similar to private pension deferred wage. It is ‘financed’ by employer (and worker) payroll tax payments into the social security trust fund from which monthly money benefits upon retirement are paid. Also deferred, like private pension benefit payments, the social wage represents employer payroll tax contributions to social security that are made in lieu of direct wages that might be paid to workers were there no payroll tax. The payroll tax represents workers’ deductions from wages they do not otherwise receive and instead have redirected to the social security trust fund. Both employer and worker wages are thus deferred and deposited to the trust fund, to be paid out in the future in wages in the form of social security benefit payments. Social security benefits are thus a form of ‘social wage’. And to the extent social security benefits are reduced, the social (deferred) wage is reduced. The wage reduction has been implemented by the government raising the retirement age to 67 at which to receive social security retirement benefits. Suspending or failing to enact cost of living adjustments to monthly payments. Cuts to SSDI benefits, i.e. social security disability insurance—all represent de facto cuts to the social wage. Rising annual deductibles and copays for Medicare are another form of social wage cut. Moreover, Trump plans to reduce Medicare in his latest budget represents yet another pending social wage cut.

Like defined benefit pension deferred wages, reductions in the social wage in the form of social security payments also represent appropriate wage categories affecting 50 million retired workers that US government agencies responsible for estimating wage changes do not include in their calculations of wage changes.

Summary Comments

Contrary to media ‘spin’, business press misrepresentations, and US government agencies’ ‘statistical legerdemain’, real wages for the vast majority of the US labor force—i.e. the 133 million— are not even close to rising in the US under Trump. Nor did they under Obama, Bush, or Clinton. Since 1980 and the advent of neoliberal capitalist restructuring of the US and global economy, a key element of neoliberal policies has been to compress wages—for all but the roughly 10% that US Capital considers essential to its further expansion and for, of course, the salaries of executives and managers. The rest of the US workforce has undergone constant wage stagnation and decline over the long term. The pace has accelerated or abated at different times, but the long term direction of decline and stagnation has not.

When wage change is not limited to considering only permanent, full time employees or averaged out, when conveniently excluded categories of workers are considered, when wages are adjusted for true inflation rates, when interest and debt effects are accounted for, and when ‘deferred’ and ‘social’ wage payments are factored into wage totals in general—it is overwhelmingly the case that US wages have been declining for some time and that decline continues in 2018 despite the media-government spin that wages are rising in America.

Dr. Rasmus is author of the most recently published book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017, and the forthcoming ‘The Scourge of Neoliberalism: Economic Policy from Reagan to Trump’, Clarity Press, 2019. He blogs at jackrasmus.com and his twitter handle is @drjackrasmus.

posted September 8, 2018
Amazon the Job Killer: Yesterday, Today & (AI) Tomorrow

Prominent in the news this past week was the report that Amazon and its CEO, Jeff Bezos, reached record levels of market valuation and wealth. Amazon is now worth more than $1 trillion and Bezos’s personal wealth stands at $165 billion. This of course is largely due to the stock price appreciation of the company, as investors in the US and worldwide pile into purchasing Amazon stock and thereby drive up its stock price, its market valuation and, in turn, Bezos’s share of that in terms of his own net worth.

Why so much investment money is surging into Amazon—and other tech company stocks like Google, Apple, and others—is a story in itself but left here for another analysis. Briefly, it has to do with the investor class’s accelerating capital gains from the $1 trillion a year distribution to them from Corporate America’s stock buybacks and dividend payouts. A trillion dollars a year, every year (2011 to 2017) for the past six years in buybacks and dividends by S&P 500 corporations alone. This year, 2018, buybacks and dividend payouts will set a record of more than $1.3 trillion in such distribution to investor-shareholders, pumped up by Trump tax cuts of more than $300 billion in 2018 that are doubling profits of S&P 500 companies.

According to a recent report by Zion Research, for the S&P 500 no less than 49% of their 2018 record profits has been due to the Trump tax cuts—a massive direct subsidy to corporate America without historical precedent in the US. For some sectors, like the telephone companies, 152% of their 2018 profits have been due to the Trump tax cuts. The massive tax-driven profits are then redistributed to their shareholder-investors via stock buybacks and dividends well exceeding $1 trillion annually. The stockholder-shareholders then plow back the much of the $1 trillion back into the stock market, driving up stock prices further that are already rising due to the record profits and buybacks. A good part of the ‘plowback’ into stocks has been going into the tech sector. The Apples, Googles, and of course Amazon especially—which leads to the company’s $1 trillion current market valuation and Jeff Bezos’s $165 billion personal net worth.
But to justify this obscene income subsidization of Corporate America by the US government—Trump and Congress—the political ‘spin’ is that it is creating jobs and wages are rising. But while wages are rising for a slice of workers in tech, healthcare, other high end professions, and salaries of managers, they are stagnant and falling for at least 133 million of the 165 million US labor force. (for more detailed analysis see my recent piece, ‘The Myth of Rising Wages’ at my blog, jackrasmus.com).

The other ‘spin’—that jobs are being created— is one that Amazon in particular has been promoting, as has most of the tech sector. But how true is that? What’s Amazon’s track record on jobs? And not just in 2018, but in recent years and, most importantly, in the decade to come? How many jobs has Amazon created? How many has it destroyed in other companies? What’s been Amazon’s ‘net’ job effect?

Competitors Job Destruction

It’s no secret that Amazon’s business model has destroyed tens of thousands, perhaps hundreds of thousands, of jobs of US workers in industries like bookstores (independent and chains like Borders Inc.). Its business model then expanded beyond book selling to general retail and resulted in destruction of local electronic, toy stores, and other mom & pop retail. In recent years this effect has begun to expand to what are called ‘big box’ retail stores like Sears, JC Penny, and others. Severely weakened by Amazon competition, they have begun closing stores and thus eliminating thousands of jobs. Sears and others will likely not survive the next recession coming soon, and go out of business altogether. While not totally due to Amazon competition, there’s little doubt that Amazon’s effect has been the ‘straw that broke the camel’s back’, as they say.

Amazon’s business model has not only contributed to job destruction directly by forcing companies to go out of business. It does so indirectly as well. A good example is WalMart and Macys. They have been rapidly transitioning to Amazon’s model and emulating it by establishing their own online e-commerce sales. As they have begun to do so, they have also been shutting down hundreds of their brick and mortar stores in malls throughout the US. With those closures go tens of thousands of jobs. That’s indirect job destruction.
That process of forcing competitors to shift to e-commerce and close stores is soon to be replicated as well in the grocery store industry. Regional grocery store chains are rushing to establish on line food sales and delivery. And once they do, good-bye to many of the tens of thousands of jobs in your local grocery stores (checkers, stockers, buyers)—as more reduce the items in them that are easily sold online as well as shut down many of their brick and mortar stores.

But what about jobs at Amazon itself? The spin is that Amazon is creating new jobs, replacing jobs being lost at its retail competitors, both large and small. One hears of plans by Amazon to set up new warehouse outlets in the US (and abroad as well), in the process creating thousands of new jobs. Cities across the US currently are intensely competing with each other in bidding for the new Amazon warehouse operations. They’re offering massive subsidies and tax cuts to Amazon to entice it to choose them as the company’s new warehouse locations. So doesn’t that mean new jobs replacing the old retail disappearing due to Amazon? Yes, but only in the very short term. In a soon-to-follow subsequent phase of operations, those jobs will disappear rapidly.

Amazon’s Job Destruction: Warehouse Automation

What Amazon doesn’t like to talk about is that it is currently running internal pilot projects in its existing warehouses that plan to eliminate thousands of jobs by using robots to order, shelve and retrieve stock, and deliver ordered goods. Unlike real workers, the ‘bots’ will work 24/7, never take lunch breaks or get sick and, just as important, never seek to form a union and push for higher wages and benefits. That is the future of jobs within Amazon. The jobs created today will soon go away. Within five to ten years, Amazon will be fully automated. The jobs will go away, but the tax concessions and subsidies from local governments will remain. Amazon costs will continue to decline dramatically, and with it so too its profitability rise. That’s why, moreover, the investor class also continues to plow money into Amazon stock purchases, driving the company’s market valuation ever higher—and with it Jeff Bezos’s personal wealth!
But the accelerated shift to new technology within its warehouse operations is not the only way Amazon and Bezos are driving job destruction. Amazon is not simply a warehouse company. It is not just a retail company. It is a tech company. And that’s how Amazon will destroy most of the jobs over the next decade.

Drone Technology & Delivery Jobs Destruction

Amazon is a leading edge developer of drone technology. Its plan by the end of the next decade is to deliver most of its packaged products by means of drones. That will force major package delivery companies like UPS, Fedex, and the US Post Office to shift to drone delivery as well. That means fewer truck drivers. There are a million truck drivers in the US today. Most are local delivery workers, not the over the road 18-wheeler drivers. Their jobs are slated to disappear by the hundreds of thousands, as Amazon (and Google and others) perfect the drone delivery technology that will take deep hold in the next decade.

Alexa, Artificial Intelligence (AI) & 31 Million Jobs Destroyed

But automation of his warehouse operations and drone delivery technology negative impact on jobs will pale against what’s coming with Artificial Intelligence (AI) technology, of which Amazon is also a major innovator and driver. So briefly what’s AI? Rudimentary AI is embodied in Amazon’s ‘Alexa’ intelligent ‘bot (home “butler”, as some call it). Alexa is the hardware device, but it’s the software intelligence within it that is the AI. Currently Alexa (and Google and Apple’s similar products) respond to simple voice commands from users. Simple tasks like ‘order this’ (from Amazon of course), ‘turn off the lights’, ‘change the thermostat’ temperature in the house, etc. But Alexa is going to get more intelligent, much more intelligent. It will ‘learn’ to anticipate user commands of its users before they are even made. It will teach itself.

In a most basic sense, AI is nothing more than software (embedded in a hardware device) that employs techniques of advanced statistical data gathering and processing, based upon which it makes decisions. And the more requests by users, the more data gathered, the more processed, and the more decisions made—the more intelligent it becomes; the software ‘learns’ by means of AI techniques called ‘natural language processing’ and ‘deep learning’.

Over time the decision making becomes more accurate than if made by a human agent. This does not mean more accurate in the case of all decisions—i.e. for complex, creative tasks and decisions. That will still remain the realm of human decision making—albeit only for that minority of highly educated or trained workers capable of making such decisions. The simple decisions, tasks, etc. made by the vast majority of workers will be increasingly assumed by future Alexa-like software driven devices. And that’s where massive job destruction will occur, and sooner than most anticipate. In fact, the major impact will begin around 2020 and will accelerate throughout that decade.

The devastation of AI on jobs and occupations will be clear by 2030, as no fewer than 50% of all companies will implement some degree of AI by 2030, according to McKinsey.

AI will create jobs at the ‘high end’ that require advanced education skills—i.e. what’s called ‘analytics’ of all kinds. But it will destroy many-fold more jobs and occupations where simpler decision making is involved—especially in retail, hospitality, basic services of all kinds, and will of course also accelerate further current job destruction already underway in manufacturing.

These are the job areas that have been already seriously impacted by what’s called ‘contingent’ job creation—i.e. part time, temp, on call, gig and other work. Contingent jobs number in the tens of millions in the US already, and similar tens of millions in Europe, Japan, Asia. But these already devastated job occupations—with lower wages and few benefits—will be totally eliminated as well by the millions as a consequence of the impact of AI in the next decade.

For example: nearly all customer service rep jobs will be replaced by even more intelligent AI-Alexa devices. This is already happening on a rudimentary level. First and second tier call center inquiries and service inquiries have already been replaced. But as AI advances, even higher level inquiries, that only trained technicians now handle, will be replaced as well. In-home ‘virtual assistant’ roles now performed by devices like Alexa will proliferate throughout businesses and the economy over the next decade. Occupations like receptionists, ticket sellers, movie kiosk and concessions workers, phone sales reps, in store retail sales assistants, tellers of all kinds, food ordering and food preparation, and so on are prime job occupations destined for displacement. AI will have a major impact as well on scores of maintenance and repair job occupations. AI will enable hardware devices of all kinds to self-maintain and even self-repair.

The auto industry will be heavily impacted by intelligent, self-maintenance and repair capabilities in new cars and trucks that will eliminate tens of thousands of auto mechanic jobs. Intelligent tires will learn to self-inflation and repair, cars to re-align themselves, and filters self-clean. Local banking and insurance services, residential real estate, accounting occupations, marketing, and what are called business ‘back office’ functions will all be job-impacted by Alexa-like devices that expand from their current role as ‘home butlers’, become more advanced, up-graded, and penetrate business operations on a wide scale.

AI will also have a profound impact on educational services: K-12 and community college teachers will be de-professionalized and increasingly become in-classroom monitors of tech equipment, software and hardware based, that will deliver the standardized classroom instruction for many of the courses taught. Online higher education instruction will increasingly become the norm as well. Wages and compensation of teachers and professors will stagnate and decline accordingly.

Amazon has plans to lead the tech industry with its Alexa product. Alexa as a residential ‘bot butler’ is just the beginning. New, faster learning, self-teaching, more powerful, high end Alexa-like devices will target business enterprises over the coming decade. They will serve as technology Trojan horses that will wipe out entire business functions and, in the process, countless job occupations as well.
How many jobs will be destroyed? And what are the economic consequences?

The McKinsey Consultants Group 2018 Study

A glimpse into the job destruction future was provided early this September by an in-depth study by the well-known McKinsey Consultancy Group. The study estimated that 60% of the current job occupations in the US will be impacted by AI by 2030. And one third, 33%, of that 60% will experience a reduction in jobs and/or hours worked. (see p. 21 of that study).

There are approximately 165 million in the US workforce today. Assuming the long term trend of 1-1.5 million growth annually in that workforce over the next 12 years—the historical average—that means on average a175 million US work force over the next decade. Assuming McKinsey’s 60% impact, and 33% of that 60% experiencing reduced employment, the result is roughly 31 million jobs will be lost, or have hours significantly reduced, due to the effects of AI over the next decade.

According to the McKinsey study, the ‘cost’ to workers will be $7 trillion. AI will reduce corporate costs by 50% where introduced, thereby boosting ‘profits’ to business from introducing job-killing AI by $13 trillion. In other words, AI will dramatically accelerate the already devastating income inequality trends in the USA. Having declined already from 64% to 56% of total national income, Labor Share will thus decline even more sharply by 2030.

Unless there is a massive government financed program of technical job retraining, a basic restructuring of the US educational system, and some sort of guaranteed annual income for those workers too old or unable to make the rapid changeover to an AI driven economy, there will be a significant negative impact to household consumption and therefore the economy in general. This will require a major restructuring of the current tax system that reverses the $15 trillion in tax cuts for corporations and investors that has been implemented since 2001.

Given the current political leadership in America at present, however, it is highly unlike the tax changes and funding shift will be implemented. Republican Congresses and presidents will argue that GDP is growing despite the job destruction, AI created jobs will be over-estimated and jobs destroyed under-estimated, and income inequality will be blamed on workers displaced not re-educating themselves and becoming more productive (and useful to tech driven economic growth). Policies will continue to provide credit and debt to households as a substitute to actual wage growth. Guaranteed annual income supplements will be called ‘socialism’, while actual subsidization of capital incomes by the government via tax cuts and cheap money—i.e. actual ‘socialism for investors and business—continue by another name. Democrats during worst times will be given a shot at the changes but will deliver too little-too late in token adjustments, thus laying the ground work for a return of Republican-Corporate solutions that claim will resolve the problem while actually making it worse.

In other words, the policy process that has characterized the last three and a half decades will likely continue into the next. AI in net terms will make the rich much richer, provide job and attractive wage opportunities for perhaps the top 10% of the US work force, leave maybe another third continuing to thread economic water, while thrusting the bottom 50% of workers in America into a still more desperate economic condition than they already experience.

Over the 2020 to 2030 decade, Amazon the tech company will be at the leading edge of AI development and its devastating negative impact on the majority of jobs and wages. Simultaneously, in the shorter run, Amazon the warehouse company will start eliminating its jobs by the thousands as it automates its warehouse operations; and Amazon the retail giant will continue to directly, and indirectly, destroy retail jobs as its competitors—small and large alike—attempt to adjust to Amazon’s job destruction machine.

Dr. Jack Rasmus
September 6, 2018

Dr. Rasmus is author of the recently published book, “Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression”, Clarity Press, August 2017, and the forthcoming companion critique of US fiscal-trade-industrial policy, “The Scourge of Neoliberalism: Economic Policy from Reagan to Trump”, also by Clarity Press. He blogs at jackrasmus.com and his twitter handle is @drjackrasmus.

posted August 23, 2018
What’s Financial Imperialism? (Complimentary concluding chapter from my ‘Looting Greece’ book, Clarity Press, 2016

An Emerging New Financial Imperialism

The recurring Greek debt crises represent a new emerging form of Financial Imperialism. What, then, is imperialism, and especially what, when described as financial imperialism? How does what has been emerging in Greece under the Eurozone constitute a new form of Imperialism? How is the new Financial Imperialism emerging in Greece both similar and different from other forms of Imperialism? And how does this represent a broader development, beyond Greece, of a new 21st century form of Imperialism in development?

The Many Meanings of Imperialism

Imperialism is a term that carries both political-military as well as economic meaning. It generally refers to one State, or pre-State set of political institutions and society, conquering and subjugating another. The conquest/subjugation may occur for largely geopolitical reasons—to obtain territories that are strategically located and/or to deny one’s competitors from acquiring the same. It may result as the consequence of the nationalist fervor or domestic instability in one State then being diverted by its elites who are under domestic threat, toward the conquest of an external State as a means to avoid challenges to their rule at home. Conquest and acquisition may be undertaken as well as a means to enable population overflow, from the old to the new territory. These political reasons for Imperialism have been driving it from time immemorial. Rome attacked Carthage in the third century BCE in part to drive it from its threatening strategic positions in Sicily and Sardinia, and also to prevent it from expanding northward in the Iberian Peninsula. Domestic nationalist fervor explains much of why in post-1789 revolutionary France the French bourgeois elites turned to Napoleon who then diverted domestic discontent and redirected it toward military conquest. Imperialism as an outlet for German eastward population settlement has been argued as the rationale behind Hitler’s ‘Lebensraum’ doctrine. And US ‘Manifest Destiny’ doctrine, to populate the western continent of North America, was used in the 19th century as a justification, in part, for US imperialist wars with Mexico and native American populations at the time.

But what may appear as purely political or social motives behind Imperialist expansion—even in pre-Capitalist or early Capitalist periods—has almost always had a more fundamental economic origin. It could be argued, for example, that Rome provoked and attacked Carthage to drive it from its colonies on the western coast of Sicily and thus deny it access to grain production there; to deny it strategic ports on the eastern Iberian coast from which to trade; and eventually to acquire the lucrative silver mines in the southernmost region of the peninsula at the time. Nazi Germany’s Lebensraum doctrine, it may be argued, was but a cover for acquiring agricultural lands of southern Russia and Ukraine and as a stepping stone to the oil fields of Azerbaijan, Persia and Iraq. And US western expansion was less to achieve a population outlet than to remove foreign (Mexico, Britain) and native American impediments to securing natural resources exclusively for US use. US acquisitions still further ‘west’—i.e. of Hawaii, the Philippines and other pacific islands were even less about population overflow and more about ensuring access to western pacific trade and markets in the face of European imperialists scrambling to wrap up the remaining Asian markets and resources.

Imperialism is often associated with military action, as one State subdues and then rules the other and its peoples. But imperialist expansion is not always associated with military conquest. The dominating State may so threaten a competitor state with war or de facto acquisition that the latter simply cedes control by treaty over the new territory it itself had conquered by force—as did Spain in the case of Florida or Britain with the US Pacific Northwest territories. Or the new territory may be inherited from the rulers of that territory. Historically, much of the Roman Empire’s territory in the eastern Mediterranean was acquired this way. Or the new territory may be purchased, one state from the other—as with France and the Louisiana Purchase, Spanish Florida accession, and Russia’s sale of Alaska to the US.

In other words, imperialism does not always require open warfare as the means to acquisition but it is virtually always associated with economic objectives, even when it appears to be geo-political maneuvering or due to social (i.e. nationalist ideology, domestic crises, population diversion, etc.) causes.

Colonies, Protectorates, and Dependencies

Another important clarification is the relationship between imperialism and colonialism. A colony is a particular way—not the only way—inn which an Imperialist state might rule over and manage an acquired state and its economy. A colony is a particular political form. As Hobson, one of the original theorists of imperialism, accurately explained, a colony is a form of imperial rule in which the imperialist state has full control over the legislature, the government and bureaucracy of the dominated state. Moreover, the extent of colonization may vary. There are colonies which have their own representative legislatures, but no government except the appointed governor of the Imperial state. There are also colonies with their own representative legislature and representative government, but where the Imperialist state exercises veto power over legislation and government decisions.

In contrast to a colony, a protectorate is where a bilateral agreement exists between the imperial and the dominated state in which the latter cedes certain authority to the former. The dominated state may retain full formal independence in the sense of selecting its own representative legislature, government and bureaucracy, but agree to the imperial state determining certain of its policiessuch as foreign policy or military policy. Institutions managing foreign-military policy in the dominated state may be simply coordinating agencies ensuring implementation and consistency with the imperial state policies. It may be argued that Scotland today is a political protectorate of Britain. So too Catalonia, of Spain. And Puerto Rico, of the US.

And as Hobson further explained, 19th century states like Canada and Australia had representative institutions but no imperial state governor or right to veto. They had even by late 19th century their own military and political policies. Nonetheless, these States’ economies were significantly integrated with that of the imperial state, the United Kingdom. So what were they, if not colonies? They may have been politically independent but were they economically dependent? At the time, they may not have been political protectorates, but could be argued to have been economic protectorates.

A dependency refers to dominated economies whose growth is dependent on the trajectory of growth in the imperialist economies. The dominated economies are so structured by the imperialist that they are unable to grow independently. Dependency is a purely economic structure. There are no forms of political control, as in protectorates and degrees of colonization. But there is economic influence and control exercised by the Imperialist economies over the dominated. This control is exercised largely by controlling the flow of money capital and investment into the dominated economies. Investment into the latter—sometimes called FDI (foreign direct investment)— only takes forms that benefit the Imperialist economies.

While economic dependency has been associated mostly with states that were once colonies and economic protectorates in the pre-1970 decades, a new trend is emerging in states with smaller economies locatednear major imperialist economies. Greece today shows signs of similarity to the kind of economic dependency that was once associated only with post-colonial, post-protectorate economies. However, as will be argued, Greece today also represents an emerging new form of economic protectorate. The Euro regime, even before the debt crises eruptions of 2010-2015, had imposed relationships of dependency upon Greece. Since 2010, however, Greece has evolved from a dependency to an economic protectorate.

Capitalism as a system is constantly restructuring and remaking itself. Imperialism is a basic element of it, but it does not expand and deepen at the same pace at all times. It ebbs and flows. Old forms of imperialism accelerate, penetrate, become established and then decline, then give way to new, and often even more ‘efficient’ forms. Late 19th century European imperialism, focusing on Africa, was similar in many ways, but also different from 18th century British imperialism or 17th century Spanish and Dutch imperialism. There was very little ‘self-government’ associated with the new imperialism of that period. Its political form was nearly always full colonization with the associated political institutional control.

Greece is not a colony of the Troika, but it is increasingly dependent on the Troika financially (i.e. in terms of credit and debt) and passed over the threshold to an economic protectorate since 2010.

Greece as an Economic Protectorate

An economic protectorate exists when the dominated State cedes control of certain of its economic institutions, policies and economic assets to the imperialist. Following the third Greek debt agreement of 2015, that is what Greece became. The “imperialist state” in this case is the Eurozone’s supra-national institutional bodies—the Troika of the European Commission, the European Central Bank, the IMF, and the pan-European court system ruling on their decisions, etc. And to the extent that the Troika institutions define the economic policies of Greece’s central bank, dictate allowable economic policy to the Greek legislature, set the budget, government spending and taxing parameters of the Greek government—then the Troika is defining and determining the economic policies of Greece. Greece has ceded this economic control to the Troika under duress, so it cannot be considered to have done so voluntarily. The debt agreements have been ‘negotiated’ in name only, in only a formal sense. The demands and proposals of the Troika have become virtually all the final terms and conditions of the debt agreements. There is little of Greece’s original proposals in the agreements. So the agreements are the result of ‘one-way’ negotiations or, in other words, they were not really negotiations at all since that would imply some reasonable degree of compromise by both parties.

An economic protectorate has thus been imposed upon Greece. Greece has become an economic suzerainty of the Troika, a de facto economic vassal state of the Eurozone.

Not only has the Troika defined Greece’s economic policies. It directs the policies of its central bank, making it an appendage of the ECB. Greece’s central bank does what the ECB asks, even to the point of criticizing its own Greek government and agreeing with the ECB’s policies that negate the Greek central bank’s role of supporting its own Greek banking system.

In exchange for Troika credit and debt, Greece’s Parliament cannot introduce legislation that may contravene the debt agreements or the budget policy set by the agreements. Nor can Greece’s legislature pass any fiscal measures—nor can government agencies initiate fiscal measures—that the Troika considers may in any way inhibit the attainment of the budget targets it, the Troika, has defined. Reportedly, representatives of the Troika remain on site and are responsible for ensuring no legislation or executive action contravenes the debt agreement and its objectives.

Greece’s government must maintain spending within the parameters defined by the Troika- determined debt agreements. Greece’s government cannot decide unilaterally whether to cut spending, or on what, or whether to cut or raise taxes, and on whom. It is told what programs it must implement to reach that budget target. The Troika de facto veto power reportedly extends down to the local government level, to ensure that local administrators implement the debt-imposed austerity as defined in the terms of the agreement.
In short, Greece now has no independent central bank and thus no independent monetary policy. It has no currency of its own that it might devaluate in order to stimulate exports and growth. Its limited fiscal authority of action has been taken away, as it is no longer allowed to determine its budget, spending programs, and taxation policies. Greece no longer has independent economic institutions of any significance. It has ceded them to the Troika. Greece’s parliament and government may exercise non-economic decisions and initiatives; but these are subject to veto by the Troika should Greece attempt to exercise economic initiatives.

Wealth Extraction as an Imperialist Objective

Whether via a bona-fide colony, near-colony, economic protectorate, or dependency the basic economic purpose of imperialism is to extract wealth from the dominated state and society, to enrich the Imperialist state and its economic elites. But some forms of Imperialism and colonial arrangements are more ‘profitable’ than others. Imperialism extracts wealth via many forms—natural resources ‘harvesting’ and relocation back to the Imperial economy, favorable and exploitive terms of trade for exports/imports to and from the dominated state, low cost-low wage production of commodities and semi-finished goods, exclusive control of markets in the dominion country, and other ways of obtaining goods at lower than market price for resale at a higher market price.

Wealth extraction by such measures is exploitive—meaning the Imperial economy removes a greater share of the value of the wealth than it allows the dominated state and economy to retain. There are least five historical ways that imperialism thus extracts wealth. They include:

Natural Resource Exploitation

This is where the imperial economy simply takes the natural resources from the land and sends them back to its economy. The resource can be minerals, precious metals, scarce or highly demanded agricultural products, or even human beings—such as occurred with the slave trade.

Production Exploitation

Instead of relocating the resources and production in the home market at a higher cost, the production of the goods is arranged in the colony, and then shipped back to the host imperial country for resale domestically or abroad. The semi-finished or finished goods are more profitable due to the lower cost of production throughout the supply chain.

Landed Property Exploitation

The imperialist elites claim ownership of the land, then rent it out to the local population that once owned it to produce on it. In exchange, the imperialist elites extract a ‘rent’ for the use of the land.

Commercial Exploitation

Here the imperialist elites of the home country, in the form of merchants, ship owners, and bankers, arrange to trade and transport goods both to and from the dominated economy on terms favorable to their costs. By controlling the source of money, either as currency, credit, or precious metals, they are able to dictate the arrangements and terms of trade finance.

Direct Taxation Exploitation

More typical in former times, this is simple theft of a share of production and trade by the administration of the imperialist elite. The classic case, once again, was Imperial Rome and its economic relations with its provinces. It left the production and initial extraction of wealth up to the local population, while its imperial bureaucracy, imposed locally, was simply concerned with ensuring it received a majority percentage of goods produced or traded—either in money form or ‘in kind’ that it then shipped back to its home economy Italy for resale. A vestige of this in modern colonial times was the imposition of taxation on the local populace, to pay for the costs of the Imperial bureaucracy and especially the cost of the imperial military apparatus stationed in the dominated state to protect the bureaucracy and the wealth extraction.

The preceding five basic forms of exploitation and wealth extraction have been the subject of critical analyses of imperialism and colonialism for more than a century. What all the above share is a focus on the production and trade of real goods and on land as the source of the wealth transfer. The five types of exploitation and extraction disregard independent financial forms of wealth extraction. Both capitalist critics and anti-capitalist critics of imperialism, including Marxists, have based their analysis of imperialism on the production of real goods. This theoretical bias has resulted in a disregard of the forms of financial exploitation and imperialism, which have been growing as finance capital itself has been assuming a growing role relative to 21st century global capitalism.

‘Reflective’ Theories of Imperialism

Marx never referred to imperialism per se, but did address colonialism—in Ireland, India, and China. He thus focused on its political forms of enforcement. The economic objective in all cases was extraction of surplus value and wealth from these colonies, but he described this extraction in terms of production exploitation and/or commercial-trade exploitation. The focus was always on real goods or physical commodities, their production and trade. Exploitation by financial arrangements was not considered primary, or independent of production, because financial relations were always a consequence of production. This was a ‘reflection theory’ of growth, of crises, as well as of imperialist exploitation.

Marx’s own explorations of banking and finance in his final unpublished notes, in his posthumous publication of Capital, volume III, edited selectively by Engels, were left undeveloped. Marx left contradictory messages in his latest notes on whether ‘finance was subordinate to industrial production’ or not. Engels in 1890 solidified the assumption that finance was a mere reflection of production (and therefore imperialism always extracted wealth by the former and not via financial relations). As Engels put it in a letter of October 27, 1890 to a Swiss journalist, finance plays a subordinate role to real production. However, like Marx, he left the door open with a qualification: “As soon as trading money becomes separate from trade in commodities it has a development of its own, special laws and special phases determined by its own nature”. So classical Marxism of Marx and Engels remained cautious about whether financial capital and Imperialism could act independently of industrial capital and production. How to compromise the two views?

This somewhat reluctant recognition that perhaps finance capital independent of industrial capital (production) and merchant capital (trade) might develop its own form of imperialist exploitation per se was recognized as well by J. Hobson in his classical book, Imperialism. In his closing remarks in chapter VII, summarizing the economics of imperialism, Hobson addressed the topic of ‘Imperialist Finance’. He raised the idea of public debt as “a normal and a most imposing feature of Imperialism”. He was referring foremost to the use of public debt by the Imperialist state to pay for the costs of military occupation and administration of the colony. But he also recognized that other kinds of public debt were possible in the imperialist-colonial relationship. Public bonds and loans were a profitable business for bondholders and finance capitalists in general, as “state guaranteed debts are held largely by investors and financiers” worldwide and not only in the Imperialist country. Hobson concluded that imperialism by its very nature is integrally connected “to the moneylending classes dressed as Imperialists and patriots”. What the possible connections between public debt and the moneylending imperialists were, exactly, was not described; nor were the relationships between industrial capital and finance capital in the pursuit of imperialist expansion. Was finance subordinate to industrial capital, as most Marxists seemed to suggest; or was it potentially independent as well?

The classical Marxist bias toward production first—and finance as merely a reflection of production—has its ultimate roots in classical economics’ preoccupation with production, productive labor, and growth. Classical economics, from Adam Smith on, poorly understood banking and finance. And Marxist economists, as inheritors of much of classical economics’ conceptual framework, repeat the same production and real goods bias of classical analyses. They therefore view financial effects as a consequence of industry and production. Imperialist wealth extraction must consequently also reflect production and trade of real goods, and not financial forces.

After Engels, most notable Marxists adopted this view. Marxist Rudolf Hilferding, in the early 20th century, attempted a compromise between the two views on the role of finance in Imperialism. According to Hilferding, in the 19th century Marx and other bourgeois economists viewed the world in terms of industrial capital and financial capital. The convergence of the two in the late 19th century resulted in what Hilferding called ‘finance capital’, which was industrial capital that had turned to financial capital independently, bypassing banks. Industrial capital had expanded so greatly, forming ‘trusts’ and raising money capital as ‘joint stock companies’, and becoming monopolies, that industrial capitalists now were able to raise their own capital and were able increasingly to bypass traditional banks as sources of capital. Industrial capital and finance capital had thus merged. Industrial capital was monopoly capital and monopoly capital had become an ascendant force within Finance Capital. Monopoly finance capital became the driving force of the new Imperialism in the early 20th century, according to Hilferding.

As Lenin would write in 1916, adopting the views of Hobson and Hilferding a decade earlier, imperialism was ‘The Highest Stage of Capitalism’. The big banks were the driving force of the new imperialism. But that was because they were organically connected to heavy industrial capital and were enabling—i.e. financing—the latter’s Imperialist expansion. The big banks had assumed control of the big industrial companies and fostered the concentration of capital into monopolies. They then financed industrial expansion into colonial territories. But Lenin still held the view that finance was ‘subordinate to industrial capital’, albeit with a twist. Big banks had become big industrial capital but the forms of exploitation were still primarily production based. The Hilferding-Lenin view was in effect a view primarily of German banking and German industrial capital at the time. Independent forms of financial exploitation were not considered. The Marxist ‘finance capital is subordinate to industry capital’ view did not permit it.

Not all Marxists at the time held to the ‘subordinate’ view, however. In her book, The Accumulation of Capital, written shortly Hobson and Hilferding and before Lenin, Rosa Luxemburg addressed the subject of International Loans and lending by finance capital directly to the dominated state. The loans and bonds provided were made to finance the import of capital equipment by the local capitalists. “Though foreign loans are indispensable for the emancipation of the rising capitalist states, they are yet the surest ties by which the old capitalist states maintain their influence, exercise financial control, and exert pressure on the customs, foreign and commercial policies of the younger capitalist states.” Luxemburg here appears not to be thinking of the financial relations of an Imperialist state to a colony, but to another less developed or small capitalist state dependent on loans and credit from a more economically powerful imperialist cousin. Could the nature of the imperialist relationship differ with the development of the dominated state? Could more independent forms of financial exploitation characterize the imperialist-small capitalist state? Luxemburg raised indirectly some interesting questions that Hilferding and Lenin ignored.

The view that finance is subordinate to industrial capital became embedded in Marxist analyses of imperialism thereafter. John Smith’s recent attempt to update Imperialism analysis to the 21st century has been much heralded in US Marxist circles. The update, however, is more a case of ‘new wine in old bottles’. Smith’s book is wedded to the traditional Marxist tradition that Imperialism is about real goods and related services, and the analysis is virtually devoid of consideration of financial forms of imperialist exploitation.

Like the preceding bias toward reflective theories of Imperialism, where finance capital is subordinate to, or subsumed by, industrial capital, Smith dismisses any real independent role to finance as a driver of imperialism or determinant of capitalist crises in the 21st century. For Smith, industrial capital and exploitation of productive labor is still the driver of imperialism (as well as of capitalist crises). Finance is subordinate to this process, relegated to assisting capital in imperialist economies to engage in ‘predatory overseas expansion’, where it is compelled to go due to the development of monopoly capital, declining rates of investment, and falling rates of profit in real production in the Imperialist core. Finance in this (post-Marx) Hildferding-Leninist view is not a cause but a “symptom” and “side effect” of the 21st century “transformations in the sphere of production, in particular its global shift to low-wage countries”. This is the old version Marxist view that it is the exploitation of labor value in producing real goods that drives the financial side of capitalism. Commenting on the global financial crisis that began to emerge in 2007, and erupted in 2008-09, Smith succinctly summarizes his classical reflective theory view: “the crisis is ultimately rooted not in finance but in capitalist production,” that what may appear as a financial crisis, or financial forms of imperial exploitation, is but a reflection of more fundamental production forces.

Alternatives to Hilferding-Lenin

To be fair, not all contemporary Marxists agree that finance is just an enabler of Imperialist expansion and ultimately just the handmaiden of monopoly capital. A more open-minded view is David Harvey’s New Imperialism, a work that explores alternative explanations of mperialism beyond reflective theories of Imperialism. Harvey suggests perhaps finance capital and financial exploitation today represents a kind of late 20th century rapacious ‘primitive capitalist accumulation’ in the Marxist sense of that term. If so, then financial imperialism, as a process of primitive accumulation, can occur outside the basic capitalist labor exploitation process. In Marx’s analysis, primitive accumulation pre-dates basic capitalist exploitation, even as it may also coexist alongside the latter at the same time. That suggests that financial exploitation, and thus Financial Imperialism, may not be a mere extension or appendage of exploitation from production. It is not ‘reflexive’. Financial Imperialism may have a dynamic of its own, interacting with traditional production-based exploitation and Imperialism, but nonetheless represent a force of its own and driven by its own causal forces.
In yet another important challenge to the Hilferding-Lenin view of Imperialism, contemporary German Marxist economist, Michael Heinrich, concludes that “the relationship between financial markets and industrial production is not constant in either a quantitative of qualitative respect. This relationship can be different in different countries, and can also change in the course of capitalism development.” Heinrich specifically challenges the Hilferding-Lenin view that the merger of industrial and bank capital, creating ‘trusts’ and monopolies, leads to declining profits in the advanced economies, thereby forcing them to expand abroad in search of more profitable, cheap labor. That capitalist state in the advanced economies assists this expansion—thus Imperialist policies emerge. Imperialism is the economic necessity of monopoly capitalism. Industrial capital integrates finance, and mobilizes the state on its behalf, to offshore its capital to developing markets where wages are less and exploitation and profits thereby high. As Heinrich correctly notes, however, more money capital has been ‘exported’ between the advanced capitalist economies, than from the latter to emerging markets in the 20th century. Imperialism in Lenin’s time does not represent the ‘highest’ or ‘final’ stage. Heinrich suggests the need “to formulate a theory of Imperialism outside Lenin’s framework” as an important task. That would necessarily mean a perspective that breaks from the notion that Imperialism is not just about production nor finance just an appendage of production.

The reflective view of what drives Imperialist expansion and exploitation is not limited, however, to the Marxists. There is a long tradition in mainstream economics that attributes supply-side, or production forces, as the main determinant of growth, of capitalist crises, as well as of the dynamic toward imperialism. The most famous in this regard is perhaps Joseph Schumpeter. Another line of analysis is offered by the neo-Ricardian, Piero Sraffa, who viewed the financial system as a mere superstructure facilitating monopoly control of industry and directing it into regions of higher profitability, including presumably colonies and emerging market economies. There is no lack of variations on the theme that it is the production of goods—and more specifically the slowing of that investment and production and therefore profitability from traditional capitalist production—that drives capitalism inherently toward seeking greater profitability by imperialist expansion. That expansion is what enables capitalism to maintain its profitability and growth.

That the forces underlying capitalism drive it toward extracting wealth from external regions is not the question. Imperialist expansion has always sought colonies and protectorates, or to make other regions dependent upon it. It has—and continues to this day—to exploit and extract wealth by means of producing with lower cost labor outside its ‘core’, by manipulating the terms of trade for exports and imports exchanges with the regions into which it expands, by stripping ownership of land from the indigenous inhabitants and then charging them land rent to use their own land, by theft of natural resources, and by imposing taxes on the indigenous populations to pay for the costs of the imperialists’ policing them. These are all historic forms of exploitation, all of which still continue today to some degree in various places globally.

Classical 19th century British Imperialism extracted wealth by means of production exploitation, commercial-trade, and all the five basic means noted above. It imposed political structures to ensure the continuation of the wealth extraction, including crown colonies, lesser colonies, protectorates, other dependency relationships, and even annexation in the case of Ireland and before that Scotland. The British organized low wage cost production of goods exported back to Britain and resold at higher prices there or re-exported. It manipulated its currency and terms of trade to ensure profit from goods imported to the colony as well. Its banks and currency became the institutions of the colony. Access to other currencies and banks was not allowed. Monopoly of credit sources allowed British banks to extract rentier profits from in-country investment lending and trade credits. They obtained direct ownership of the prime agricultural and mining lands of the colony. They preferred and promoted highly intensive and low cost labor production. Production and trade was structured to allow only those goods that allowed Britain investors the greatest profits, and prohibited production and trade that might compete with Britain’s home production. But the colonial system was inefficient, in the sense that was costly to administer. The cost of administration was imposed on the local country in part, but also on the British taxpayer.

Twentieth century US Imperialism proved a more efficient system. It avoided direct, and even indirect, political control. State legislatures, governments, and bureaucracies were locally elected or selected by local elites. There were few direct costs of administration. The local elites were given a bigger share of the exploitation pie, as joint production and investment partnerships in production and trade were established with local capitalists as ‘passive’ minority partners who enjoyed the economic returns without the management role. Only when their populace rebelled did the US provide military assistance, covertly or overtly, either from afar or from within as the US set up hundreds of military bases globally throughout its sphere of economic interests. The US and local militaries were tightly integrated, as the US trained local officer ranks, and even local police. Security intelligence was provided by the US at no cost. The offspring of the local elites were allowed to enter private US higher education establishments and thereby favorably socialized toward US interests and cooperation. Foreign aid from the US ended up in the hands of local elites as a form of windfall payment for cooperation. US sales and provision of military hardware to the local elites provided built-in ‘kickback’ payment schemes to the leading politicians and senior military ranks of the local elites. Local military forces became mere appendages of the US military, willing to engage in coups d’etat when necessary to tame local elites that might stray from the economic arrangements favoring more local economic independence beyond that permitted by US interests.

US multinational corporations were the primary institution of economic dominance. They provided critical tax revenues to the local government, employment to a share of the local workforce, and financial credits from US globally banking interests. The US also controlled the dominated states’ economies through a series of new international institutions established in the post-1945 period. These included the International Monetary Fund, established to address local management of currency and export-import flows when they became unbalanced; the World Bank, which provided funding for infrastructure project development; and the World Trade Organization and free trade agreements—bilateral or regional—which enabled selective access to US markets in exchange for unrestricted US corporate foreign direct investment into dominated state economies, financed by US financial interests. These investment and trade arrangements were tied together by the primacy of the US currency, the dollar, as the only acceptable trade currency in financial and goods exchanges between the US and the local economy.

This new ‘form’ of economic imperialism—a system of political dominance sometimes referred to as ‘neo-colonialism—was a far more efficient and profitable (for US capitalists and local capitalist elites as well) system of exploitation and wealth extraction than the 19th century British system of more direct imperial and colonial rule. And within it were the seeds of yet a new form of imperialism based on financial exploitation. As the US economy evolved toward a more financialized system after 1980, the system of imperial dominance associated with it began to evolve as well. Imperialism began to rely increasingly on forms of financial exploitation, while not completely abandoning the more traditional production and commerce forms of wealth extraction.

The question is: What are the new forms of imperialist exploitation developed in recent decades? Are new ways of extracting wealth on a national scale emerging in the 21st century? Are the new forms sufficiently widespread, and have they become sufficiently dominant as the primary method of exploitation and wealth extraction, to enable the argument that a new form of financial imperialism has been emerging? If so, what are the methods of finance-based wealth extraction, and the associated political structures enabling it? If what is occurring is not colonialization in the sense of a ‘crown colony’ or even dependent ‘neo-colony’, and if not a political protectorate or outright annexation, what is it, then?

These queries raise the point directly relevant to our current analysis: to what extent does Greece and its continuing debt crises represent a case example of a new financial imperialism emerging?

Greece as a Case Example of Financial Imperialism

There are five basic ways financial imperialism exploits an economy—i.e. functions to extract wealth from the exploited economy—in this case Greece.
• Private sector interest charges for financing private production or commerce
• State to State debt aggregation and ‘interest on interest’ wealth extraction
• Privatization and sale of public assets at fire sale prices plus subsequent income stream diversion from the private acquisition of the public assets
• Foreign investor speculative manipulation of government bonds
• Foreign investor speculation on stock, derivatives, and other financial securities’ as a result of price volatility precipitated by the debt crisis
The first example represents financial exploitation related to financing of private production and trade. It is associated with traditional enterprise-to-enterprise, private sector economic relations where interest is charged on credit extended for production or trade. This occurs under general economic conditions, however, unrelated to debt crises. The remaining four ways represent financial exploitation enable by State to State economic relations and unrelated to financing private production or trading of goods.

One such form of financial exploitation involves state-to-state institutions, public sector economic relations where interest is charged on government (sovereign) debt and compounded as additional debt is added to make payments on initial debt.

Another involves financial exploitation via the privatization and sale of public assets—i.e. ports, utilities, public transport systems, etc.—of the dominated State, often at firesale’ or below market prices. Privatization is mandated as part of austerity measures dictated by the imperialist state.as a precondition for refinancing government debt. This too involves State to State economic relations.
Yet a third example of financial exploitation also involving States occurs with private sector investor speculation on sovereign (Greek government) bonds that experience price volatility during debt crises. State involvement involvement occurs in the form of government bonds as the vehicle of financial speculation.

Even more indirect case, but nonetheless still involving State-State relations indirectly, is private investor speculation in private financial asset markets like stocks, futures and options on commodities, derivatives based on sovereign bonds, and so on, associated with the dominated State. This still involves State to State relations, in that the investor speculation is a consequence of the economic instability caused by the State-State debt negotiations.

Finance capitalists ‘capitalize’ on the debt crises that create price volatility of financial securities, making speculative bets on the financial securities’ volatility (and in the process contributing to that volatility) in order to reap a financial gain from changes in financial asset prices. And they do this not just with sovereign bonds, but with stocks, futures options, commodities, and other financial securities.

All the examples—i.e. interest on government debt, returns from firesale prices of public assets, investor speculative gains on sovereign bonds, as well as from financial securities’ price volatility caused by the crisis—represent pure financial wealth extraction. That is, financial exploitation separate from wealth extraction from financing private production. . . All represents ‘money made from money’, in contrast to money made from financing the production or trading of real assets.

Before describing in more detail each instance, and how they occur in Greece, here are some general comments on financial imperialism.

Financial Imperialism does not displace other traditional forms of imperialist exploitation based on production, commerce, or any others of the five methods noted previously. Financial imperialism adds to, and therefore intensifies, traditional exploitation. Financial forms of imperialism may function as an integral part of the traditional forms. But they may also arise and exploit independent of traditional forms as well—as in the case of financial asset speculation and even privatization of real public assets.

In its most basic sense, finance is about extending money and credit in the expectation of receiving a greater value of money and credit in return. Debt is the equivalent expression of credit. The lender extends credit and the borrower accepts it, thus incurring a debt equal to the credit. The total debt to be repaid is always more than the original credit-debt extended, as ‘interest’ on the debt is added to the initial value of the extended credit. The residual difference between the total debt and principal is the interest charged on the debt.

Private Sector Interest Transfer

In its basic form, financial imperialism and exploitation is about interest flows that originate from the production and commerce of goods. That is, interest payments from credit extended for production and trade.

A foreign bank or financial institution or (jointly owned or foreign) business engaging in foreign direct investment (FDI) into Greece, extends credit to a Greek business to build and/or operate production facilities. The bank or financial institution or foreign business then eventually repaid the loan (principal) plus a rate of interest. The interest charge is ultimately paid for by the Greek worker-producer and/or Greek consumer, as the debt is factored into the wage paid the worker or added onto the price of the product. If the full debt in the in form of interest is not retrievable by shifting its interest cost to wages or prices, then the industrial capitalist (Greek and/or foreign) may write off the interest cost as a deduction from taxes. The Greek taxpayer thus assumes the residual burden of interest. Or, all the above occur—the worker, the consumer, and the taxpayer all pay part of the interest on a basic, private sector financial investment. In private financial exploitation, the imperialist multinational corporation often functions as a monopolist or oligopolist, so it is easily able to shift the burden of interest payment to the local workforce, or to the market price of its product, or to the foreign or Greek taxpayer.

What this process represents is a private sector set of economic relationships, not state to state relationships. It represents private sector credit, debt and interest payment. It is a traditional form of financial exploitation involving production and commerce. It is not yet state-to-state financial exploitation, which is an essential feature of the new financial imperialism.

As it concerns interest payments on credit extended to production and commerce, the flow of payments is quite simple: the enterprise receiving the credit repays the bank on a set schedule of principal and interest payments with certain associated terms and conditions. If the bank is not a Greek bank, the interest payment flows from Greece to the core Euro bank. The interest payment may be to a jointly owned Greek bank, part of which is then redistributed in turn to the Euro bank by the Greek bank. This works until such time as a financial or economic crisis interrupts and prevents the interest payment being made by the enterprise and/or by the Greek bank to the core Euro bank. The latter now faces potential losses from defaulted loans to the enterprise and seeks to ensure the payments occur. Arrangements are pursued that permit the Greek government (or central bank) to provide funds to bail out the Greek enterprise or Greek bank so that it is able to continue to make its scheduled interest payments to the core bank.

Initially this is possible by the Greek government issuing bonds, the proceeds from which are used to bail out Greek banks and enterprises about to default, or defaulting in fact, on scheduled interest payments to Euro banks. But when the economic downturn is severe, as was it was in 2008-09, issuing government bonds may be difficult (or too expensive) and therefore the amount raised is insufficient to cover deficits and bailouts. Diverting government revenues from other sources from the Greek budget is an alternative. But the economic contraction’s severity makes it difficult to redistribute declining tax revenues to bail out Greek enterprises and banks facing default. Unable to sell sufficient bonds, or redistribute declining tax income internally in sufficient volume, to bail out its own Greek banks and enterprises—and itself also in need of more borrowing to cover deficits as its economy collapses from the crisis—the Greek government turned to borrowing from the only source then available to it as a member of the Eurozone: the Eurozone’s Troika institutions. The Troika was willing to lend to ensure Greek banks and businesses did not default on Euro bank and business loans But it was only willing to lend the minimum necessary—after Greece squeezed everything it could first from issuing its own bonds and raising taxes and cutting spending (i.e. austerity).

But the Eurozone as constructed in 2010 had no central fiscal authority, and poorly developed funds, from which Greece (and other periphery economies) could borrow. There was no contingency built into the Eurozone from its inception to handle such situations. ECB to national central bank rules limited the credit the ECB might lend Greece’s central bank. And government to government lending was just then being constructed ‘on the fly’ by the EC and poorly so. By 2012 it was still a cumbersome, bureaucratic and highly politicized process. The manner in which debt negotiations took place further exacerbated Greek government debt levels, as did austerity policies.
In summary, to ensure scheduled principal and interest payments established in the private sector prior to 2008, in the midst of the 2008-09 crisis that wasn’t of Greece’s making, led inevitably to Greek government borrowing from the Troika and its institutions. Private interest on private debt was thus offloaded onto government balance sheets as Greek banks and businesses were bailed out by Greek central bank and Greek government borrowing from the Troika. Private sector interest payments were ensured in the short run, but only by replicating the private payments as debt on Greek government balance sheets for which interest was also to be paid to the Troika. Private debt became government debt, and private interest payments to Euro banks and businesses became mirrored in Greek government debt and Greek interest payments to the Troika.

State to State Debt and Interest Aggregation and Transfer

Financial imperialism is not just a matter of a bank lending to a private enterprise, which eventually in turn repays principal and interest to the bank. That is the kind of financial exploitation that occurs at an enterprise or ‘micro’ level. In the case of financial imperialism, however, overlaid on this basic ‘micro’ relationship are complex ‘macro’ relationships: i.e. imperial state institutions lending to dependent governments; imperial central banks to governments and their central banks; central banks repayments to imperial institutions; dependent governments to all the above; and so on.

Credit, debt, and interest have always been an element of traditional forms of imperialism based on production and commerce (trade). What’s fundamentally different in the case of financial imperialism is that the interest charged is not just on the principal credit extended for the production and transport of a particular private good or service. Interest ends up being charged on interest, as debt is incurred to pay for previous debt. With financial imperialism the primary institution is no longer just the enterprise or the private bank that funds the enterprise goods production and/or trade. Financial imperialism involves state-to-state exchange and interest payments. In the case of Greek debt, the role of the imperial state is played by the entire structure of Eurozone Troika institutions—the European Commission, the European Central Bank (ECB), the IMF, the various funds established for lending by the Troika to Eurozone member governments and their central banks, and ultimately the national central banks and governments that determine the policies of the Troika itself.

In 21st century financial imperialism the imperialist state/structure plays the role of aggregator of private bank credit, which it then extends as its own credit (Troika) to the dominated state’s (Greece) institutions. Greece incurs Troika credit as debt, and then in turn extends the credit to its banks and non-bank enterprises. These private enterprises, bank and non-bank, may include foreign enterprises and banks doing business in the country as joint enterprises or as solely owned local enterprises and banks. The loans and credits provided are then recycled as private payments to enterprises and banks in the imperialist economy beyond Greece. Thus the private money as private credit is recycled completely—from imperialist banks, investors and enterprises through Imperialist state institutions to Greek government institutions, to Greece’s private sector, and from there back to the originating ‘core’ Euro banks and investors.
When a major financial crash and extended recession occur, this financial flow is seriously disrupted. Greece’s private sector—banks and business—cannot make payments on their private debt and default. Their default then threatens losses for the originating creditors in the imperialist economy. If the banks and investors in the imperial ‘core’ are also experiencing potential or actual default—as was the case in 2008-09 in the Eurozone banking core and then again during the 2011-2013 second recession—the need to ensure debt repayment from the local debtors by some alternative means becomes especially important. In addition, if the northern core Eurozone banks, already in trouble, are deeply invested in the major Greek banks, then the bailout of the Greek banks is necessary as part of a bailout of the Eurozone core banks.

But if both Euro core and Greek banks are simultaneously in trouble as they were in 2008-09, from where would the payments come? The Greek private sector debt would have to be assumed by the government sector in order to make the payments, in effect transferring Greek private debt to the balance sheets of government institutions. This is how the Greek debt run-up originated—as a transfer of private debt to government balance sheets. But it was only the beginning of the Greek government’s debt buildup. As was the case with all governments during the 2008-09 crisis, the deep recession meant a collapse of tax revenues just as social payments to support household spending and small business rose simultaneously. This meant government deficits escalated and therefore government debt. Overlaid on these two important sources of rising Greek government debt, were the austerity measures imposed by the Troika from 2010 onward. The double dip recession of 2011-13 in the Eurozone further exacerbated Greek deficits and austerity conditions.

How the Troika handled the debt negotiations also contributed significantly to the buildup of Greek government debt. The Troika insisted repeatedly on Greece raising debt (issuing bonds) in private markets first, before lending to it, even though, due to the crises, the interest on the new bonds sold on the private market rose to extreme levels. Global shadow bank (hedge funds, etc.) speculators during each crisis drove up the bond rates further, thus further increasing Greek debt. There were additional factors as well. By delaying providing loans to Greece as the crises each deteriorated the Greek economy—which the Troika did on each of the three occasions—the Troika in effect allowed the debt totals to rise further than otherwise might have been the case. But even this was not all. As the debt crises and negotiations ran their course, withdrawal of deposits by businesses and wealthy investors from Greek banks required even more loans from the Troika to re-stabilize (i.e. recapitalize) Greece’s private banks. This meant the Greek government had to borrow even more from the Troika to bail out its own banking system, after the Troika purposely permitted—and actually encouraged—it to crash during debt negotiations as a way to pressure Greece to accept Troika terms.

So Greek government total debt—and rising interest payments on the escalating debt—is attributable to six basic causes:

• transfer of private sector debt to government balance sheets,
• rise of government deficits associated with the 2008-09 crash and subsequent double dip Euro recession of 2011-2013,
• excessive speculation on Greek government bonds by private investors and vulture funds,
• ECB action during crises that ensured excessive Greek bank withdrawals and capital flight requiring additional ECB lending to Greece’s central bank to recapitalize Greece’s banking system,
• austerity policies of the Troika that drove Greece into depression, raising deficits and debt
• Troika insistence that debt be piled onto debt, in lieu of debt relief, to ensure Greece would make payments on old debt with new debt.

The rising interest on the Greek government debt is paid from Greek national production. Just as in basic financial exploitation, where the worker-consumer-taxpayer ultimately bears the burden of payment of interest on private debt, government debt and interest is fundamentally the same—except that payment occurs not on an individual enterprise level, but at the level of the entire economy.
The imperialist state structure (Troika) dictates and arranges the terms of the payment on behalf of the banking and private investor interests outside Greece. The Greek state is the ‘middleman’ in the process, implementing the austerity and other measures from which wealth is extracted from Greece’s economy and sent as interest and principal on debt repayments to the Troika. The Troika in turn redistributes the payments to the private bankers, investors and businesses from which it originally raised its bailout funds that it has loaned to Greece.

That is why, as the EMST study showed and concluded, 95% of the Greek government’s debt payments ultimately end up in the private sector in the Eurozone outside Greece—i.e. in the hands of Eurozone bankers and investors. Of the 215.9 billion euros in credit extended by the Troika to Greece in the 2010 and 2012 agreements alone, 86.9 billion of principal was repaid but 119.3 billion was repaid in interest, to private investors or to recapitalize Greece’s banks. Only 9.7 billion ended up in the Greek economy. What appears as a state-to-state structure transfer of wealth—from Greece to the Troika and its institutions— is really in essence a transfer of wealth from the Greek society and economy in general to private interests outside Greece in the Eurozone.

The recycling of the interest payments occurs through both Greece and the Troika—that function together as interest aggregators from Greece to private banks and investors outside Greece. That interest aggregation and distribution process for each of the Troika institutions occurs in brief as follows:

The EC: The Greek government makes interest payments on loan debt incurred from the EC (EFSF, ESM, etc.). The EC raises the loans from its constituent country members, who raise it from their national banks and investors. Greek debt payments to the EC flow back to their respective member governments and in turn back to the private banks and investors.

The ECB: Greece’s central bank repays ECB loans, which then are redeposited to its member central banks’ accounts with the ECB. The funds ultimately contribute to ECB purchases of mostly German and core government bonds and now corporate bonds as well. The money ultimately is redistributed to the corporate sector via QE and other pre-QE liquidity injection measures by the ECB
The IMF: Greek government payments to the IMF are then re-loaned by the IMF to other economies in crisis, which eventually redistribute it largely to western banks who participate as partners in all the IMF bailouts. Example: Ukraine IMF loans from 2005 to 2014 that went to repay loans from participating western banks and investors.

But the money used to repay the Greek government debt and interest must come from somewhere. Part appears to come from new debt incurred in order to be able to repay old. But the money to repay that new debt on old interest must also come from somewhere ultimately. Where it comes from is the aggregate Greek economy and society, from Greek production and commerce on a national (not private enterprise) scale, organized through the medium of Troika-Greece negotiated austerity policies and programs.

In Financial Imperialism, therefore, the extraction of wealth in the form of aggregate interest on debt is arranged through the medium of the state itself, as well as at the level of the individual enterprise. It is becoming one of financial imperialism’s defining characteristics in the 21st century, emerging in the most vulnerable smaller economies, which are being consolidated into new free trade-single currency-banking union transnational capitalist economies like the Eurozone, European Union, TPP, NAFTA-CAFTA, and scores of others that exist or are in development worldwide.

Debt has become a major tool for extracting profit in the form of interest for globalized finance capital in the 21st century. The interest on ever-rising debt from loans and bonds and other securities paid to the Imperialist state are extracted from the entire Greek population—not just on an enterprise basis—though of course forms of interest as payment on credit extended to private enterprise continue. But superimposed on interest from the traditional production or trade exploitation, where goods are involved, is not just interest, but interest on interest due to rising levels of government debt and inability to make payments.

To pay principal and interest on its escalating debt, the Greek government is required to extract income and value from the Greek people by means of austerity: reducing wages, pensions, benefits and services while raising taxes. Greece must generate a sufficient increase in GDP to obtain tax payments with which to repay Troika and private debt. If GDP does not grow, which it cannot do in depression conditions, income taxes decline thus requiring raising of sales (VAT) and small property taxation. If sales taxes are insufficient to make debt payments, the Greek government must also cut spending. Spending cuts focus primarily on government employment and wages, pensions and health services, education and other social services. Labor market restructuring is often the means to reduce benefits and wages of government workers and thereby minimum wages and union-bargained wages and social security benefits for the rest of the private sector working class. When private sector jobs and wages in turn fall, the reduced income for working class Greeks becomes Greek government ‘savings’ that are available for redistribution to the Troika and private investors in the form of debt payments. Greeks must give up a greater share of their wages in the form of taxes to repay debt which they had not personally incurred. As austerity impacts the economy, they then become jobless due to the need to repay debt, or have their ‘deferred wages’ (pensions, health services, social security) reduced, the savings from which are redistributed to the Troika, and so on. The cumulative result is a reduction in economy-wide wage and other earned income that is extracted by the Greek government and paid to the Troika and private investors as debt principal and interest. Through this process of state intermediation, debt and the suffering and reduction in well being it entails is spread to the entire population, irrespective of their role in incurring it.

Financial Imperialism from Privatization of Public Assets

If tax increases and Greek government spending reductions are insufficient to make debt payments, then the Greek government is forced by the Troika to raise additional funds by selling public goods and investment—i.e. privatization of Greek public assets—utilities, railroad and urban transport systems, airports and seaports, etc. Privatization results in a double form of financial exploitation: The Greek government sells the public assets to private investors, most of whom are German, British, Chinese and other investor groups, at a below market price, often at what are called ‘fire sale’ prices. By setting prices well below market value, the investors are thus subsidized by the Greek government. The investors make a financial profit in various ways. They may hold the public asset and then resell it in whole or part at a market price equal or above the asset’s fire sale price. While awaiting the market price of the asset to recover, the investor reaps a stream of income that may be produced by the public asset as well. For example, purchased Greek railroad systems, electricity systems, or ports produce an income stream, which the private investor enjoys in the interim before resale. The asset may be still further exploited by investors’ issuing new bonds on the asset. Or investors may reap a financial windfall through government provision of low cost, subsidized loans to purchase the public asset; or loan guarantees, which the government subsequently pays if the income stream from the privatization does not reach some contractually agreed upon level. Privatization thus creates multiple ways to exploit—i.e. to extract wealth—financially, once the government is on the hook for debt.

Foreign Investor Speculation on Greek Financial Asset Price Volatility

Financial imperialism includes generating interest and money flows from buying and selling government financial securities. This includes professional investors’ speculation in Greek government bonds, notes, financial derivatives tied to bonds (credit default and interest rate swaps), and residential foreclosures and mortgage debt acquisition at below market prices, and even stock price speculation as Greece’s stock market swings widely (contracts) in the run-up to the crisis and after a debt deal is signed (expands).

The periodic debt crises provide great opportunity for speculators and professional investors (mostly in the EU but globally and among Greek investors as well) to realize significant capital gains due to the volatility induced by the crisis. This is not interest on debt—private enterprise or state to state aggregated. There is no austerity required to pay for the financial gains. But it is financial exploitation of the crisis based on the debt nonetheless, a kind of spin-off affording financial exploitation.

As the Greek debt rises, that precipitates an awareness of crisis, and as crisis negotiations begin between the Troika and Greek government, investors dump Greek bonds. Bond prices fall and Greek bond interest rates escalate just as the Greek government attempts to raise significant additional revenue from bonds in order to deal with the debt crisis (since the ECB and Troika insist the government raise funds from private markets as much as possible before

posted August 14, 2018
Turkey & Emerging Markets Perfect Storm Redux

The global economy is again becoming financially fragile. Financial fragility is an indicator of increasing likelihood of the eruption of a major financial instability event–i.e. stock crash, bond market implosion, housing-commercial property price deflation, sovereign debt defaults, etc. In Chapter 3 of my 2016 book, Systemic Fragility in the Global Economy, I described ‘The Emerging Markets Perfect Storm’. The chapter discussed fragility in the EMEs and explained how emerging markets economies would be destabilized and that destabilization could precipitate the next global economic contraction. The causes of the destabilization lay in US and other advanced economies raising interests rates that would in turn cause the US dollar to escalate and then emerging market currencies to plummet. That would provoke EME capital flight, to which EME central banks would respond by raising domestic interest rates that, in turn, would drive their economies into deep recession. The spreading contraction in the EMEs could thereafter transmit to the US and other advanced economies via debt contagion, stock market contraction, capital flight to US Treasury securities, a credit crunch, and general psychological ‘risk off’ investor attitudes in the advanced economies as well. That analysis, scenario and prediction was made in January 2016 in the book. The emerging Turkey crisis, as it spills over to other EMEs, and then through Italian banks to Euro banks and the US-EU real economies may now be in the early stages of development.

Global and US events delayed the process during 2015-16 during which ‘The Emerging Markets Perfect Storm’ chapter was written. Fed rates stayed low, as the US central bank retreated quickly from its threat to raise interest rates, and the dollar in turn stayed low throughout the Obama period. In the past year, however, that delayed scenario has again begun to emerge, with Fed rates now rising sharp and fast, the dollar steadily escalating, and an increasing number of EME currencies in turn crumbling and collapsing–causing capital flight, domestic inflation, recessions, inability to service external debt, and risks of contagion of the EME crises spreading to other regions of the global economy.

The current case of Turkey’s economy is at the center of this re-emerging process, its currency having plummeted 40% to the dollar just this year. (It has temporarily stabilized this week, but the decline will soon continue once again since the fundamentals have not changed).

But Turkey isn’t the only indicator of growing fragility in the global economy, Other EME currencies are also in sharp decline now at various stages: Argentina, Brazil, South Africa, Indonesia, and India. Russia’s Ruble is also deflating and China’s Yuan, the strongest currency in the EMEs, is nonetheless pushing against its lower band fixed to the dollar, within which it too has deflated by 6-10%. It has been prevented from falling further only due to China central bank’s recent intervention in global currency markets propping up the value of its currency, Yuan/Renminbi, in order to prevent further devaluation. Should Trump continue his trade war with China, however, that intervention could end and the Yuan devalue significantly further. That would ratchet up the emerging global currency war and exacerbate conditions in economies like Turkey,

Rising global financial fragility is rising due to obvious increasing contagion effects. The Turkish LIRA crisis is spilling over to other EME currencies, causing a further decline in those currencies in addition to the already significant forces driving down those currencies. Turkish dollarized debt payment obligations to Italian, EU and US banks are being noted in the business press. Italian bank debt is especially exposed, when Italian banks already sit on $500 billion in non-performing bank loans. The transmission mechanism to a broader European bank crisis might easily occur from Turkey to Italian banks to the general banking system. US banks like Citibank are also exposed to Turkish debt. Other indicators of growing potential contagion from the Turkish fallout are the global currency speculators (hedge funds, vulture investors, etc.) now plowing into short selling of the LIRA, further depressing its price, the rising interest rates on Turkey government and private bonds. The response of other EME central banks in raising their interest rates to try to stem the outflow of capital as their currencies follow the LIRA down. (Argentina being the worst case, as its central bank raises rates to 45%–thus ensuring that country’s current recession will collapse into an even more serious contraction, perhaps even depression). The first phase of the general contagion effects of the LIRA collapse have now occurred. A second ‘shoe’ will inevitably fall within weeks. Financial fragility is rising in the global economy–and will eventually impact the US economy in 2019, thus further ensuring a US recession sometime in 2019 that this writer has been predicting.

For readers interested in my 2016 analysis, ‘The Emerging Markets Perfect Storm’, (Ch. 3 of ‘Systemic Fragility’ book also reviewed on this website), that complimentary Chapter 3 follows here below: (follow my blog, jackrasmus.com, for weekly updates and analyses as the Turkey and other EME crises continue to develop):

Systemic Fragility in the Global Economy
Chapter 3 The Emerging Markets’ Perfect Storm
Copyright 2016 Jack Rasmus

An economic perfect storm is now developing offshore. Its winds of economic destruction are gaining momentum. Where it first makes landfall is unknown for now, but its ‘eye’ is clearly located in the emerging markets sector of the global economy.

Earlier the source of growth that propped up the global economy from 2010-13—preventing an otherwise likely descent into global depression in the wake of the 2008-09 economic crash—the Emerging Market Economies (EMEs) are today the focal point of a continuing global crisis that has not ended, but whose eye has only shifted from the AEs to the EMEs. Both the slowing global economy and the forces building toward yet another global financial crisis are concentrated in the EME sector.

What an accelerating decline of the EME sector, representing 52% of global GDP, means for the rest of the world economy is ominous. Continuing weak growth in the advanced economies (AEs) today does not appear capable of offsetting the EME’s current slowdown and decline. That is a fundamental difference from 2010-2013, when EME growth largely offset stagnation and weak growth in the AEs over that period. In net terms, therefore, the global economy is far weaker today in terms of real growth prospects, and is growing simultaneously more unstable financially as well.

The EMEs are being economically pounded today from multiple directions:

• the slowing of the Chinese economy and China demand for EME commodity exports;
• weak demand for EME commodity and manufactured exports by Europe and Japan;
• the drift toward higher interest rates in the US and UK;
• the escalation of currency wars provoked by QE policies of Japan and Europe and China’s currency devaluation response of August 2015;
• the additional impact of collapsing world crude oil prices for those EMEs whose economic growth and stability is dependent on crude oil production and exports;
• China’s stock market bubble and implosion of 2015.

These are problems external to the EMEs themselves, largely beyond their control, although impacting them severely nonetheless. But external forces that cause EME economic instability in turn exacerbate additional ‘internal’ problems that result in further EME economic contraction and fragility. Moreover, internal and external factors interact and feedback on each other, causing still further instability in both real and financial sectors.

The additional internal factors exacerbating EME economic instability include:

• the collapse of EME currencies;
• escalating capital flight from EMEs back to the traditional advanced economies (AEs) of US, Europe, and Japan;
• rising consumer goods inflation;
• EME policy responses to currency decline, capital flight, and inflation;
• collapsing EME equity (stock) markets;
• a growing threat to EME bond markets issued in dollar denominated debt.

This combination of external and internal problems does not bode well for EME future real growth and financial stability—nor in turn for the global growth or world financial instability in stocks, bonds, and foreign exchange markets.

As for the EME real economy, according to the European mega-bank, UBS, EMEs together grew at only a 3.5% annual rate in the first three months of 2015. But that includes China as an EME, with an official growth rate of 7%. If China is excluded, the 2015 growth rate of all EMEs is only a few tenths of a percent above zero. And if China’s real GDP rate is at 5% or less, as many sources now maintain, it’s probably no more than zero. In other words, EMEs as a group—half of the world economy—have virtually stalled. Moreover, that data only represents conditions as of March 2015. Events which may occur in the near future—such as China’s further economic slowdown, rising US interest rates, and a deeper plunge in global oil and commodity prices—will almost certainly further depress EME economic conditions as a group to recessionary levels.

As for EME financial instability indicators, EME stock prices have fallen more than 30% from their 2011 highs, not counting China’s summer 2015 stock market contraction of more than 40% from June through September 2015. In the even more important bond markets, more than half of the acceleration in global debt since 2007 has occurred in private sector debt in general, of which the EMEs in turn have been responsible for more than half, according to a recent McKinsey Consultants study. Much of escalating EME private debt is of ‘junk’ quality, especially in regions like Latin America and Southeast Asia. That means the debt must be paid back in US dollars, which makes EMEs dependent upon selling more exports in the a global economy where trade is slowing everywhere. Either that, or more must be borrowed at ever higher interest rates to finance the debt. And should income from exports decline further, EME corporate defaults can be expected to rise rapidly. Defaults on government debt are also likely to rise among EMEs, especially where government borrowing has grown in US dollar denominated debt—as is the case in many African EMEs.

EMEs are therefore growing significantly more ‘fragile’, with both governments borrowing in dollars and private sector corporations loading up on dollar denominated junk bond debt. Odds in favor of a subsequent EME bond bust are a growing possibility, following in the wake of the EME stock declines already underway across the sector. The prospect of a double-edged financial instability event—involving both stock and bond markets—would have serious repercussions and contagion effects for the global financial economy at large.

What’s An EME?

Before proceeding in terms of further detail concerning the deteriorating condition of EMEs, some conceptual clarifications may be useful. First, what is an EME?

The International Monetary Fund (IMF) identifies EMEs as the 152 emerging and developing economies. The MSCI Stock Index, in contrast, identifies 51 economies, with 28 of the 51 comprising the very small in GDP terms ‘frontier’ economies and the remaining 23 as larger EMEs. Various other definitions list economies in between in terms of GDP, asset wealth, and other factors.

Economies like Brazil, Indonesia, India, Mexico, Turkey, Argentina, South Africa, and others certainly qualify as EMEs. But it is questionable whether China belongs in that category, as the second largest economy (and largest in PPP inflation adjusted terms). Whether economies like South Korea are EMEs is also r questionable. Chile is considered an EME, and is ‘larger’ in a number of economic ways than Portugal, which is not regarded as an EME. Australia is not regarded as an EME, but exhibits many of the characteristics of one, with its dependence on commodity exports, its ties to China, and its recent currency swings like other EMEs. And where do Russia, Saudi Arabia, smaller Eastern Europe economies, and Singapore fit in the various classifications of EMEs?
The oil producers, like Nigeria, Venezuela, Iran, North African and other middle eastern economies, and again Mexico and Indonesia comprise a special subset of EMEs. A second tier of commodity producing EMEs usually includes economies with strategic materials or services, like Chile-Peru (copper), Singapore (finance). A third tier of EMEs are sometimes referred to as ‘frontier’ economies. The so-called BRICS (Brazil, Russia, India, China, South Africa) are often considered the more important economies within the EMEs, although states like Mexico, Turkey, Indonesia and a few other EMEs are important as well. Still other ways EMEs are classified at times are as ‘commodity producing’ EMEs, or as ‘manufacturing’ EMEs, although a number of larger EMEs share characteristics of both commodity and manufacturing producing.

However one may choose to classify the group, the essential point is that the above spectrum of EMEs constitutes a major bloc in the global economy. Along with China, their growth after 2009 and until 2012-13 kept the global economy from collapsing into depression, at least temporarily. That growth, both real and financial, enabled advanced economy (AE) banks, shadow banks, and investors to recapitalize and realize a new level of corporate profits and AE corporate stock price appreciation. But that was yesterday, which began to end in 2012-13, and at mid-year 2015 has begun to rapidly draw to a close. The temporary surge of the EMEs and China in the immediate post-2009 period has ended convincingly as of late 2015. That phase of development of the global economy and economic crisis is over.

A transition has begun. EMEs are under extreme economic pressure from falling demand for their commodities, oil and semi-finished goods, from accelerating capital flight as US and UK raise rates, from growing currency instability in the wake of Japan-Europe QEs and then China’s currency devaluation, from slowing global trade and slowdown in exports, and from sliding stock markets and growing fragility in their financial markets in general. A wildcard adding additional potential economic stress and disruption is the growing political instability in various EMEs—in particular at the moment in Brazil, Malaysia, Turkey, South Africa, Venezuela, and soon elsewhere.

External Forces Destabilizing EMEs

The China Factor

The Chinese economic slowdown, accelerating in late 2015, produced a collapse in China’s demand for commodities and oil that much of the EME growth of 2010-12 was based upon. That declining commodities demand has had a double negative effect on EME economies: first, it has slowed commodities production and exports from the EMEs to China, and consequently EME economic growth; second, the decline in demand for EME commodities has caused a collapse of commodities prices, i.e. commodities deflation, which in turn has lowered revenues and profits in the EMEs and further dampened production.

With Chinese growth closer to 5% GDP (and some estimate as low as 4.1%) instead of its official 7%, China’s demand for EME commodities has plunged. Formerly absorbing approximately half the global demand for copper, aluminum, and other metals, nearly half of iron and steel, and roughly a third of food commodities, and 12% of world oil—a decline in Chinese demand has had a major impact on EME exports and production.

China’s slowdown is reflected in the Bloomberg Commodity Index (BCOM) of 22 key items which has fallen by late summer 2015 by 40% since 2012, to its lowest point since 1999. As commodities output has fallen, world commodity prices have deflated in the 25%-50% range, and even more for crude oil which has fallen from a $120/barrel high to $40 in a little over a year, from 2014-2015. The greatly lower volume plus the deflating price for commodities translates into a slowing of domestic production of the same and thus of EME growth rates in general.

The slowdown in EME exports is not just a function of China demand, of course. Stagnation in the European economy since 2010 and repeated recessions in Japan have also slowed demand for EME commodities and manufactured goods. And as the EMEs have begun to slow as a group after 2013, demand for commodities EMEs might mutually have sold to each other has slowed as well, adding further to the downward spiral of slowing commodities demand, commodities price deflation, lower EME exports, and ultimately slower EME growth.

According to the independent corporate research house, Capital Economics, in the year between June 2014 and June 2015, EME imports growth slowed by 13.2%. However, EME export growth is slowing even faster. In just the March through May 2015 period, exports growth slowed by 14.3%. In Latin America alone, after having peaked in 2011 at $550 billion, exports from those economies fell to $480 billion in 2014 and are projected to decline to as little as $400 billion in 2015. According to World Trade Organization data, after rising 20% from 2011 through 2013, developing countries (EMEs) combined exports peaked in the first quarter of 2014 and began slowing thereafter. The EMEs most heavily impacted have been Brazil, South Africa, various South Asian economies since 2014 and EME oil producers as well, beginning the second half of 2014.

The AE Interest Rate Factor

Simultaneous with the decline in Chinese demand for commodities, a policy shift began around 2013 in the advanced economies (AEs)—the US and UK initially. The shift involved a retreat from their 2009-2013 policies of QE and zero interest rates. The US and UK QEs were wound down by late 2013. Both US and UK then announced intentions to start raising short term interest rates from their near-zero levels. Just the announcement of their intention to raise short term rates sent long term interest rates drifting upward.

Just the announcement of a rise in US-UK interest rates has had a negative impact on EMEs; the actual rise in short term rates, when it comes, will impact them even more. The process is roughly as follows: rising rates in the core AE economies (US-UK) attract money capital back to the AEs from the EMEs, after having flowed in massive volumes from the AEs to the EMEs in the previous 2010-13 period. The money capital (i.e. capital flight) flows back seeking the higher returns from rising rates in the US-UK, given the expectation of slowing growth in the EMEs from China commodities demand decline simultaneously. Thus the two forces—slowing commodities growth in EMEs and rising interest rates in the AEs—combine to have a doubly negative effect on EME capital available domestically for growth.

When the US Federal Reserve announced in 2013 that it was going to ‘taper down’ and then discontinue its quantitative easing, QE, program this was interpreted by financial markets in the EMEs that the excess liquidity created by the QEs would no longer flow into EME markets and economies as much as before. EME markets reacted, in what was called the ‘taper tantrum’, contracting sharply, and capital flight from EMEs back to the AEs—the US and UK in particular—rose. The Federal Reserve quickly backed off in July 2013, and EME markets temporarily stabilized.

Once QE3 was discontinued in late 2013 by the US, the focus of concern by EMEs shifted to the growing possibility of US and UK central banks’ raising short term interest rates. The US Federal Reserve signaled its rate rise plan in January 2014 and the EME panic returned. Once again the US Federal Reserve backed off from an immediate hike in US rates.

But the prospects of eventual rising rates were already taking a toll on the EMEs. EME capital flight was already happening by 2014, in anticipation of the eventual rise in US-UK rates. EME capital flight then received another ‘shot in the arm’ in June 2014, as global oil prices began to collapse. By the second half of 2014 capital flight was in full swing. And in 2015, further shocks from China’s growth slowdown, stock market implosion, and currency devaluation would accelerate it even faster.

Global Currency Wars

Japan began implementing its first massive QE money injection program in April 2013. That drove down Japan’s currency, the Yen. Japan’s QE action led to the currency wars ratcheting up just as the slowdown in global commodity markets was about to begin and as the US Federal Reserve signaled its intention to raise interest rates—both events increasing downward pressure on EME currencies. Japan’s QE especially depressed its currency in relation to China’s Yuan, which rose by 20% in relation to the Japanese yen.

To compete with Japan for global exports to China, which rose with Japan’s de facto devaluation from QE, many EMEs lowered their currency values. Japan then accelerated its QE program in late 2014. This came just after global oil prices began to slide rapidly the previous summer. Japan’s QE, the Fed’s talking up US rates, and the oil deflation resulted in the beginning of the sharp decline in EME currencies in the second half of 2014 and the associated escalation of net capital outflows and capital flight from QEs.

Currency wars escalated further in early 2015, as the Eurozone introduced its version of an 18 month, $1.1 trillion dollar QE program starting March 2015. Its currency then declined, putting more pressure on already falling EME currency exchange rates to do the same. China initially allowed its currency to appreciate in relation to the Euro by around 20%, as it had in relation to the Yen. Those decisions cost China a significant loss of global export share and global trade.

However, following China’s stock market crash that began June 12, 2015, China reversed its policy and responded to the QE-induced Yen and Euro currency devaluations. In August 2015 China entered the currency wars by devaluing the yuan by approximately 4%. That was to be only the start.

The QE devaluations by Japan and the Eurozone together escalated the global currency war, as slowing global trade volume has led more AEs to attempt to capture a larger share of the slowing global trade pie by devaluing indirectly by QE policies. The currency war, plus rising US interest rates, and then China’s response together required EMES to increase downward pressure on their currencies in an attempt to adjust to the currency initiatives by the AEs. Failure to do so would mean a further decline in EME share of world exports and thus of economic growth at home. But doing so also meant falling exchange rates would add further impetus to already net capital outflows and capital flight, which it did. EMEs thus found themselves circa mid-2015 caught in a vise—of AE/China driven devaluations and rising US-UK rate prospects—and at a time when demand for their commodities globally were in freefall. The most seriously impacted EMEs, would be those whose commodity exports mix was composed, half or more, of crude oil.

Global Oil Deflation

In early 2014 the collapse of global crude oil prices began, yet another major development exacerbating capital outflow. . Since collapsing oil prices are typically associated with a rising US dollar, they have a similar effect as rising US interest rates. Both drive up the US dollar and consequently lower EME currency values.

So what’s behind the collapse in global crude oil prices in the first place? The start to that answer lies in the Saudi and US economies. As the global economy has continued to slow since 2013, not only has it provoked a currency war but also an energy production war. While the currency war was set in motion by Japan and Europe’s ‘dueling QEs’, the energy war was precipitated by the Saudis and emirate OPEC partners as a response to the challenge of US shale oil and gas producers.

From 2008 to 2014 global oil production rose by 80% to 9 billion barrels a day. That supply increase was driven in large part by the boom in China and EME real economies that characterized the second phase, 2010-13, of the global economic crisis. China’s 2009-10 fiscal stimulus, nearly 15% of its GDP, and its accelerating demand for EME commodities that accompanied it, plus the liquidity inflows to China and the EMEs from the advanced economies that enabled the financing of it all—explain much of the 80% global oil supply surge from 2008 to 2014. So when the demand origins of that supply surge began to weaken after 2013 in China and the EMEs, the natural result was an excess of supply and the beginning of oil price decline around mid-2014.

However weakening oil demand is only part of the picture. Simultaneous with the demand decline by 2014 was an augmentation of supply. North American oil production expanded sharply in 2014—as a consequence of the shale gas/oil boom by then in full swing in the US as well as Canadian tar sands production growth. That further weakened oil prices significantly. So did Libya’s quadrupling of its oil output in 2014. And all that was further exacerbated by many independent EME oil producers, whose oil production was more or less nationalized, expanding their output despite the falling price, in order to maintain foreign currency reserves and revenues desperately needed by their governments to keep their budget deficits manageable. Toward the end of 2014, crude oil prices had fallen from $115 a barrel to $70 a barrel.

In retrospect, , it appears the Saudis in 2014 tried to eliminate their new shale oil competitors by increasing their oil output, convinced that if the price per barrel of oil could be reduced to $80, that would be uneconomical for US shale producers, forcing them to leave the market. This would return control to global market oil prices to the Saudis and their friends. But this view proved to be dramatically wrong. US shale producers, whose production is based on new lower cost fracking technologies, were able to reduce costs and remain profitable even at $40 a barrel, according to a Citigroup analysis at the time, by shutting unprofitable wells and expanding output in those which were profitable; their cost cutting made it even more profitable to continue producing at previous output levels. US 2014 oil production rose to its highest level in 30 years. And by November 2014 the global price of crude had fallen by 40%.

It was about to fall much further. Global oil deflation crossed a threshold of sorts with the November 28, 2014 OPEC meeting in Vienna, Austria, at which Saudi Arabia drove a decision by OPEC not to reduce production of crude oil, but to maintain OPEC production at 30 million barrels a day, and thus let the price of oil to continue to drop. Many of OPEC’s non Saudi-Emirate members were clamoring for a cut in production to raise the price of oil. So too were many of the non-OPEC players, like Russia. But the Saudis resisted. The question immediately arises, why would OPEC and the Saudis so decide? Purely business logic would argue OPEC should have voted to cut oil production to support the global price of oil. But they didn’t.

Possible explanations include: First, with $750 billion in foreign currency reserves, Saudis could hold out earning oil revenues at lower levels for some time. Smaller producers like Venezuela, Nigeria and others could not. Second, the stakes were high for the Saudis. They were quickly losing control of global oil prices to the new US driven technology and output surge. OPEC and the Saudis knew that global shale production of oil and gas posed a relatively near term existential threat to their dominance. But there was even more to the story. Saudi Arabia and its neocon friends in the USA were targeting both Iran and Russia with their new policy of driving down the price of oil. The impact of oil deflation was already severely affecting the Russian and Iranian economies. The Saudi policy of promoting global oil price deflation found much favor with certain political interests in the USA, who wanted at the time to generate a deeper disruption of Russian and Iranian economies for to forward their global political objectives.

An immediate impact of the Saudi November 28, 2014 decision was a further fall in global oil prices. Thereafter, the currencies of the other EME oil producers began to decline faster than before. EME and Euro stock markets also contracted. Saudi currency and stock markets were not affected, since they pegged their currency to the US dollar. Further currency decline would also generate more capital flight from the EMEs. To recall, it was the second half of 2014 through the first quarter of 2015 when EME capital flight began to accelerate rapidly, amounting to nearly $1 trillion in outflows over the nine month period. That magnitude of capital outflow, thereafter unavailable for domestic investment in the EMEs, contributed to slowing domestic EME investment and growth that also began to contract in 2014.

In the first quarter of 2015 the US economy’s GDP came to another standstill, which reduced global oil demand further and deflated global oil prices still more. The Eurozone also stalled, prompting the introduction of its QE program. The dollar and Euro weakened, and currencies of many EMEs followed, especially the oil commodity producers like Venezuela, Nigeria, Russia and others. In the spring of 2015 the US Congress then began debating lifting the ban on US oil and gas exports, threatening a further surge of gas and oil supply on global markets. That prospect suggested further downward pressure on oil prices.

Nine months of consecutive negative data out of China by spring 2015 suggested strongly that the Chinese economy was slowing faster than the repeated assurances given by China officials that it would remain at a 7% GDP growth level. Then in mid-June the Chinese stock markets began to implode. That too helped deflate global oil prices. Global oil futures, a financial asset, are influenced by—and influence in turn—other financial assets. The connection between oil futures as a financial asset and equity assets is the global professional investors who speculate in both. When one asset class declines too rapidly it has a negative impact often on other asset classes, as investors retreat from markets in general and wait to see what happens.

In August 2015 oil prices recovered some of their $75 a barrel losses of the preceding year, rising from $38 a barrel lows back to the mid $50s on rumors that the Saudis and friends might agree to some kind of production cut. That sent oil prices scaling upward overnight by 20% and more. They retreated when the rumors proved incorrect. That kind of 20% price swing overnight shows how little oil prices are the result of supply and demand forces, and the extent to which they are determined by professional financial speculators driving the oil commodity futures market. Then August data for China and EMEs showed their real economies were slowing even faster than official reports. And Iran announced it would pump more oil at whatever price. Oil prices fell again. And so did EME currencies, stock markets, and the outflow of capital back to AEs.

What the past eighteen months clearly reveals is that the global oil deflation, already emerging due to a slowing global economy by 2014, accelerated as a result of the competition between US shale oil and gas producers and Saudi-Emirate producers attempting to re-assert their effective monopoly control over the price of world oil. As the Saudis and the North American shale gas producers battle it out over who would dominate the global oil industry, the EMEs continue to pay the greater price.

Both directly and indirectly, global oil deflation has functioned as an accelerator to the growing economic instabilities in the EMEs since 2014. Declining currencies, commodities exports and prices, along with capital flight and currency wars, etc.— are all intensified by the global oil deflation.

Who ‘Broke’ the EME Growth Model?

Like the slowing China commodities demand, AE interest rates, and global currency wars, the global bust in oil prices reflect forces largely out of the EMEs’ control. These are external developments imposed on them over which they have little influence. How they respond to these developments of course is a matter of some choice. However, as the following discussion of ‘internal forces’ (i.e. EME responses) shows, the range of choices available is not all that good. For example, while an EME might choose to stem capital flight by raising its own domestic interest rates, that only slows its real economy even further. Or if the EME responds by trying to expand its exports by reducing their cost of production, that might mean less consumer spending and less domestic growth that in turn encourages further capital flight. Reducing government spending to offset rising import goods inflation has the same effect. And so on.

What all this suggests is that much of the causation for the EMEs’ growing economic problems originates in policies in the AEs and China—just as previously, from 2010-2013, much of the expansion of the EMEs also emanated from those same ‘external’ sources. It’s not that the ‘model’ of growth used by EMEs is ‘broken’, a favorite theme recently in the US-European business press. It is that the AEs ‘exported’ their growth to the EMEs during 2010-2013 through their monetary policy, and now are ‘re-importing’ that growth back by reversing that monetary policy. The current economic weakness of the EMEs might therefore be labeled: ‘Made in the AEs’.

A recent article by Kynge and Wheatley concludes: “The dynamic economic models that allowed developing nations to haul the world back to growth after the 2008-09 financial crisis are breaking down—and threatening to drag the world back towards recession”. But was the model created by the EMEs, or imposed on them by the AEs back in 2010? And is that model now being ‘broken’ as a result of EME decisions made 2010-2013, or is in the process of breakdown due to decisions once again being made in the AEs and, to an extent, by the Saudis?

The interesting and even more fundamental question is why did the AEs focus on the EMEs as their source of initial recovery from the 2008-09 crash instead of their own economies? And why now, in 2014-2015, have AE policymakers decided to reverse that policy? The AEs, in particular the US and UK, made the conscious policy decision in 2009 to generate recovery first by bailing out their banks and financial institutions by means of massive liquidity injections. That injection, and the financial asset investment and speculation that produced financial profits restored banks’ balance sheets. AE policy makers also decided early to accelerate recovery for non-financial multinational corporations by incentives to expand investment and returns in emerging markets, including China, because the returns there promised to be quicker and larger compared to investment in their own AEs. This dual strategy worked for both finance capital and non-finance multinational corporations, both of which recovered quickly and realized record profits. But it left the AEs own economies stagnating for the next five years, as other forms of real investment languished. The AE policy shift that began in 2013 thus in effect represents a refocus on their own economies, by bringing money capital back to try to stimulate domestic investment as they (US and UK) discontinue QEs and raise interest rates, in a desperate attempt to get AE GDP rates back up. But that means at the expense of the EMEs in this phase of the post-2008 crash and continuing slowing global economy.

The preceding four major ‘external’ forces that are now having an increasing negative effect on the EMEs are the result of conscious policy decisions made by the AEs, China, and in the case of the oil deflation, by Saudi Arabia and its petro allies. Of course, deeper conditions have forced all three to make these policy decisions: the AEs have not been able to get their economies back on a reasonable growth path since 2010; China has not been able to make the transition to private investment and consumption driven growth; and the Saudis and friends have decided to try to drive the US shale oil producers out of business to protect their long run strategic control of oil production and oil prices. Nevertheless, the consequences for the EMEs of these conditions and policy shifts in the AEs, China, and the Saudi-Emirate economies have been serious. And the consequences have been growing worse by the day. If the next depression is said to be ‘made in the emerging markets’, it will have been the AE-Chinese-Saudi decisions that ultimately made it.

Internal Forces Causing EME Instability

Notwithstanding who is ultimately responsible for the rapid deterioration of EMEs today, it is important to note that the various external causes of that deterioration have set in motion additional internal forces that further exacerbate the EME decline and that, in part, are also the consequence of policy choices made by the EMEs themselves.

In attempting to confront the economic dislocations caused by the external forces, EMEs have had to choose between a number of highly unattractive trade-offs: raising domestic interest rates to slow capital flight, spending their minimal foreign currency reserves to keep their currency from falling, cutting government spending to try to reduce inflation from rising imports; lowering their currency exchange rate in order to compete on exports with AE countries doing the same; and so on. All these choices, however, result in short term and temporary solutions to the external caused forces. The choices almost always lead to a further deterioration of EMEs’ real economy and deepening financial instability.

EME Capital Flight

Capital outflow has multiple negative effects on an economy. First, it means less money available for real investment that would otherwise boost the country’s GDP, create jobs, and produce incomes for workers for consumption. Capital flight also discourages foreign investors from sending their money capital ‘in’ as well. So as capital flight flows out, often capital inflow simultaneously slows or declines. Both produce a double negative effect on money capital available for domestic investment in the EME. More outflow plus slowing inflow also means less purchases of EME stock by investors as they take their money and run. Falling equity values discourage money in-flow still further. A downward spiral thus ensues between capital flight, less investment, a slowing economy, and slowing or declining stock prices.

The scope and magnitude of the capital flight is revealed by recent trends in the EMEs. Net capital inflows for the EMEs were mostly positive prior to the 2008-09 crash, starting at $200 billion in 2002 and rising thereafter. During the 2008-09 crisis, however, there were EME outflows of $545 billion. Starting in late 2009, as the EMEs boomed and benefited from the redirection of the massive liquidity injections by the AE central banks and the concurrent China commodity demand surge, net capital inflows to the EMEs rose rapidly once again. Roughly $2.2 trillion in capital flowed into the EMEs from June 2009 to June 2014.

But that inflow all began to reverse, slowly at first but then at a faster rate, beginning with the ‘taper tantrum’ of 2013 when the Federal Reserve signaled its intention to raise interest rates. EME capital outflow began, but it was temporary, as the Federal Reserve soon backed off in response to the EMEs’ ‘tantrum’. Capital flight resumed again in January 2014 when the Federal Reserve signaled once more its intent to raise US rates. EMEs panicked but net inflows returned as the Fed back-pedaled a second time. But it was to be the last time for the Fed to do so.

By mid-2014, EME net outflows and capital flight resumed with a vengeance, as Chinese growth slowed faster, oil deflation set in, QE currency wars intensified, US interest long term rates starting drifting upward in expectation of Fed policy, and EME real economies and currencies began to slow rapidly. The corner had been turned so far as EME capital outflow was concerned after mid-year 2014.

For example, from July 2014 through March 2015, the 19 largest EMEs experienced net capital flight of no less than $992 billion, or almost $1 trillion in just nine months. And that was only the largest 19. The $992 billion, the most recent available data, represents an outflow of more than twice that occurring during a similar nine month period from July 2008 through March 2009, when a $545 billion net outflow occurred. So the capital flight crisis for the EMEs is twice as serious as during the 2008-09 crash. Not only does the $992 billion represent only the 19 largest EMEs, but the nearly $1 trillion pre-dates the China stock market collapse that began in June 2015 and China’s shift to a devaluation of its currency policy the following August. Therefore, the third and fourth quarters of 2015 will likely show that EME capital flight will exceed the preceding nine months’ $992 billion. A trillion more in capital flight could easily occur in just the second half of 2015. That will mean the five years of accumulated $2.2 trillion inflow will be reversed in just 18 months. That magnitude and rate of capital flight and outflow suggests, in and by itself, a massive economic contraction may be soon forthcoming in the EMEs in 2016 and beyond.

EME Currency Collapse

Currency decline is directly associated with capital flight. The greater the rate of flight, the greater the rate of decline, or collapse. That’s because capital flight requires investors in the country to convert the country’s currency into the currency of another country to which they intend to send the money capital. That involves selling the EME’s currency, which increases its supply and therefore lowers the price of that currency, i.e. its exchange rate. And when many investors are selling an EME currency, it also means a drop in demand for the currency that further depresses its price.

There have been three phases of EME currency decline since 2013. The first during the 2013 ‘taper tantrum’. The second commenced mid-2014 with the collapse of global oil prices and the growing awareness China’s was slowing. The third phase began the summer of 2015, as China’s stock markets collapsed and it subsequently devalued its currency, the yuan. The stock market crash in China quickly set off a wave of similar stock contractions throughout the EMEs. Investors sought to pull their money out and send it to the AEs, as both a haven and in anticipation of better returns. More EME money capital was converted to dollars, pounds, euros and yen, sending those currencies’ values higher (and thus pushing EME currencies still lower).

As an indication of the magnitude of the impact of capital flight and currency conversion on EME currencies, the J.P. Morgan EME Currency Index fell by 30% from its peak in 2011 by July 2015, virtually all of that in the past year, 2014-2015. An equivalent index for Latin America compiled by Bloomberg and J.P. Morgan revealed a more than 40% decline in currency values for that region’s EMEs during the same period.

In just the first eight months of 2015, January-August, some of the largest EME currencies have fallen by more than 20%, including those of Brazil, South Africa, Turkey, Columbia, Malaysia, while others like South Africa, Mexico, Thailand, Indonesia and others dropped by more than 10%.

In yet another vicious cycle, the collapse of currency exchange rates for EMEs causes an even greater momentum in capital flight. No investors, foreign or domestic, want to hold currencies that are falling rapidly in value and expected to decline further. They take their losses, take their money capital out of the country, convert to currencies that are rising (US dollar, UK pound, and even the Euro or yen) and speculate that price appreciation will provide handsome capital gains in the new currencies. Currency decline thus has the added negative effect of provoking a vicious cycle of capital flight-currency decline-capital flight.

One would think that declining currency values would stimulate export sales. But only in a static world. In a dynamic world of ever-changing forces and economic indicators, declining currencies for different EMEs that are occurring in tandem mean a race to the bottom for all. No country gets a competitive export advantage by currency devaluation for long, before it is ‘leap frogged’ by another doing the same, negating that advantage.

In addition, the advantages to economic growth from expanding exports might also be easily offset by declining real investment due to accelerating capital flight, rising domestic interest rates implemented by governments in desperate efforts to try to stem the capital outflow, falling stock market prices associated with the net capital outflows, and slowing domestic consumption for various reasons. The latter developments typically overwhelm the very temporary relative advantages to exports gained from declining currency exchange rates—as has happened, and continues to happen, in the case of the EMEs post-2013.

Domestic Inflation

Currency decline has the added negative effect of directly impacting domestic consumption by contributing to import inflation. When a currency declines, the cost of imported goods goes up. And if imports make up a significant proportion of the EMEs’ total goods consumed, then EME domestic inflation rises. Many EMEs in fact import heavily from the AEs, for both consumer goods and semi-finished goods that they then re-manufacture for consumption or re-export for sale. If consumer inflation is significant, it means less real consumption and therefore slower EME growth; and if producer goods import inflation is significant, it means rising costs of production, less production and again, less EME growth.

Capital flight due to currency decline also contributes to inflation, albeit in a manner different from import inflation due to currency decline. Import inflation affects consumption, whereas capital flight works through investment. More capital outflow translates into less investment, which means less productivity gains, higher production costs and cost inflation. In short, currency decline, capital flight, and EME inflation all exacerbate each other, and combine to have significant negative effects on EME real growth. It starts with currency decline, which accelerates capital flight and reduces investment and also contributes to inflation which slows real consumption as well.

The decline in China that reduced global commodities demand, the deflation in commodities that followed, the subsequent currency decline and capital flight, and the eventual imports-goods inflation together reduced consumption, real investment and economic growth. These elements all began to converge in the EMEs by mid-2014. After mid-2014 additional developments exacerbated these negative trends further—including the global oil deflation, growing prospects of US interest rate increases, intensifying currency wars, and the unwinding of Chinese and EME stock markets.

The multiple challenges faced by EMEs from these developments, intensified and expanded in the second half of 2014 and after, forcing the EMEs into a general no-win scenario. They have responded variously. Brazil, South Africa and a few other EMEs have raised their domestic interest rates to slow capital flight and attract foreign capital to continue to invest, although that choice has slowed their domestic economies more. Another option, using their foreign currency reserves on hand, accumulated during the 2010-2013 boom, to now buy their currencies in open markets to offset their decline, works only to the extent they accumulated foreign reserves during the 2010-13 period. Many EMEs did not. And those who had accumulated have been depleting them fast. Similarly unpromising, they can try to reduce their currency’s value by various means, in order to compete for the shrinking pie of global exports. That means participating in the intensifying global currency war ‘race to the bottom’, in a fight they cannot win against the likes of China, US, Japan and others with massive reserves war chests. What the oil producing EMEs have done in response to the growing contradictions with which they are confronted is to just lower the price of their crude in order to keep generating a flow of income upon which their government and economy is dependent. Others face the prospect of simply trying to borrow from AE banks, at ever higher and more undesirable terms and rates, in order to refinance their growing real debt.

While the EMEs enjoyed a robust recovery from 2010 to 2013, thereby avoiding the stagnation, slow growth, and recessions experienced by the AEs during the period, now the roles after 2013 were being reversed. AE policies began creating massive money capital outflows from the EMEs, slowing their growth sharply, causing financial instability, and leaving EMEs with a set of choices in response that promised more of the same. The case example of Brazil that follows reflects many of the ‘hobson’s choices’ among which the EMEs have been forced to choose, as well as the negative consequences they pose for EME economic growth and financial instability.

Brazil: Canary in the EME Coalmine?

No country reflects the condition and fate of EMEs better than Brazil. It’s a major exporter of both commodity and manufactured goods. It’s also recently become a player in the oil production ranks of EMEs. Its biggest trading partner is China, to which it sells commodities of all types—soybeans, iron ore, beef, oil and more. Its exports to China grew fivefold from 2002 to 2014. It is part of the five nation ‘BRICS’ group with significant south-south trading with South Africa, India, Russia, as well as China. It also trades in significant volume with Europe, as well as the US. It is an agricultural powerhouse, a resource and commodity producer of major global weight, and it receives large sums of money capital inflows from AEs.

In 2010, as the EMEs boomed, Brazil’s growth in GDP terms expanded at a 7.6% annual rate. It had a trade surplus of exports over imports of $20 billion. China may have been the source of much of Brazil’s demand, but US and EU central banks’ massive liquidity injections financed the investment and expansion of production that made possible Brazil’s increased output that it sold to China and other economies. It was China demand but US credit and Brazil debt-financed expansion as well—a s is the case of virtually all the major EMEs. That then began to shift around 2013-14, as both Chinese demand began to slow and US-UK money inflows declined and began to reverse. By 2014 Brazil’s GDP had already declined to a mere 0.1%, compared to the average of 4% for the preceding four years.
In 2015 Brazil entered a recession, with GDP falling -0.7% in the first quarter and -1.9% in the second. The second half of 2015 will undoubtedly prove much worse, resulting in what the Brazilian press is already calling ‘the worst recession since the Great Depression of the 1930s’.

Capital flight has been continuing through the first seven months of 2015, averaging $5-$6 billion a month in outflow from the country. In the second half of 2014 it was even higher. The slowing of the capital outflow has been the result of Brazil sharply raising its domestic interest rates—one of the few EMEs so far having taken that drastic action—in order to attract capital or prevent its fleeing. Brazilian domestic interest rates have risen to 14.25%, among the highest of the EMEs. That choice to give priority to attracting foreign investment has come at a major price, however, thrusting Brazil’s economy quickly into a deep recession. The choice did not stop the capital outflow, just slowed it. But it did bring Brazil’s economy to a virtual halt. The outcome is a clear warning to EMEs that solutions that target soliciting foreign money capital are likely to prove disastrous. The forces pulling money capital out of the EMEs are just too large in the current situation. The liquidity is going to flow back to the AEs and there’s no stopping it. Raising rates, as Brazil has, will only deliver a solution that’s worse than the problem.

Nor did that choice to raise rates to try to slow capital outflow stop the decline in Brazil’s currency, the Real, which has fallen 37% in the past year. A currency decline of that dimension should, in theory, stimulate a country’s exports. But it hasn’t, for the various reasons previously noted: in current conditions a currency decline’s positive effects on export growth is more than offset by other negative effects associated with currency volatility and capital flight.

What the Real’s freefall of 37% has done, however, is to sharply raise import goods inflation and the general inflation rate. Brazil’s inflation remained more or less steady in the 6%-6.5% range for much of 2013 and even fell to 5.9% in January 2015, but it has accelerated in 2015 to 9.6% at last estimate.

With nearly 10% inflation thus far in 2015 and with unemployment almost doubling, from a January 4.4% to 8.3% at latest estimate for July, Brazil has become mired in a swamp of stagflation—i.e. rising unemployment and rising inflation. Brazil’s central bank estimated in September 2015 that the country’s economy would shrink -2.7% for the year, the deepest decline in 25 years. With more than 500,000 workers laid off in just the first half of 2015, it is not surprising that social and political unrest has been rising fast in Brazil.

The near future may be even more unstable. Like many EMEs, Brazil during the boom period borrowed the liquidity offered by the AEs bankers and investors (made available by AE central banks to their bankers at virtually zero interest) to finance the expansion. That’s both government and private sector borrowing and thus debt. Brazil’s government debt as a percent of GDP surged in just 18 months from 53% to 63%. The deteriorating government debt situation resulted in Standard & Poor’s lowering Brazil government debt to ‘junk’ status.

More important, private sector debt is now 70% of GDP, up from 30% in 2003. Much of that debt is ‘junk bond’ or ‘high yield’ debt borrowed at high interest rates and dollar denominated—i.e. borrowed from US investors and their shadow and commercial banks and therefore payable back in dollars—, to be obtained from export sales to US customers, which are slowing. An idea of the poor quality of this debt is indicated by the fact that monthly interest payments for Brazilian private sector companies is already estimated to absorb 31% of their income.

With falling income from exports, with money capital fleeing the country and becoming inaccessible, and with ever higher interest necessary to refinance the debt when it comes due—Brazil’s private sector is extremely ‘financial fragile’. How fragile may soon be determined. Reportedly Brazil’s nonfinancial corporations have $50 billion in bonds that need to be refinanced just next year, 2016. And with export and income declining, foreign capital increasingly unavailable, and interest rates as 14.25%, one wonders how Brazil will get that $50 billion refinanced? If the private sector cannot roll over those debts successfully, then far worse is yet to come in 2016 as companies default on their private sector debt.

Brazil’s monetary policy response has been to raise interest rates, which has slowed its economy sharply. Brazil’s fiscal policy response has been no less counter-productive than its monetary policy. Its fiscal response has been to cut government spending and budgets by $25 billion—i.e. to institute an austerity policy, which again will only slow its real economy even further.

The lessons of Brazil are the lessons of the EMEs in general, as they face a deepening crisis, a crisis that originated not in the EMEs but first in the AEs and then in China. But policies which attempt to stop the capital flight train that has already left the station and won’t be coming back’ will fail. So too will competing for exports in a race to the bottom with the AEs. Japan and Europe are intent on driving down their currencies in order to obtain a slightly higher share of the shrinking global trade pie. The EMEs do not have the currency reserves or other resources to outlast them in a tit-for-tat currency war. Instead of trying to rely on somehow reversing AE money capital flows or on exports to AE markets as the way to recovery and growth, EMEs will have to try to find a way to mutually expand their economic relationships and forge new institutions among and between themselves as a ‘new model’ of EME growth. They did not ‘break the old EME model’; it was broken for them. And they cannot restore it since the AEs have decided to abandon it.

EME Financial Fragility & Instability

Instability in financial asset markets matter. It is not just a consequence of conditions and events in the real, non-financial sector of the economy. Anyone who doubts that should recall that it was the collapse of shadow banks, derivatives, and housing finance practices that not only precipitated the crash of 2008-09, but also played a big role in causing the more rapid and deeper real economy contraction that followed. Financial asset markets have also played a major role in the stop-go, sub normal recovery of the AEs since 2009. Financial assets and markets will play no less a role in the next crash and greater contraction that is forthcoming.

Other examples prior to 2008-09 provide further evidence of the importance of financial forces in real economic contractions. The dot.com tech bust of 2001 and the recession that followed were the result of financial asset speculation. The 1997-98 ‘Asian Meltdown’ crisis was fundamentally about currency speculation. Japan’s crash in 1990-91, prior recessions in the US in 1990, the US stock market crash of 1987, junk bonds and housing crises in the 1980s, the northern Europe banking crisis of the early 1990s—all had a major element of financial instability associated with them. So finance matters.

Declining equity markets are a signal of problems in the real economy, of course. They are also a source that can exacerbate those problems. For example, China’s stock bubble implosion of 2015 is contributing to the further slowing of real investment in China and to the major capital flight now exiting that economy. The capital flight will in turn cause more instability in global currency markets and accelerate financial asset prices in property and other asset markets in the UK, US, Australia and so forth. The China equity market collapse has had, and will continue to have, depressing effects on stock markets elsewhere in the world. The major stock index for emerging markets, the MSCI Index, has declined more than 30% from its highs. Stock markets of major economies like Brazil, Indonesia, and others have all fallen by 20% and more in just the first seven months of 2015. Financial asset deflation is occurring not only in oil commodity futures, but in global equity prices as well.

Falling stock values also mean that corporations may be denied an important source of income—i.e. equity finance—with which to make payments on corporate debt. One of the major characteristics throughout the EMEs is that many of EME corporations have borrowed heavily during the boom and now must continue to make payments on what is now to a large extent ‘junk’ or high yield debt, and high yield debt also borrowed in dollars, from their various sources of income. But raising money capital by means of stock issuing or stock selling is extremely difficult when stock prices are plummeting.

As its currency exchange rate falls for an EME, it means whatever income a company has available now ‘pays less’ of the debt—effectively, the company’s real debt has risen. Rising real debt is therefore an indicator of growing financial fragility as well—there is declining income with which to pay the debt. Falling currency may also make it more difficult for a company to refinance its debt, or force it to do so at an even more expense interest rates. That too reflects growing financial fragility.

Still another financial market is the oil futures market, especially for those EMEs who are dependent on oil production and sales. Oil is not just a product. It is a financial asset as well. And when the price of that financial asset collapses, the income of the oil producer EME also collapses in many cases. Expectations of future oil prices determine current oil prices, regardless of actual supply and demand in the present. So the more prices fall the more professional speculators may drive the deflation further. Creating a global oil commodities trading market has had the result of introducing more financial instability into the global market for oil. Income from oil production may thus be impacted significantly and negatively by financial asset price movements.

Finally, the EMEs are clearly highly unstable with regard to bond markets—both sovereign or government bonds as well as corporate bonds. And in many EMEs much of the corporate debt (and some government debt as in Africa) is denominated in dollars and therefore must be repaid in dollars. As the aforementioned McKinsey Consultant study shows, one half of all the increase in global debt since 2007 has occurred in EMEs and the lion’s share of that has been in private corporate debt. From 2010 to mid-2015 more than $2 trillion in EME bonds have been issued in dollars, with another $4 trillion plus issued in local EME currencies. Asian Bond debt is 113% of Asian economies’ combined GDP, a record high, according to the J.P. Morgan EMBI+ bond index. As more EMEs attempt to address their crisis by raising domestic interest rates, as Brazil and now South Africa have done, that will drive bond prices down dramatically. A general bond price collapse will make stock market declines pale in comparison as to the consequences for global economic stability. And if corporations in the EMEs can’t refinance their mountain of debt at rates they can pay given their declining sources of income, then a wave of corporate defaults will rock the EME and global economy.

As the economic problems for the EMEs multiply in coming months, the financial market problems will become more serious, not just for EMEs but for AE banks and investors in the wake of their debt defaults. And when financial markets ‘crack’, they typically lead to a new level of economic crisis in the real economy in turn. Most recently, Oxford Economics research has predictred the EMEs aggregate GDP growth rate will fall to its lowest level since the 2008-09 crisis. Other sources warn the situation is beginning to look more like 1997, when a major financial crisis involving EME currencies erupted. It is quite possible 2016 may witness that kind of real and financial sector negative interaction once again.

posted August 4, 2018
Will Trump’s Trade War Precipitate a Currency War?

In mid-July, Trump threatened $500 billion in tariffs on China imports, escalating his prior threat to impose $200 billion on China. He then threatened hundreds of billion in tariffs on world auto parts imports, targeting Europe. But Trump’s threats and announcements do not constitute a trade war. Threats and even announcements of tariffs are one thing; the actual implementation of tariffs another. But even the current scope of tariff implementations do not yet represent a trade war. Bona fide trade wars occur when tariff fights spill over to currency devaluations and generate currency wars.

To date, only $34 billion in tariffs on China industrial imports to the US has been actually implemented, plus another $2-$3 billion in intermediate steel and aluminum products. In response, China has so far imposed an equivalent $36 billion in tariffs on imported US agricultural goods, targeting US soybeans, port, cotton and other grains produced in Trump’s political base of the US Midwest agricultural belt.

Elsewhere around the globe, earlier in July Trump threatened to escalate a trade conflict with the European Union, threatening to impose $200 billion on Europe and global auto part imports to the US. But to date there’s only been US tariffs implemented on Europe steel and aluminum imports. And the response from Europe has been a mere $3 billion in counter tariffs on US imports. Ditto for trade with Mexico-Canada. US steel-aluminum tariffs on imports from Mexico-Canada have elicited a token response of $15.8 billion in Mexican and Canadian tariffs on US imports.

Total actually implemented US import tariffs to date—mostly levied against China—amount to only $72 billion, or 2.3% of a total of $3.06 trillion imports into the US annually. US trading partners have responded measuredly in kind, with their own 2.3% in tariffs on US exports on the total $2.58 trillion US exports worldwide. Tariffs of 2.3% hardly represent a tariff war, let alone a trade war. Bona fide trade wars are never limited to tariffs. Trade wars involve not only tariffs but also non-tariff barriers to trade. Even more important, bona fide trade wars occur when tariff spats escalate and precipitate currency devaluations.

Should Trump follow through with threats of $200-$500 billion more tariffs on China imports, the US and China will likely slip into a currency war as China allows its currency, the Yuan, to devalue further. And that devaluation will almost certainly quickly go global— given the current significant decline in currency exchange rates already taking place throughout various throughout key emerging market economies (Argentina, Turkey, India, etc.). Other emerging market economies will have no choice but to follow China’s devaluation lead. Nor will advanced economies like Japan and Europe be immune from having to devalue, as they try to offset Trump tariffs in order to maintain their share of global trade that Trump policies are clearly attacking.

Trump’s Dual Track Trade War

Trump apparently believes he can control the response of US trading partners to his threats and intimidations, and that he can conclude token trade deals, if necessary, to avoid falling over the trade cliff of currency devaluations. While he might be able to backtrack and quickly close trade deals with NAFTA partners and Europe—just as he settled a quick, token deal with South Korea early this year—the settling of a quick trade deal with China may not prove so easy. And the longer the tariff conflict with China continues, and escalates, as appears likely, the greater the likelihood or the current US-China tariff spat descending into a currency war.

A Trump two track trade policy has been underway since early 2018. One track is with US trading allies. Here Trump will prove flexible and eventually settle for minor adjustments in trade terms, just as he did with the South Korea trade pact earlier this year. Trump will then exaggerate and misrepresent the dimensions of the deals with allies, selling it all as great achievements benefiting his domestic US political base and confirming his US ‘economic nationalism’ policy that proved so politically valuable to him in the 2016 elections. Much of the trade war with allies is really about US domestic politics and the upcoming US November midterm elections.

Unlike China, where trade negotiations are currently frozen and no discussions are underway, both Europe and Mexico in recent weeks have been signaling they are amenable to a quick deal with Trump if he will settle for relatively minor concessions. Mexico president elect, Lopez Obrador, sent his trade negotiator to Washington DC this past week to explore concessions with Trump. A deal was negotiated last spring by US and Mexican trade representatives but was subsequently scuttled by Trump. Trump introduced a new demand in US-Mexico negotiations that any trade deal would have to ‘sunset’ and be renegotiated every five years. Trump did not want a deal too early. Trump wants a deal closer to the US November elections so that he can tout it to his domestic political base as proof his ‘economic nationalism’ policy works. The current differences between the US and Mexican positions in negotiations currently are otherwise not significant; should Trump drop his sunset demand, which he will do when the timing for his domestic politics is appropriate—that is, just before or soon after the US midterm elections—a deal with Mexico (and thereafter similarly with Canada) will be concluded quickly. And according to US Commerce Secretary, Wilbur Ross, just last week, an agreement between the US and Mexico will soon be announced.

The same Trump flexible approach was evident in the just announced ‘deal’ with European Commission president, Jean-Claude Juncker, who also came to Washington this past week. Juncker’s goal was to get Trump to back off his threats to impose tariffs on Europe auto part imports. Not actual tariffs, in other words, but to get Trump to retract his threat to perhaps introduce them. Trump and Juncker then announced a ‘deal’. The so-called deal is merely verbal and indicate objectives the parties, US and Europe, hope to maybe achieve, at some point undefined in the future. It was not actually a trade agreement. Just a mutual statement they would negotiate toward a deal. Trump backtracked from his threat to impose tariffs on autos. In exchange, Juncker offered to buy more US soybeans and US natural gas at some point in the future. In terms of actual tariffs, or any other ‘trade’ measure, the Trump-Juncker announcement was mostly a public relations stunt for both parties designed to placate their domestic critics.
The US trade war with Europe is just a war of words, as it has been thus far with NAFTA. What exists in fact is just a couple billion dollars of actual tariffs on steel and aluminum imposed by the US on Europe and a similar amount of token tariffs implemented by Europe on select US imports to Europe. The so-called trade war with NAFTA and Europe is still phony. Not so the case, however, with China. And while negotiations continue with NAFTA and Europe, no further discussions are underway with China and will likely not occur soon.

What the US Wants from China—And Won’t Get

Unlike NAFTA and Europe, a quick settlement with China is not in the works. The US wants concessions from China that it is not demanding from NAFTA, Europe and other allies. The US wants concessions in three areas from China: more access to China markets by US banks and multinational corporations, including 51% and then 100% US corporate ownership of their operations there. Second, the US wants China to purchase at least $100 billion more in US goods, mostly from Midwest US agribusiness and manufacturing. Third, it is demanding stringent limits and reductions in China’s current policy requiring US nextgen technology transfer from US businesses operating in China. What has the US defense and intelligence establishment especially worried is China plans to leapfrog the US in nextgen technologies like 5G wireless, Artificial Intelligence, and Cybersecurity. These represent not only the source of industries of the future, but threaten a quantum leap in China military capabilities. The US refers to the nextgen technologies as ‘intellectual property’ since they are fundamentally software based. But what the US really means is nextgen military-capable software intellectual property.

When negotiations opened with China this past spring, China cleverly offered major concessions to the US. It announced it would grant 51% ownership rights for US multinational corporations doing business in China, and signaled it could agree to 100% as well. That delighted US bankers and multinational corporations. Their representative on the US trade negotiating team, US Treasury Secretary, Steve Mnuchin, publicly declared a deal with China was therefore imminent. China also signaled it could purchase $100 billion more a year in US agricultural products. But it would not budge on the tech transfer issue. A deal was close but was then upended by US defense-intelligence-war industries US negotiating faction. Through their friends in Congress, they aborted any prospective trade deal with China. Trump then followed up by threatening to impose an additional $200 billion of tariffs on China in response to China matching US tariffs on China imports by implementing an equivalent $34 billion on US exports to China, especially targeting US soybeans, pork and other grains. And when China declared it would match the US further threat of another $200 billion in tariffs, Trump doubled down by threatening a further $500 billion on China imports. While Trump’s threats of more tariffs and intimidation tactics have proven successful eliciting the response he wants from Europe and NAFTA partners, it has not to date proved similarly effective with China. Nor will it likely.

While China will allow significant US corporate access to its markets, and will agree to purchase hundreds of billions more of US exports, especially agricultural, China shows no signs of bending on its technology development objectives. And while US bankers, multinational corporations, and agribusiness-farmers appear willing to cut a trade deal on market access and US exports purchases, it appears that the US defense establishment (Pentagon, Intelligence agencies, defense contractors), together with its friends in Congress, will not allow a deal with China without major concessions by China on technology.

From Tariff Spats to Currency Wars

Trump believes his intimidation tactics—thus far proving successful with NAFTA and Europe—will work as well with China. He believes he can close token deals quickly when he chooses with the former two, which is true. But he can’t do so similarly with China. And the longer the tariff spat with China drags on, and deteriorates, the more likely a US-China tariff war will escalate into a bona fide trade war involving currencies and US dollar-Yuan exchange rates. And that is the prospect US and global business interests are particularly worried about.

A currency war between the US and China will reverberate across the global economy that already shows signs of slowing and, in some key sectors, is already descending into recession. Tariff spats involve two trading partners and may affect their mutual economies, but currency wars quickly spread across all economies in a chain-like contagion of devaluations.

This potential scenario is approaching, as Europe’s economy is slowing rapidly and tending toward stagnation once again. Japan is already in another recession. A growing number of emerging market economies are contracting—the worst case scenarios being Argentina, now in a 5.8% economic contraction, but Brazil, South Africa, and others are continuing to slip further deeper into recession. Turkey’s currency is now collapsing rapidly, a harbinger of real economic contraction on the near horizon. Meanwhile, India and other south Asian currencies and economies are also growing more unstable. In short, the global economy is growing more fragile in terms of both trade and production. A trade war involving currency instability between China and US will almost certainly tip the balance.
But Trump clearly believes China’s economy can be destabilized by the US trade offensive. That China has more to lose than the US, since it has benefitted from US trade more than the US has from China trade. But this is a naïve and simplistic analysis, typical of Trump and his advisors. Typical of a financial speculator mentality, Trump believes that so long as the US stock markets are doing well, the real economy is strong and can weather an intensification of a tariff war. For Trump, ‘tariffs are great’. Just raise them further to intimidate trading partners and force concessions from them to the benefit of US corporate interests and the economies of his domestic political US base.

China has already begun to ‘dig in’, however, in anticipation of a longer, protracted contest with the US over tariffs and their economics effects, and US demands to restrict China technology development. It has just announced another major fiscal-monetary stimulus to its economy this past week, in anticipation of slower growth from exports and trade with the US. A massive money injection to spur bank lending, tax cuts, and more government investment are planned to offset any export slowdown. It is also aggressively pursuing other trade deals with Europe and other economies to offset any decline in US trade. China also has various measures it can employ in a Trump trade war escalation. It can slow its purchase of US Treasury bonds. It can impose more non-tariff administrative barriers on US companies in China and those exporting to China. It can launch a boycott of US made goods among China consumers. These are likely measures of last resort, however. More likely is China may allow its currency, the Yuan, to devalue against the dollar—thus even offsetting any Trump tariff effects. And ironically somewhat, the devaluation of China’s currency will be allowed to occur due to market forces, not any China official declaration of devaluation, since the US policy is already causing a devaluation of the Yuan.

Trump’s trillion dollar annual US budget deficits have resulted in the US Federal Reserve central bank raising interest rates. The Fed must raise rates to finance Trump’s now estimated annual trillion dollar deficits for the next decade (caused by Trump’s $3 trillion in tax cuts and trillion dollar hikes in defense spending; with trillions more tax cuts and defense spending in the Congressional pipeline before year end 2018).

To pay for the multi-trillion dollar deficits, the US central bank, the Fed, is rapidly raising interest rates. Rising interest rates are driving up the value of the US dollar. That dollar appreciation in turn is causing an inverse decline in the value of emerging market economy currencies—and that includes China’s Yuan currency. The Yuan has devalued by 10% since the US tax cuts, deficits, and interest rate hikes in 2018. A seven percent Yuan devaluation in just the last three months. The Yuan is now at the edge of its trading band at 6.8 to the dollar. Should it slip further, which is inevitable as US interest rates and the dollar continue to rise, a devaluing Yuan will set off a chain reaction of devaluations throughout the global economy—i.e. a currency war will have arrived. And as currencies devalue, Trump’s tariffs will have been offset, neutralized, negated.

Trump has declared ‘tariffs are great’. But Trump’s tariffs will have been negated in turn by a currency war set in motion by Trump’s own domestic fiscal and monetary policies that are causing the US dollar to rapidly appreciate worldwide. Trump is betting his intimidation approach can produce quick results before his tariff war precipitates a currency war and a severe global economic contraction. He is rolling the economic dice. He and his advisors clearly believe if it gets too serious, he can call off the tariff disputes with NAFTA, Europe and other trading allies quickly. He probably can, by backing off and getting token agreements which he’ll misrepresent and exaggerate. But the scenario for a quick resolution is quite different with China. It will not back off so easily. The US-China dispute is far different than the US-trading allies (NAFTA, Europe) trade war of words.

Some Conclusions

Thus far, Trump’s trade wars with allies are phony. A NAFTA deal is imminent. A hiatus even in the trade war of words with Europe has been declared. And a further escalation with China has not yet occurred. Trump will announce token and fake deals with Mexico and Canada before the US November elections for purposes of touting to his US domestic political base. He has suspended the war of words with Europe. He will make outrageous threats to China while perhaps trying to lure them back to negotiations. But China knows his game and most likely will not negotiate until it sees what happens with the US November elections and the Mueller investigation of Trump.

At some point China and the US will negotiate. And the key to whether a real trade war emerges thereafter—and that will only be with China—will depend whether Trump follows through with his threats to impose another $200 billion in tariffs on China imports to the US. And whether the Pentagon and US defense industry lobby agrees to accept less stringent limits on technology transfer demands in current negotiations. How China will respond to more US tariffs and technology transfer is the lynchpin to any US-China trade war.
Trump and his advisors believe China cannot match tit for tat an equal $200 billion since it doesn’t import that magnitude of goods from the US. But China has other measures, which it has signaled it is prepared to employ (without yet revealing the details). A devaluation of its currency would almost be high on its agenda of possible responses should Trump implement $200 billion more in tariffs. China’s currency is already pushing the edge of its band against the dollar, at 6.8 to 6.9 to the dollar. China has been intervening in money markets to keep it there so far. All it needs to do, however, is stop intervening and the Yuan will devalue beyond the band due to market forces. It doesn’t need to declare a devaluation. Just let the dollar rise, as it will, and the Yuan will devalue without China intervening to prevent it. A Yuan devaluation will allow China to offset Trump tariff costs by an equivalent amount, thus negating Trump’s tariff actions.

At that point the skirmish on tariffs between the US and China will morph into a currency war, and signal a true trade war will have begun. And the US-China trade war will have significant repercussions on global currencies as a contagion of currency devaluations follow. Currency exchange rates will adjust even lower globally throughout emerging markets, as well as in Europe and Japan, than they already have. And that will sharply slow global trade and, in turn, global economic growth.

Jack Rasmus, July 31, 2018

Dr. Rasmus is author of the book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017, and the forthcoming, ‘The Scourge of Neoliberalism: US Policy from Reagan to Trump’, also by Clarity Press. He blogs at jackrasmus.com and tweets @drjackrasmus.
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posted July 15, 2018
European Central Bank’s Performance Failures: From 1999 Origins to 2017

ECB PERFORMANCE: FROM ORIGINS TO THE BANKING CRISIS OF 2008

During the period from its origins in 1999 to the banking crash of 2008-09, the ECB’s primary central banking function was limited to managing the money supply. The ECB had no bank supervision function at this time, which remained in the hands of the national central banks. Nor was there any test of its function as lender of last resort. The central bank was tasked primarily with launching the Euro as the new currency and the task of converting national currencies to the new one until around 2002; thereafter providing sufficient liquidity to fuel the boom in intra-Eurozone exports and imports that escalated from roughly 2003 to 2007. This was a period of financial asset bubbles that mostly impacted economies outside the Eurozone: the global currency crisis of 1997-98 affected mostly Asian economies, the series of sovereign debt crises that followed impacted select emerging market economies and east Europe, and the dotcom tech bust of 2000-02 involved mostly North America and Japan. The ECB was allowed to focus on managing the new Euro money supply, targeting price stability, and employing its key interest rates of marginal lending facility (MLF) and discount facility (DF) as the primary tools for injecting liquidity into the new regional economy.

It is a well-known fact that when the Eurozone countries began the conversion of their domestic currencies to the Euro, Germany and other northern core economies’ currencies were overvalued. They thus received an excessive share of the Euro allotments.

The M1 money supply grew by 104% from 1999 through 2006, as the ECB pumped excessive liquidity into the regional economy in order to jumpstart intra-Eurozone trade, which was heavily weighted as exports from the core northern Europe economies of Germany-Netherlands-Belgium-France to the periphery economies of southern Europe and Ireland. That expansion of liquidity was nearly 25% faster than GDP economic growth during the same period. In other words, the money supply was increased at a greater rate than the rate of real economic growth. Rising at double digit rates annually, the excess liquidity was in turn reflected in total Eurozone bank credit, which rose at an annual rate of 6.72% from 1999 through October 2007. Banks were taking the ECB liquidity and lending it out at a rapid rate. Where was the bank lending going? From the northern core banks to the periphery economies.

Core banks were lending to private banks in the periphery, as well as to periphery private businesses directly. They expanded their operations in the periphery, including investing into partnerships and buying into periphery banks. Non-bank corporations in the core economies were also funneling loans from their core banks as direct investment into the periphery economies, expanding operations there, making acquisitions, launching new subsidiaries. Their borrowings from their core banks were redirected to the periphery in turn. The ECB was also providing liquidity to the NCBs in the periphery economies, which were then also lending to their private banks and non-bank businesses. Money capital was flowing from core to periphery in volume through various channels throughout the 1999 to 2007 period.

Much of the inflow of capital was going to finance housing and commercial property investment, especially in the economies of Spain, Portugal, and Ireland where property booms were growing. By mid-decade, the credit flowing to the periphery was also increasingly employed to purchase northern core export goods, especially from Germany. That country had compressed wages and retooled its manufacturing as it implemented its version of the EMU’s Lisbon Plan, which called for austerity and labor reforms to reduce labor costs to make export goods more competitive. Germany thereafter began to gain an ever-greater share of total exports within the Eurozone. The Euro conversion made it the pre-eminent production for exports powerhouse within the Eurozone after 2004-05.

While the lending of the excess liquidity and money capital to the periphery enabled an explosion of property investing, as well as acquisitions of periphery banks and businesses by core banks and businesses, it also raised general income levels in the periphery that enabled consumers and businesses there to purchase the ever-rising volume of German-core exports to their periphery economies. In short, as a consequence of the core bank lending, core businesses’ direct investment into the periphery, and the rising standard of living in the peripheries, the money capital was flowing to the periphery economies and then recycling right back to the core as interest payments to core banks and as purchases for core exports. German-core banks and businesses were enjoying record profits from production for exports, as well as from investment and speculation on rising property prices in the periphery. But the credit extension to the periphery enabling it all was meanwhile piling up debt in the periphery economies.

It is important to note, however, that this debt buildup was initially largely private sector debt, and not sovereign debt. While some government spending was also increasing to provide infrastructure expansion in the periphery and as social payments to sectors of the populace not directly benefiting from the property and export booms—enabled by rising GDP and tax revenues that were occurring—government debt as a percent of GDP was not accelerating particularly excessively in the periphery economies from 1999 through 2006. That government or sovereign debt would not escalate rapidly until the banking crash of 2008-09, and the shift of private sector debt in the periphery to periphery governments that occurred after 2008.

When the 2008-09 crash came, the inflows of credit to the periphery dried up. But the debt repayments from the prior credit-debt buildup remained to be paid. Thereafter, money and liquidity provided to the periphery economies would increasingly assume the form of additional loans—i.e. debt—in order to make payments on the previously accumulated debt. Credit and debt was extended to repay debt. And fiscal austerity was imposed on the periphery economies as the means to finance the debt repayments in exchange for the EC-IMF-ECB (called the ‘Troika’) providing more debt to repay debt.

It was a vicious downward cycle, but nonetheless one with origins in the excessive liquidity injections of the ECB during the 1999-2007 period—excess liquidity that led to excessive private debt accumulation in the periphery economies that would transform into sovereign debt after 2008. One might therefore reasonably conclude that the ECB’s central bank function of managing the money supply was not so well performed in the run-up to the 2008 crisis. Indeed, the debt it enabled was central to the crisis and its aftermath.

ECB PERFORMANCE FROM BANKING CRISIS TO QE: 2008 to 2015

The ECB’s interest rate management policies also clearly contributed to the 2008 crisis and, for Europe, the even more serious 2010-2013 double dip recession and related sovereign debt crises that wracked the periphery economies from 2010 to 2014.

As the general Eurozone economy heated up by 2006, the ECB began to raise its key interest rates, the marginal lending facility (MLF), and discount facility (DF). But it continued raising rates for too long—for an entire year from March 2007 through July 2008, well after it was clear that a property bubble was already contracting. Only after the US banking crash in September-October 2008, did it shift course. Even then it was not particularly aggressive in reducing rates. The ECB similarly proceeded slowly in injecting liquidity into the banks, that were now beginning to hoard cash as their financial assets and balance sheets began to collapse.

Even more damaging was the ECB’s reversal of interest rates at the worst possible time. Instead of continuing to reduce rates, in April 2011 it raised rates again just as the Euro economy was sliding into its second, double dip recession. The 2011-2013 recession was in some ways even worse than the 2008-09 global contraction and the ECB was at least partly responsible for precipitating it by raising rates in 2011 into the economic downturn. In short, ECB interest rate policies were counterproductive, both in 2007-08 and again in 2011. These inopportune shifts were clearly demonstrated the central bank’s poor performance so far as management of its traditional monetary policy tools was concerned.

Money Supply Function

While the US and UK central banks quickly engaged in non-traditional, experimental tools to more quickly inject liquidity into their collapsing banking systems, the ECB did not. It would not turn to tools like quantitative easing until 2015. In the interim, it attempted to provide liquidity to Euro banks by expanding its traditional bond buying operations and tweaking new approaches.

The problem in banking crises is that liquidity quickly dries up. The prior excessive liquidity injections, accumulated before the crash, end up being hoarded by banks once the crisis emerges. Liquidity may also get wiped out by widespread financial asset price collapse, defaults, and bankruptcies. Losses on banks’ balance sheets exceed banks assets and liquidity that remain. Banks then stop issuing credit, i.e. lending, to non-bank businesses. A credit crunch ensues (or a more serious credit crash, where no loans are available). Unable to borrow from banks that won’t lend, non-bank businesses severely cut back production and beginning mass layoffs, cutting wages and benefits, and suspending payments to banks for loans they previously took out. The banks and financial sector thus propagate the financial crisis to the non-financial side of the economy. Non-bank businesses’ suspension of repaying the principal and interest on their debt to the banks lead to further bank losses and curtailment of credit. The real economy thus causes a further deterioration in the financial sector. And on it goes, vice versa, in a downward spiral of general contraction. Prices for goods and services as well as for financial securities together stagnate and then deflate. With deflation, the value of the prior debt incurred that remains actually rises in real terms even further. It’s a nasty cycle that requires action to break the causal relations that continue to feed upon themselves. Somehow price deflation must be checked and reversed, and begin to rise again—or the massive debt overhang must be offloaded from the banks, businesses, and households’ balance sheet. Or the banks must be allowed to go under. From their perspective, unthinkable—not only from the precedent it may set but also from the contagion effects, unknown even to the banks, that the complex relationships of inter-bank debt might lead to!

The central bank’s task in such conditions is to get the banks to lend once again. But that’s easier said than done. The central bank can provide extra liquidity to the banks and lower the cost of borrowing (interest rates) from the banks, but if non-bank businesses and household consumers’ incomes are declining due to the recession in the real economy, it doesn’t matter how low interest rates go or how much money supply banks may have on hand to lend. The demand for credit takes precedence over the cost of credit (rates) and if credit demand is contracting faster than interest rates or liquidity injection, bank lending won’t result. So the central bank keeps lowering interest rates and futilely pumping more and more liquidity into the banks hoping if they have a massive excess to lend, some of it will leak out into the real economy.

A problem in recent decades is the excess liquidity provided by the central bank to the banking system produces an insufficient ‘leakage’. The banks take the central bank’s liquidity but then may simply hoard it on their balance sheets. Or loan it to the ‘safest’, large multinational corporations that redirect it to offshore markets and investment. Or the bank loans are used to speculate in financial asset markets that typically recover before the real economy. Or non-bank businesses borrow the money from the banks and use the credit to buy back their company’s stock or increase their payout of dividends to shareholders. In all these ‘leakage’ events, the consequence is bank lending does not recover despite the emergency liquidity injection programs of the central bank. The liquidity doesn’t get where it is intended, in other words, and the real economy continues to stagnate for lack of borrowing for the purpose of real investment. That’s exactly what happened in the case of the ECB after 2008—as it did with the US and UK economies.

An added problem in the ECB case was that the central bank’s emergency liquidity injections in 2008-09 weren’t even as aggressive as the US and UK. They were not as large and they came late. And, unlike the US and UK economies, the Eurozone lacked what are called ‘capital markets’. These are alternative sources for borrowing by non-bank businesses apart from traditional banks. In the Eurozone more than 80% of all sources of credit come from the traditional banks. The Eurozone still has undeveloped capital markets. The combination of weaker initial liquidity injections by the ECB, undeveloped capital markets, and the greater relative reliance on traditional banks for loans meant that bank lending stagnated even more in Europe after the 2008-09 crash than it did in the US and UK.

Furthermore, the ECB was still raising rates in mid-2008 as the global crisis was unfolding. It started lowering rates late into the crisis by October 2008, but then did so relatively slowly., The ECB’s main rates, MLF and DF, were reduced from peak highs in July 2008 of 5.25% and 3.25%, to 3% and 2%, respectively by year end 2008, while the US Federal Reserve, in contrast, lowered its key federal funds ten times in 2008, thus far more aggressively as the crisis erupted, and by December 2008 had reduced the rate to a mere 0.15%. It was virtually free money for the banks.

Similarly, with regard to non-traditional liquidity programs, the US Fed immediately introduced special programs in 2008 that provided an additional $1.159 trillion to US banks and financial markets by the end of December 2008, while the ECB simply tweaked an existing program called the Long Term Refinancing Option (LTRO), by raising the duration of loans to banks from 3 months to 6 months. Furthermore, to get the LTRO loans the banks had to put up certain narrowly defined collateral which many did not have. The ECB’s increase in short term lending accomplished little in terms of stimulating bank lending to non-banks. What the banking system needed was more long term lending to banks—without collateral of any kind if necessary— if the banks were to resume lending again to non-bank businesses in turn. More free money, in short.

The ECB was reluctant to do that. Continuing its go-slow liquidity strategy the ECB diverged even further from the US in 2009. As the US central bank launched even more liquidity programs, the ECB virtually stopped expanding even its traditional programs. It wasn’t until May 2009 that the ECB again raised its LTRO lending, and then modestly, by offering loans of 12 months duration instead of three and six months. And not until July 2009 did the central bank introduce its first new program, the Covered Bond Purchase Program (CBPP). However, the CBPP was limited to liquidity totaling only a token 60 billion Euros.

Meanwhile, Euro banks’ lending was rapidly drying up. From the 6.7% annual average growth of total credit by EU banks, from 1999 through 2007, in 2008-09 annual bank credit growth declined to 3.14%. Thereafter, in each of the next five years, 2009 through 2014, bank credit would collapse to an annual average growth of only 0.8% over the five year period. Bank lending had virtually stopped. Real economic activity in the region slowed sharply thereafter, and with it, government tax revenues. In 2008 Europe’s GDP declined from $14.1 trillion to $12.9 trillion. It would fall again in 2009 and thereafter essentially stagnate over the next five years while bank lending continued to either decline or stagnate as well.

The stagnating Euro real economy was producing rising deficits and government debt in the periphery economies. According to the Bank of International Settlements (BIS), the northern Europe core banks were exposed to $1.579 trillion in periphery economy government debt by 2010. In May 2010, the ECB therefore launched what it called the Securities Markets Program (SMP), which involved ECB indirect purchases of sovereign bonds and other securities. Over the next two years up to 210 billion Euros of liquidity would be provided through the SMP. But in 2010 and 2011 it was not enough or fast enough to contain the sovereign debt crises that were deepening in the periphery.

The damage from the ECB’s delays in 2008 in rate reductions and its insufficient liquidity injections were growing evident. By 2010 the ECB and Eurozone was now also facing a general sovereign debt crisis throughout its periphery, focused on Greece and Ireland but also Portugal. New non-ECB sources of liquidity had to be created to refinance the periphery governments’ debt—this time raised by the European Commission instead of the ECB. These new programs were the European Financial Stability Facility (EFSF), created in 2010, and succeeded by the European Stability Mechanism (ESM) in 2012.

The EFSF was set up as a private corporation in Luxembourg. Euro member states each contributed financing in the form of guarantees of the bonds that were to be issued by the EFSF, up to a total of 440 billion euros. The EFSF was authorized to issue and sell bonds up to 440 billion. A fund was established from the bond sales proceeds from which Governments in trouble—i.e. Greece, Ireland, etc.—could borrow. The borrowed funds could be used to bail out their private domestic banks. So it offered not just a government bailout but also a way to provide liquidity to banks in trouble. However, there was a hitch. A condition of borrowing was that the governments had to introduce fiscal austerity measures to reduce their spending to ensure they could repay the loans from the EFSF. The governments thus incurred additional debt with which to bail out their banks even though “The chief aim of the exercise was to help banks strengthen their balance sheets rather than support struggling peripheral states”.

More ECB liquidity measures followed targeting injection of funds into the national central banks and/or their domestic banking systems. In July 2011 the 6 month LTRO program was extended, followed by a far more massive much longer term, 3 year LTRO program that provided 489 billion euros to 523 banks at year end 2011. The ECB allowed a broader definition of collateral for these loans. It also reduced the banks’ reserve requirement, releasing another 110 billion euros for potential lending.

Conditions continued to deteriorate into 2012. Spain and Italy could not obtain new loans to refinance their debt. Speculators were destabilizing government bond prices. Deflation was growing. It was feared that the Euro system itself might implode. The ECB quickly reversed its interest rate direction and cut rates. It was at this time that ECB chair, Mario Draghi, made his famous public declaration in July 2012 that the central bank would “do whatever it takes’ to bail out the banks, stimulate lending again, and get the real economy growing once more. He immediately introduced yet another new bond buying program in September 2012 called the OMT (Outright Monetary Transactions), which promised to potentially buy an unlimited amount of bonds and thus provide ‘whatever it takes’ in liquidity injection. The prior SMP program was rolled into the new OMT. The OMT is estimated to have added another 600 billion euros, inclusive of the remaining SMP liquidity.

In short, an institutional framework for addressing liquidity needs of both governments and banks was being created ‘on the fly’ as the crisis continued and deepened in 2012. But the proliferation of liquidity programs were still just variations on the theme of adjusting or tweaking existing approaches to liquidity provisioning by the ECB. The liquidity provided by all these measures from May 2010 through 2012 did not reflect a significant rise in the M1 money supply—i.e. which meant the liquidity was not being loaned out and getting to the economy at large. From January 2010 through 2012 the M1 for the Eurozone rose from 4.53 trillion euros to only 5.10 trillion.

With the recession coming to an end in early 2013, the ECB slowed its liquidity and bond buying programs. An expansion of the CBPP in 2014 added another 228 billion euros and a new Asset Backed Securities Purchasing program (ABSP) added a further 23 billion. By 2014 the ECB’s balance sheet reflecting the liquidity provided by the various programs from 2010 through 2013 had risen to a level of 2.27 trillion euros after partial repayments to the central bank. That was not appreciably higher than the ECB’s balance sheet of 2.07 in 2008. The modest net growth in the central bank’s balance sheet is another indication that the liquidity injections after 2008 were not all that effective—either in increasing the money supply or in generating bank lending.

No new programs were introduced in 2013-2014, as the worst of the recession ended. The ECB again grew complacent. Prices were essentially stagnant from spring 2013 through fall 2014 and then began to deflate by late 2014 as the Euro economy weakened again and threatened a possible third recession by late 2014. The preceding five years of liquidity injections through various traditional approaches had not resolved anything in terms of creating sustained economic recovery, rising prices, or renewed bank lending. Calls for an even more aggressive liquidity program along the lines of the US and UK ‘quantitative easing’ (QE) initiatives were raised throughout the region. The ECB prepared to embark on its own QE program for 2015, which was announced in January of that year.

Bank Supervision Function

Bank supervision has also been weak throughout much of the ECB’s history. Prior to 2008 the ECB’s authority did not extend to bank supervision. That was left to the country NCBs and other regulatory national institutions. This lack of ECB bank supervision authority would continue until late 2014.

With the eruption of the sovereign debt crisis in Europe in May 2010—behind which was a more fundamental banking crisis—proposals for providing the ECB with banking supervision authority grew. But it was only talk. Nothing much came of it throughout the period of the first sovereign debt crisis in the Euro periphery. It was only when the double dip recession of 2011-2013 threatened a collapse of the entire banking system in 2012 that serious consideration started to be given to the idea of having the ECB assume elements of the critical central bank function of bank supervision.

The event that precipitated the new consideration was the collapse of the large Spanish bank, Bankia, in May 2012, requiring tens of billions of euros to bail out from the Euro Member States’ financed ESM bailout fund. Rather than just waiting for bank collapses and pouring money after them, the idea finally dawned on members of the EC and the GC of the ECB that perhaps it might be preferable, and less costly, to properly supervise the banks in order to avoid such costly bailouts. As much as Germany disliked the idea of shifting bank supervision authority to the ECB, it disliked even more having to pay for bailouts post hoc, so it too supported the shift of supervisory authority to the ECB. The Single Supervisory Mechanism, SSM, was therefore created in November 2013. After a year of transition, the SSM took effect in November 2014.

The SSM was set up as a division within the ECB. Under the SSM the ECB was given authority to conduct on-site inspections of banks and set what are called ‘capital buffers’ at the banks, in order to protect against future bankruptcies. This was essentially ‘micro’ supervision, bank by bank. The SSM did not have authority to address ‘macro’ supervision, i.e. supervision designed to prevent a system-wide banking crisis. Nor did the SSM’s authority extend to the shadow banking sector or the wholesale debt securities markets or the derivatives markets and derivatives trading houses. There were other problems. The SSM authority extended only to the largest banks. Bank inspections required involvement of national regulators and were to be carried out jointly—i.e. an arrangement conducive to bureaucratic infighting and inertia. The information the SSM could require from the banks was also strictly limited. The largest banks’ operations elsewhere in Europe, outside the Eurozone, were subject to supervision—but only if those countries signed on to the SSM. Operations outside Europe were excluded from supervision. Another big exemption was financial institutions that did not qualify as ‘credit institutions’ under the EMU. To qualify as such, the institution had to accept retail depositors. This meant that financial entities like stock and bond brokers and dealers were not subject to SSM jurisdiction. The SSM was not even given the responsibility to monitor financial system risks and stability. That role remained with another agency altogether, the European Systemic Risk Board. Finally, there was the question of adequate staffing and resources even to perform on-site inspecting. ECB inspections and staffing have barely expanded since the SSM was established. Many critics conclude therefore that the ECB’s SSM lacks the competency and the institutional capacity to carry out the bank supervision function it assumed in late 2014.

Perhaps the best indicator of poor bank supervision record under the ECB is the chronic and significant overhang of non-performing bank loans (NPLs). NPLs that remain on bank balance sheets have a major negative impact on bank lending. Stagnant or declining bank lending in turn stifles investment that might create jobs and wage incomes that in turn might generate inflation. NPLs generally translate into reduced investment, poor wage-income growth, and therefore stagnant prices or even deflation for goods and services. When the SSM was established there was more than a trillion dollars in NPLs in the Eurozone. Two and a half years later that total has not measurably declined. Not until March 2017 did the ECB even issue guidelines as to how to address the NPL problem.

The effectiveness of the ECB’s bank supervision under the SSM has continued to fester. German discontent with the SSM’s handling of the ongoing Italian bank crisis and the Eurozone’s conservatively estimated 920 billion euro NPLs continues into 2017. The SSM has still not restructured the Italian bank, Monte dei Pasche, which is technically bankrupt. The SSM continues to stall. As Daniele Nouy, its director, replied to German critics of the SSM’s lack of progress resolving the Italian and general NPL problem, “We are definitely willing to use our powers…but we have to be fair. As supervisors, we have to demonstrate we are developing the issues with proportionate action”.

The creation of the SSM represents the belated recognition that the ECB in 2012 was not a bona fide central bank and could not therefore carry out a central bank’s primary functions. The SSM was viewed as a step toward transforming the Eurozone into a truer form of banking union. In addition to managing money supply in a stable manner, and supervising banks at both a micro and macro level, a banking union also required some form of ‘deposit insurance’ system, as well as some organization to manage what was called ‘bank resolution’—a fancy term for winding down, dismantling, merging, or otherwise financing the restructuring of banks that fail. The ECB had none of that authority before November 2014. By 2017, although it has been granted bank supervision and resolution authority it has hardly been able to exercise it for various reasons. The test case of bank resolution—i.e. Monte dei Pasche and the Italian banks in general—remains as evidence of the ECB-SSM’s general ineffectiveness at bank supervision.

Lender of Last Resort Function

There are two ways of looking at the lender of last resort function. One is how well the central bank performs in rescuing individual banks that may become insolvent. The other is a more ‘macro-prudential’ view of how well it performs in ensuring or restoring financial stability to the entire banking system in the event of a major banking crash and crisis.

Assessing the ECB’s performance with regard to the latter ‘macro’ task is difficult, since bailing out banks in a general crisis in the Eurozone before 2014 involved bailing out the national governments as well in 2010 and 2012. As shown, debt by banks is highly integrated with the debt of the national governments. By EMU rules, moreover, the ECB was precluded from directly lending to national governments. Yet national governments and their national central banks were critical to rescuing their private banking systems. Furthermore, the domestic banks of the periphery economies held large volumes of their governments’ debt in turn. As noted previously, one cannot be bailed out without bailing the other.

Given the EMU rules, in the Eurozone periphery economies from 2010 through 2013 the lender of last resort function by definition had to be a joint effort involving the ECB with the participation of the European Commission and the IMF. The EC in fact provided the major share of the direct government bailout—a kind of ‘political’ liquidity injection—while the ECB participated by providing loans to the NCBs of the countries in question—mainly Greece, Italy, Portugal, Spain and Ireland. Were the ECB (and EC-IMF) therefore successful as collective lenders of last resort? Yes, in a sense, private banks and their governments were both saved from total collapse in 2012. But did lender of last resort financing resolve anything? Were the banks fully restored? Did bank lending resume? Were the banks prevented from collapse but remain technically insolvent coming out of 2012, overloaded with non-performing loans? Here the answer is no. Much of the bad loans and non-performing loans remained on most banks’ balance sheets after 2012. The banks were rescued only temporarily. The lender of last resort function was therefore not completely fulfilled.

Targets and Tools Before QE

As noted previously, price stability was the only ‘target’ of the ECB since 1999 and remains so to this day. Targeting price stability failed during the 2008 to 2015 period. Prices stagnated at best, and often deflated on various occasions during the period. So it cannot be said that the ECB performed well in terms of achieving its target of price stability.

So far as central bank monetary tools are concerned, the ECB explored various ways to buy bonds as a means by which to provide liquidity to the private banking system, from government or sovereign bonds to ‘covered bonds’ to even asset-backed securities. More than two trillion euros were injected into the Eurozone economy by such measures. Were the tools effective? Apparently not. The ECB could not get the price level up to the target of 2%, and struggled to keep it from deflating. The bond buying did not stimulate investment and thus the real economy; the 2011-2013 severe recession occurred simultaneously with the bond buying. NPLs were not removed from banks’ balance sheets and bank lending did not improve much despite the massive injections. On the other hand, the liquidity provided jointly by the ECB, EC, and IMF did eventually stabilize the sovereign bond market, bringing soaring bond prices for Spanish, Italian, Greek and other bonds back down from the heights. It took a lot of liquidity to accomplish just that. If the bond buying was only partly effective, it was certainly not efficient in any sense.

Interest rates as a tool also proved largely ineffective during the 2008-2014 period. After the ECB’s error of raising rates in summer 2011 as the Euro economy was entering its double dip recession, it shifted interest rate policy and began cutting rates again. By 2014 the DF rate was zero, and the MLF rate at an historic low of 0.75%. But like the bond buying measures, interest rates had virtually no real effect on the economy. It was what economists call the classical ‘liquidity trap’. The central bank could provide all the increase in money supply it wanted. Rates could be zero. But banks would still not lend.

With near zero rates and after two trillion or more of bond buying, what was to be done? In 2014 it looked once again that the Euro economy was headed for another, third recession in 2015. At this point the ECB embarked on a path of introducing more experimental liquidity injection programs, like the US-UK and Japan had already done. It launched its own version of ‘quantitative easing’, QE, and then adopted an even more radical program of negative interest rates (NIRP).

ECB PERFORMANCE UNDER QE & NIRP: 2015-17

QE and NIRP became the centerpiece of ECB monetary policy action starting in 2015. On January 22, 2015, the ECB announced what it called its Public Sector Purchase Program (PSPP). The central bank in March began purchasing not only sovereign bonds from euro governments but also debt securities from banks and agencies, at a rate of 60 billion euros every month. Prior programs of Asset-Backed Securities Purchasing (ABSPP) and the CBPP-covered bond buying program, were carried over and expanded as well.

A year later, in March 2016, the central bank expanded QE further by purchasing corporate bonds. It additionally raised the monthly total of purchases to 80 billion euros a month.

The problem with the program in 2015-16 was that the ECB’s purchase of bonds—both public and corporate—did not actually reduce the level of bonds held by the banks. If the ECB was buying bonds at such an enormous rate of 80 billion every month, bond supply on euro banks’ balance sheets should have been reduced significantly but it wasn’t. “This suggests that government bonds purchased under the PSPP have mostly been purchased from non-bank entities and foreign banks”.

Credit to non-financial corporations continually declined for four years, 2012-2016, stabilizing around zero by 2016. Thus it didn’t accelerate significantly during 2015-16 due to the introduction of PSPP. So one may reasonably conclude that QE in its first two years failed to significantly stimulate bank lending—and therefore investment and economic growth. Not surprising, nor did prices rise to anywhere near the 2% price stability goal.

When QE (PSPP) was announced in January 2015, prices had already deflated to their lowest level ever in the Eurozone. Inflation was -0.6% that month. Once QE was launched, prices had risen three months later but only to a tepid 0.3%. Thereafter for the next 18 months, into the summer of 2016, inflation ranged between -0.1% and 0.3%. Prices were more often deflating than stagnating. This was far from the ECB’s price stability target of 2%. One can only conclude therefore that QE failed during its first two years, 2015-2016, in so far as enabling the Eurozone to attain its price stability targets.

Although economic growth and recovery is not a target or mandate of the ECB, the effect of QE on GDP and employment was as unimpressive during its first two years as it was for attaining its price stability target. GDP for the euro region averaged approximately 1.7% in both 2015 and 2016. But most of that was German growth. Italy and other periphery economies averaged growth rates of less than 0.5% on average, and other economies like Greece fared far worse.

Official studies commissioned by the European Parliament concluded that QE’s contributions to growth were “small relative to the size and type of monetary policy interventions”. The effect of QE on unemployment was similarly weak, as the same studies concluded “there does not seem to have been a significant effect from QE on the pace of unemployment reduction”. This minimal to negligible impact of QE on inflation, economic growth and employment occurred despite the ECB growing its balance sheet as a consequence of QE from 2 trillion euros at year end 2014 to more than 4.1 trillion euros by 2017.

In contrast to QE’s failure with regard to price stability and economic recovery, there are three areas in which the ECB’s QE program appears to have had a noticeable effect: On stock prices. On the Euro currency exchange rate. And on income inequality within the Eurozone. As soon as QE was announced, the dollar-euro exchange rate plummeted, from 1.4 to 1.1 in the ensuing months making German and other Eurozone exports more competitive. It has remained in the sub-1.10 rate since. Stock prices also immediately surged, then later moderated somewhat. But in the process raised Eurozone capital incomes while high unemployment and lack of wage gains in the region lowered labor incomes. The consequence of this dual effect on incomes created more income inequality.

The QE program was adjusted again at the close of 2016 as Draghi, the ECB’s chairman, announced a reduction in the rate of bond buying under QE from the increase to 80 billion euros per month announced in March 2016 back to the original 60 billion, but indicated as well that the program would be extended beyond its scheduled earlier 2017 expiration to the end of 2017. The QE program had injected an approximate 1 trillion euros of liquidity in its first two years. And it has been estimated that, if the QE program continued through end of 2017, it would add another 780 billion euros to the ECB’s total balance sheet, raising that total to just under 5 trillion euros by the end of 2017. Demands for its phase-out continued to grow by late 2016, intensifying into 2017.

The ECB’s partial pullback of the program was in part its response to a growing critique of the program’s effectiveness and demands that it should be ‘tapered’ and phased out altogether in 2017-18. Once again the opposition was driven by Germany, which argued that the extended period of low interest rates was making household savers pay the price of providing free money to buyers of bonds of the periphery economies—in effect subsidizing investors at the expense of households. This of course was correct. A direct consequence of QE in all cases, not just in Europe, is an extended period of artificially low interest rates that results in small savers earning no interest on their savings, while investors everywhere get to borrow money at virtually no cost. ECB interest rates by 2017 had been lowered to either zero or, in the case of the central bank’s DF rate, to negative -0.4%. QE thus creates a direct income transfer that contributes significantly toward growing income inequality—one of the direct negative consequences of QE programs everywhere.

2017 witnessed the growing assertion of German and its political allies’ opposition to QE. The ECB’s chair, Draghi, had been able to expand the role and function of the central bank on a number of fronts since the 2012 crisis—bank supervision, direct bond buying of sovereign debt, etc.—but as the Eurozone economy appeared to have improved by 2017 (due to global economic developments) Draghi and the ECB were once again on the defensive.

The question in 2017 is whether the German-led opposition can reassert its hegemony over the central bank and force it to exit its QE free money program and start reducing by year-end its 5 trillion QE-bloated balance sheet. The ECB appears reluctant to do so. It looks at the possibility of political instability in Europe negatively impacting the economy. It looks at what the US Fed and Japan central banks will do in terms of raising their interest rates. It looks at the possible negative effects of Brexit. And it is still not convinced that the recent growth blip in Europe (as elsewhere) is not just a temporary response to expectations of renewed fiscal stimulus by the US Trump administration. So the ECB holds steady with its policy of QE and general liquidity injections that drive its balance sheet in 2017 even in excess of the US FED’s estimated $4.5 trillion QE-generated balance sheet.

The other major monetary policy development during the 2015-17 period in the Eurozone was the descent into negative interest rates. First introduced by the ECB in June 2014 the total euro bonds in negative territory rose to more than $5 trillion by 2016. When followed by Japan in February 2016, global negative bond rates thereafter more than doubled in less than a year during 2016, peaking at $13.3 trillion in September 2016. In December 2016 German bond rates hit a record low of -0.8%.

The logic behind the shift to negative rates is that if banks have to pay to deposit their money at the central bank they will instead lend it out in order to avoid the cost. Thus negative rates are theoretically envisioned as a way to stimulate stagnant bank lending and thereby stimulate investment and economic growth. A parallel problem with negative rates, however, is that it raises bank costs somewhat, but perhaps not enough to generate more lending. The net effect is higher bank costs that discourage lending. Negative rates may also encourage businesses to hoard cash instead of investing it. Another problem is what if banks pass on the charge by raising charges on their customers’ checking accounts and even charging for depositing their savings with the banks? That may actually reduce spending and slow the economy. If not an actual fee on checking-savings accounts, it certainly reduces even the rates that banks might otherwise pay their household and business depositors. Negative rates also signal to household savers, businesses and investors that the central bank is engaging in desperate, extreme measures, the effects of which are unknown. That creates uncertainty and fears that maybe something is really wrong with the economy that is not publicly known. So that psychological effect of negative rates also discourages business borrowing and consumer spending.

Another accurate criticism of negative rate policy is that it distorts financial markets. The central banks’ policies of near zero rates (ZIRP), exacerbated the past two and half years by negative rates (NIRP), destabilizes sectors of the economy such as pensions and insurance. Pension funds and life insurance companies (selling annuities) heavily invest in fixed income securities in order to finance their retirement payouts. But if rates are extremely low, they cannot meet their retirement payment liabilities. The problem is exacerbated with negative rates.

The period of zero-bound rates (ZIRP) central bank policy—which was initiated by the US Fed in 2008-09—is approaching a decade. ECB and Japanese NIRP has been in effect for nearly three years. How much longer pension funds and insurance companies can hold out without collapsing is unknown. ZIRP and NIRP have forced the pension funds/insurance company industries toward ever more risky investment alternatives in order to achieve the returns necessary to fulfil their retirement payment commitments. These critical and very large industries of the shadow banking sector which invest in trillions of assets may become the focal point of the next financial crisis, should ZIRP and now NIRP central bank policies continue much longer.

The threat from negative rates receded somewhat at the end of 2016 and by early 2017, as a sell-off in the bond markets globally resulted in interest rates on bonds rising. The sell-off has been the product of investors’ expectations that the US Trump administration will stimulate the economy and the US FED will follow suit by raising US rates, a move that will raise the value of the US dollar. The post-US election effect reduced the $13.3 trillion in negative bond rates by $2.5 trillion by year end 2016.

Keying off US rates and the dollar, the ECB (and Japanese) QE policies have been put on hold, as the ECB is now in a wait and see mode with respect to a possible fiscal policy shift by the Trump administration and therefore FED rates and the dollar, and the effect of that. Latest indications by the ECB is that it will continue its current level of QE bond buying. It has no intention of reducing QE or selling-off its balance sheet, and probably will not until the Fed begins to do so with further rate hikes and its balance sheet.

To sum up the Eurozone’s QE and NIRP programs’ effectiveness as central bank radical, experimental monetary policy tools: They have not proved particularly effective in stimulating bank lending and therefore investment and growth. They have not resulted in raising inflation and achieving price stability at 2%. The inflation rate increase that has occurred in early 2017 has been mostly due, as Draghi himself has admitted, to rising costs of energy and import prices as the euro currency has devalued. The inflation rate minus these effects is still well below 1% in the Eurozone. The bond buying has mostly been done by foreign banks and foreign investors. The low rates have stimulated corporations’ issuing of corporate bonds. There’s little evidence NIRP policy has stimulated bank lending and investment, but it has increasingly begun to distort other financial markets. On the other hand, QE and NIRP have contributed to lowering and keeping low the Euro exchange rate and stimulating Euro exports (from which Germany has gained the lion’s share of benefits).

ASSESSING ECB PERFORMANCE OVERALL

The ECB’s performance in general can only be described as marginally successful at best, and in some cases, dismal. This has been especially true since the 2008-09 crisis.

During its first phase from 1999 to 2007, the central bank was a key enabler of the structural distortions in the Eurozone economy. In converting to the euro from the national currencies it over-injected liquidity to the advantage of Germany and its northern core economy allies. This enabled a massive money capital inflow to the periphery economies and the buildup of excess private debt in those economies. The money capital accumulating in the periphery was recycled back to core banks and business in the north as interest payments and purchases of German-core exports. An internal trade deficit in favor of German-core developed. When the crash of 2008 occurred, the money inflow to the periphery dried up but the interest payments had to continue to prevent a Euro-wide banking crisis. The ECB was prohibited by the EMU charter from lending to any but central banks in the member states and thus could not bail out the periphery economies alone. Special government bailout facilities were slowly created in response to the continuing sovereign debt crises, which were necessary in order to rescue the banks as well, due to the tight integration of government and bank indebtedness.

The ECB lowered interest rates too slowly as the crisis developed, and actually raised rates twice at the worst timing, thus exacerbating the crises. The ECB also developed bond buying and lending facilities late and in insufficient magnitude or composition to effectively resolve banking conditions. The LTRO programs were traditional and did not inject funds directly into the banks. The loans were short term and required restricted collateral. The SMP was deficient in focus and volume. Bond buying was only from secondary markets and not direct. The OMT was more talk than a reality. Most important, all these pre-QE ECB lending facilities were required to be accompanied by what is called ‘sterilization’ in banking quarters. That meant for whatever liquidity they provided, an equivalent amount of money had to be taken out of the system by the central bank. The resultant net liquidity contribution therefore was not that great, as evidenced by the money supply growth record and the decline in credit availability from 2012-2016. In short, the ECB money supply function was poorly managed.

As a lender of last resort, the central bank was unable by itself to bail out the banks during the 2011-2013 recession and crisis. Other non-ECB pan-European government entities, like the European Commission’s Stability Mechanism, had to be created to do so. This was not all the ECB’s fault, as its charter since creation has prevented it from acting like a true central bank, though it evolved slowly toward becoming one after 2013, as it was given bank supervision and resolution authority. But that authority remains limited and restricted, especially in so far as system-wide financial instability is concerned. Its bank supervision function to this day remains deficient, as evidenced by the lingering problems of Eurozone-wide NPLs, especially in the case of Italy.

So the ECB as a central bank has performed poorly in terms of primary central bank functions of money supply management, liquidity provisioning for lender of last resort and bank supervision. It Furthermore, the ECB has never to this date achieved its primary target of 2% price stability, even as its balance sheet has ballooned to 5 trillion and as it has driven interest rates into negative territory with all the distortions that has produced. Not least, its experiment with non-traditional monetary tools like QE was delayed and not even introduced until well after its disastrous recession and debt crisis of 2011-2013. What QE has accomplished is subsidizing euro export-oriented companies while exacerbating income inequality trends still further.

It now faces the problem it created with its 5 trillion euro balance sheet: how to exit QE and reduce its balance sheet without further destabilizing the Euro economy and still troubled financial system? Selling off the massive bond totals it has accumulated won’t be easy. Sales of bonds in this magnitude will almost certainly increase their supply and therefore depress bond prices significantly. That will mean rising bond rates and costs of borrowing, which can only mean less borrowing, less bank lending, less investment, and slower growth and price deflation in the end. In other words, the ECB’s policies of injecting trillions of liquidity will likely eventually exacerbate the very conditions which the liquidity injections were supposed to resolve in the first place. Slower growth and more financial fragility may be the ultimate consequence of policies that were to stimulate growth and reduce financial instability.

The solution to the crisis creates anew and even amplifies the very conditions that lead to the next crisis, although ‘next time’ will almost certainly prove worse.

posted July 1, 2018
Is There a Trump-Justice Kennedy-Russian Oligarchs Connection?

Some very interesting news has just appeared in recent days in the mainstream press–i.e. NY Times and Wall St. Journal–raising questions about Justice Kennedy’s recent resignation at the last minute before the Supreme Court’s session ended. As is obvious, Kennedy announcing his retirement will enable Trump to appoint a more radical right winger to the Supreme Court before the November 2018 elections. Should Trump lose control of the Senate in November, he might not be able to get another radical right winger through a Senate confirmation process, to give him a 6-3 super majority on the Court. Kennedy’s resignation all but ensures now he will get his second right winger (after Gorsuch last year) and get it approved by the Senate before the November 2018 elections.

But what’s behind Kennedy’s early retirement now, before the November elections, that enables all this to happen?
Justice Kennedy privately went to the White House before his announcement. Why was that necessary? What did he and Trump perhaps discuss? Here’s a possible scenario:

The Mueller Report on Trump will soon be released. My bet is that it will show very close financial connections between Trump and various Russian Oligarchs. The oligarchs loaned Trump large sums of money when US banks would not. It kept Trump’s real estate empire from collapsing. And who knows what else the Oligarchs have on him during Trump’s trips to Moscow before the 2016 elections.

So what does that Trump-Oligarch connection have to do with the Trump-Justice Kennedy connection and Kennedy’s recent surprise resignation?

Deutsche Bank Connection

It happens that the shady global investment bank, Deutsche Bank, known to broker deals under the table and launder money worldwide for elites like Trump, served as the money launderer for Trump and the Russian Oligarchs. And guess who, as senior manager at Deutsche bank, was in charge of the Oligarch-Trump deals? None other than the son of Justice Kennedy. (source: OZY Daily Presidential Brief, ‘Deutsche Bank Fails Federal Reserve Stress Tests’, June 29, 2018).

This raises some interesting questions. Was Kennedy ‘encouraged’ by Trump to resign now so he, Trump, could push through his latest radical candidate for the Supreme Court, to ensure his 6-3 majority? Trump knows Mueller’s report will show his Russian Oligarch connections. Trump will definitely fire Mueller. That’s a done deal already. And he’ll probably fire Rosenstein and others at the Justice Dept. to clean house of his adversaries there (including possibly even Jeff Sessions). It will create a firestorm response. And if he, Trump, loses control of the Senate or the House in November, it will almost certainly result in impeachment proceedings being raised or debated.

But Trump has already publicly declared he has the right to pardon himself under the Constitution. A 6-3 majority Supreme Court will then support his interpretation and likely rule that the president can pardon himself under the US Constitution.

A Trump self-pardon will dispel the fiction that in America no one is ‘above the law’. Trump believes he is, has said so publicly in recent weeks, and he is now setting up a scenario where he will be able to pardon himself. Kennedy’s resignation is one element on the road to that end.

Trump: Neither Fascist Nor Dictator but Tyrant

Progressives and even liberals increasingly today are warning of a kind of ‘creeping fascism’ in the US today, driven by Trump. Or they say that Trump is a dictator. But fascism is a movement resorted to by ruling elites to destroy opposition to them in a crisis by unions, opposition parties, and the press. Trump doesn’t need to resort to physical destruction of his opponents. The Unions are on the run, or all but destroyed already. The Democratic Party has moved so far to the right since Bill Clinton that it has lost its mass base and has become merely a legislative party. It has retreated to enclaves in a few big cities or on the coasts. Its leadership since Clinton has been in the pocket of big moneybags, who are doing all they can to prevent an internal resurrection by Sanders and other grass roots elements. So there are no alternative progressive or liberal forces on the left that are organized to stop Trump that Trump needs to take on ‘in the streets’ to destroy. Trump doesn’t need a fascist movement. He (and the ultra right wing capitalists behind him–i.e. the Mercers, Olins, Adelsons, Kochs, etc.) don’t need it, at least not yet. Trump is winning without it. The traditional capitalist elite who thought they could populate his cabinet and ‘tame’ him, have all been driven out of his administration (Priebus, McMaster, Cohn, Tillerson, and soon to leave Kelly as well). Trump is mobilizing and agitating his domestic political base with his anti-foreigner ‘America First’ ideology–both immigrants and other capitalist globalists in Europe, Canada, Mexico, etc. (America First echoes other ‘foreigners are the problem’ appeals when ‘jews, communists, and gypsies’ were identified as the enemy). The ideology in development may be there with Trump, but the organized fascist movement is not yet.

Nor, contrary to liberal and progressive claims, is Trump yet a ‘dictator’, although he is well on his way to taming the Republican party and reconstructing it as his own. Trump doesn’t need to directly ‘dictate’ laws in lieu of a representative legislature determining the law. His Freedom Caucus friends in the House now do his bidding, his buddy Mitch McConnell in the Senate is in his pocket, and now Trump’s packing of Federal Courts (with the help of McConnell) means Trump is able indirectly to dictate and thereby negate the laws established democratically before him. But he’s not yet a ‘dictator’ in the direct sense. That too is not yet necessary. The form of democracy still remains, even as its content is being significantly destroyed. No, he’s not a fascist nor a dictator yet. He doesn’t have to be to get what he wants.

But what Trump is much nearer to becoming is a Tyrant. He already believes he is ‘above the law’. He even says it publicly. And a politician ‘above the law’ is the classical definition of Tyranny!! Of a Tyrant. Trump is a tyrant in the making. Tyranny is being installed before our very eyes. So what has this to do with the Trump-Justice Kennedy connection?

Trump’s Next Step: Firing Mueller & Self-Pardon

The resignation of Kennedy will enable Trump to take one step closer (now very close) to his avowed desire to be ‘above the law’, a Tyrant. Trump will pardon himself after November if the Mueller report leads to an impeachment–which itself is a long shot. But Trump is taking no chances. Packing the Supreme Court with a solid 6-3 majority in his favor is his way to protect himself against Mueller and a possible impeachment down the road. If charged, Trump will pardon himself. And the Supreme Court 6-3 will rule the US Constitution allows him to self-pardon–that is, to declare himself ‘above the law’, to permit a Trump Tyrannus.

It will be interesting to see if the forthcoming Mueller report says anything about the Kennedy-Deutsche Bank-Russian Oligarchs Trump connections. It should. But don’t count on it. Congress, the Presidency, the media are all held in the lowest esteem by the American people. One of the few democratic fictions left in America is that the US Supreme Court is impartial and not political. That it is not part of the destruction of democracy in the USA that has been developing now for two decades since the Supreme Court in 2000 manipulated the national election to give George W. Bush the presidency that year. Americans forget the role of the Supreme Court in that subversion of Democracy that gave George W. Bush the presidency (and the rest of us the Iraq war, the banking crash of 2008, and the Great Recession that followed).

If anyone thinks that Justice Kennedy’s recent surprise announcement of resignation from the Court is just an individual act and has nothing to do with broader political developments in the US, they are naively deluding themselves. And all the liberal media spin recently that Justice Kennedy was a sometime liberal ‘swing vote’ on the Supreme Court is such bull. He’s the guy that gave us Citizens United and enabled billionaires like Trump and his buddies to buy American democracy and elections, with his 5-4 ‘swing vote’. And his replacement by Trump will be even worse! More brazenly anti-democracy, anti-worker, anti-immigrant, and pro-Trump.

One can only wonder what Justice Kennedy and his son at Deutsche Bank will get out of a deal with Trump? We know what Trump gets.
Dr. Jack Rasmus
copyright 2018

Dr. Jack Rasmus is author of ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017, and the forthcoming ‘The Scourge of Neoliberalism’, Clarity Press, 2018.

posted June 11, 2018
Emerging Markets’ Perfect Storm’

(Selections from Chapter 3 of ‘Systemic Fragility in the Global Economy’ on Emerging Markets in Crisis. Read my blogpiece, ‘South America’s ‘Made in the USA’ Growing Crisis’ for the update)

“Internal Forces Causing EME Instability

Notwithstanding who is ultimately responsible for the rapid deterioration of EMEs today, it is important to note that the various external causes of that deterioration have set in motion additional internal forces that further exacerbate the EME decline and that, in part, are also the consequence of policy choices made by the EMEs themselves.

In attempting to confront the economic dislocations caused by the external forces, EMEs have had to choose between a number of highly unattractive trade-offs: raising domestic interest rates to slow capital flight, spending their minimal foreign currency reserves to keep their currency from falling, cutting government spending to try to reduce inflation from rising imports; lowering their currency exchange rate in order to compete on exports with AE countries doing the same; and so on. All these choices, however, result in short term and temporary solutions to the external caused forces. The choices almost always lead to a further deterioration of EMEs’ real economy and deepening financial instability.

EME Capital Flight

Capital outflow has multiple negative effects on an economy. First, it means less money available for real investment that would otherwise boost the country’s GDP, create jobs, and produce incomes for workers for consumption. Capital flight also discourages foreign investors from sending their money capital ‘in’ as well. So as capital flight flows out, often capital inflow simultaneously slows or declines. Both produce a double negative effect on money capital available for domestic investment in the EME. More outflow plus slowing inflow also means less purchases of EME stock by investors as they take their money and run. Falling equity values discourage money in-flow still further. A downward spiral thus ensues between capital flight, less investment, a slowing economy, and slowing or declining stock prices.

The scope and magnitude of the capital flight is revealed by recent trends in the EMEs. Net capital inflows for the EMEs were mostly positive prior to the 2008-09 crash, starting at $200 billion in 2002 and rising thereafter. During the 2008-09 crisis, however, there were EME outflows of $545 billion. Starting in late 2009, as the EMEs boomed and benefited from the redirection of the massive liquidity injections by the AE central banks and the concurrent China commodity demand surge, net capital inflows to the EMEs rose rapidly once again. Roughly $2.2 trillion in capital flowed into the EMEs from June 2009 to June 2014.

But that inflow all began to reverse, slowly at first but then at a faster rate, beginning with the ‘taper tantrum’ of 2013 when the Federal Reserve signaled its intention to raise interest rates. EME capital outflow began, but it was temporary, as the Federal Reserve soon backed off in response to the EMEs’ ‘tantrum’. Capital flight resumed again in January 2014 when the Federal Reserve signaled once more its intent to raise US rates. EMEs panicked but net inflows returned as the Fed back-pedaled a second time. But it was to be the last time for the Fed to do so.

By mid-2014, EME net outflows and capital flight resumed with a vengeance, as Chinese growth slowed faster, oil deflation set in, QE currency wars intensified, US interest long term rates starting drifting upward in expectation of Fed policy, and EME real economies and currencies began to slow rapidly. The corner had been turned so far as EME capital outflow was concerned after mid-year 2014.
For example, from July 2014 through March 2015, the 19 largest EMEs experienced net capital flight of no less than $992 billion, or almost $1 trillion in just nine months. And that was only the largest 19. The $992 billion, the most recent available data, represents an outflow of more than twice that occurring during a similar nine month period from July 2008 through March 2009, when a $545 billion net outflow occurred. So the capital flight crisis for the EMEs is twice as serious as during the 2008-09 crash. Not only does the $992 billion represent only the 19 largest EMEs, but the nearly $1 trillion pre-dates the China stock market collapse that began in June 2015 and China’s shift to a devaluation of its currency policy the following August. Therefore, the third and fourth quarters of 2015 will likely show that EME capital flight will exceed the preceding nine months’ $992 billion. A trillion more in capital flight could easily occur in just the second half of 2015. That will mean the five years of accumulated $2.2 trillion inflow will be reversed in just 18 months. That magnitude and rate of capital flight and outflow suggests, in and by itself, a massive economic contraction may be soon forthcoming in the EMEs in 2016 and beyond.

EME Currency Collapse

Currency decline is directly associated with capital flight. The greater the rate of flight, the greater the rate of decline, or collapse. That’s because capital flight requires investors in the country to convert the country’s currency into the currency of another country to which they intend to send the money capital. That involves selling the EME’s currency, which increases its supply and therefore lowers the price of that currency, i.e. its exchange rate. And when many investors are selling an EME currency, it also means a drop in demand for the currency that further depresses its price.

There have been three phases of EME currency decline since 2013. The first during the 2013 ‘taper tantrum’. The second commenced mid-2014 with the collapse of global oil prices and the growing awareness China’s was slowing. The third phase began the summer of 2015, as China’s stock markets collapsed and it subsequently devalued its currency, the yuan. The stock market crash in China quickly set off a wave of similar stock contractions throughout the EMEs. Investors sought to pull their money out and send it to the AEs, as both a haven and in anticipation of better returns. More EME money capital was converted to dollars, pounds, euros and yen, sending those currencies’ values higher (and thus pushing EME currencies still lower).

As an indication of the magnitude of the impact of capital flight and currency conversion on EME currencies, the J.P. Morgan EME Currency Index fell by 30% from its peak in 2011 by July 2015, virtually all of that in the past year, 2014-2015. An equivalent index for Latin America compiled by Bloomberg and J.P. Morgan revealed a more than 40% decline in currency values for that region’s EMEs during the same period.

In just the first eight months of 2015, January-August, some of the largest EME currencies have fallen by more than 20%, including those of Brazil, South Africa, Turkey, Columbia, Malaysia, while others like South Africa, Mexico, Thailand, Indonesia and others dropped by more than 10%.

In yet another vicious cycle, the collapse of currency exchange rates for EMEs causes an even greater momentum in capital flight. No investors, foreign or domestic, want to hold currencies that are falling rapidly in value and expected to decline further. They take their losses, take their money capital out of the country, convert to currencies that are rising (US dollar, UK pound, and even the Euro or yen) and speculate that price appreciation will provide handsome capital gains in the new currencies. Currency decline thus has the added negative effect of provoking a vicious cycle of capital flight-currency decline-capital flight.

One would think that declining currency values would stimulate export sales. But only in a static world. In a dynamic world of ever-changing forces and economic indicators, declining currencies for different EMEs that are occurring in tandem mean a race to the bottom for all. No country gets a competitive export advantage by currency devaluation for long, before it is ‘leap frogged’ by another doing the same, negating that advantage.

In addition, the advantages to economic growth from expanding exports might also be easily offset by declining real investment due to accelerating capital flight, rising domestic interest rates implemented by governments in desperate efforts to try to stem the capital outflow, falling stock market prices associated with the net capital outflows, and slowing domestic consumption for various reasons. The latter developments typically overwhelm the very temporary relative advantages to exports gained from declining currency exchange rates—as has happened, and continues to happen, in the case of the EMEs post-2013.

Domestic Inflation

Currency decline has the added negative effect of directly impacting domestic consumption by contributing to import inflation. When a currency declines, the cost of imported goods goes up. And if imports make up a significant proportion of the EMEs’ total goods consumed, then EME domestic inflation rises. Many EMEs in fact import heavily from the AEs, for both consumer goods and semi-finished goods that they then re-manufacture for consumption or re-export for sale. If consumer inflation is significant, it means less real consumption and therefore slower EME growth; and if producer goods import inflation is significant, it means rising costs of production, less production and again, less EME growth.

Capital flight due to currency decline also contributes to inflation, albeit in a manner different from import inflation due to currency decline. Import inflation affects consumption, whereas capital flight works through investment. More capital outflow translates into less investment, which means less productivity gains, higher production costs and cost inflation. In short, currency decline, capital flight, and EME inflation all exacerbate each other, and combine to have significant negative effects on EME real growth. It starts with currency decline, which accelerates capital flight and reduces investment and also contributes to inflation which slows real consumption as well.

The decline in China that reduced global commodities demand, the deflation in commodities that followed, the subsequent currency decline and capital flight, and the eventual imports-goods inflation together reduced consumption, real investment and economic growth. These elements all began to converge in the EMEs by mid-2014. After mid-2014 additional developments exacerbated these negative trends further—including the global oil deflation, growing prospects of US interest rate increases, intensifying currency wars, and the unwinding of Chinese and EME stock markets.

The multiple challenges faced by EMEs from these developments, intensified and expanded in the second half of 2014 and after, forcing the EMEs into a general no-win scenario. They have responded variously. Brazil, South Africa and a few other EMEs have raised their domestic interest rates to slow capital flight and attract foreign capital to continue to invest, although that choice has slowed their domestic economies more. Another option, using their foreign currency reserves on hand, accumulated during the 2010-2013 boom, to now buy their currencies in open markets to offset their decline, works only to the extent they accumulated foreign reserves during the 2010-13 period. Many EMEs did not. And those who had accumulated have been depleting them fast. Similarly unpromising, they can try to reduce their currency’s value by various means, in order to compete for the shrinking pie of global exports. That means participating in the intensifying global currency war ‘race to the bottom’, in a fight they cannot win against the likes of China, US, Japan and others with massive reserves war chests. What the oil producing EMEs have done in response to the growing contradictions with which they are confronted is to just lower the price of their crude in order to keep generating a flow of income upon which their government and economy is dependent. Others face the prospect of simply trying to borrow from AE banks, at ever higher and more undesirable terms and rates, in order to refinance their growing real debt.

While the EMEs enjoyed a robust recovery from 2010 to 2013, thereby avoiding the stagnation, slow growth, and recessions experienced by the AEs during the period, now the roles after 2013 were being reversed. AE policies began creating massive money capital outflows from the EMEs, slowing their growth sharply, causing financial instability, and leaving EMEs with a set of choices in response that promised more of the same. The case example of Brazil that follows reflects many of the ‘hobson’s choices’ among which the EMEs have been forced to choose, as well as the negative consequences they pose for EME economic growth and financial instability.

Brazil: Canary in the EME Coalmine?

No country reflects the condition and fate of EMEs better than Brazil. It’s a major exporter of both commodity and manufactured goods. It’s also recently become a player in the oil production ranks of EMEs. Its biggest trading partner is China, to which it sells commodities of all types—soybeans, iron ore, beef, oil and more. Its exports to China grew fivefold from 2002 to 2014. It is part of the five nation ‘BRICS’ group with significant south-south trading with South Africa, India, Russia, as well as China. It also trades in significant volume with Europe, as well as the US. It is an agricultural powerhouse, a resource and commodity producer of major global weight, and it receives large sums of money capital inflows from AEs.

In 2010, as the EMEs boomed, Brazil’s growth in GDP terms expanded at a 7.6% annual rate. It had a trade surplus of exports over imports of $20 billion. China may have been the source of much of Brazil’s demand, but US and EU central banks’ massive liquidity injections financed the investment and expansion of production that made possible Brazil’s increased output that it sold to China and other economies. It was China demand but US credit and Brazil debt-financed expansion as well—a s is the case of virtually all the major EMEs. That then began to shift around 2013-14, as both Chinese demand began to slow and US-UK money inflows declined and began to reverse. By 2014 Brazil’s GDP had already declined to a mere 0.1%, compared to the average of 4% for the preceding four years.

In 2015 Brazil entered a recession, with GDP falling -0.7% in the first quarter and -1.9% in the second. The second half of 2015 will undoubtedly prove much worse, resulting in what the Brazilian press is already calling ‘the worst recession since the Great Depression of the 1930s’.

Capital flight has been continuing through the first seven months of 2015, averaging $5-$6 billion a month in outflow from the country. In the second half of 2014 it was even higher. The slowing of the capital outflow has been the result of Brazil sharply raising its domestic interest rates—one of the few EMEs so far having taken that drastic action—in order to attract capital or prevent its fleeing. Brazilian domestic interest rates have risen to 14.25%, among the highest of the EMEs. That choice to give priority to attracting foreign investment has come at a major price, however, thrusting Brazil’s economy quickly into a deep recession. The choice did not stop the capital outflow, just slowed it. But it did bring Brazil’s economy to a virtual halt. The outcome is a clear warning to EMEs that solutions that target soliciting foreign money capital are likely to prove disastrous. The forces pulling money capital out of the EMEs are just too large in the current situation. The liquidity is going to flow back to the AEs and there’s no stopping it. Raising rates, as Brazil has, will only deliver a solution that’s worse than the problem.

Nor did that choice to raise rates to try to slow capital outflow stop the decline in Brazil’s currency, the Real, which has fallen 37% in the past year. A currency decline of that dimension should, in theory, stimulate a country’s exports. But it hasn’t, for the various reasons previously noted: in current conditions a currency decline’s positive effects on export growth is more than offset by other negative effects associated with currency volatility and capital flight.

What the Real’s freefall of 37% has done, however, is to sharply raise import goods inflation and the general inflation rate. Brazil’s inflation remained more or less steady in the 6%-6.5% range for much of 2013 and even fell to 5.9% in January 2015, but it has accelerated in 2015 to 9.6% at last estimate.

With nearly 10% inflation thus far in 2015 and with unemployment almost doubling, from a January 4.4% to 8.3% at latest estimate for July, Brazil has become mired in a swamp of stagflation—i.e. rising unemployment and rising inflation. Brazil’s central bank estimated in September 2015 that the country’s economy would shrink -2.7% for the year, the deepest decline in 25 years. With more than 500,000 workers laid off in just the first half of 2015, it is not surprising that social and political unrest has been rising fast in Brazil.

The near future may be even more unstable. Like many EMEs, Brazil during the boom period borrowed the liquidity offered by the AEs bankers and investors (made available by AE central banks to their bankers at virtually zero interest) to finance the expansion. That’s both government and private sector borrowing and thus debt. Brazil’s government debt as a percent of GDP surged in just 18 months from 53% to 63%. The deteriorating government debt situation resulted in Standard & Poor’s lowering Brazil government debt to ‘junk’ status.

More important, private sector debt is now 70% of GDP, up from 30% in 2003. Much of that debt is ‘junk bond’ or ‘high yield’ debt borrowed at high interest rates and dollar denominated—i.e. borrowed from US investors and their shadow and commercial banks and therefore payable back in dollars—, to be obtained from export sales to US customers, which are slowing. An idea of the poor quality of this debt is indicated by the fact that monthly interest payments for Brazilian private sector companies is already estimated to absorb 31% of their income.

With falling income from exports, with money capital fleeing the country and becoming inaccessible, and with ever higher interest necessary to refinance the debt when it comes due—Brazil’s private sector is extremely ‘financial fragile’. How fragile may soon be determined. Reportedly Brazil’s nonfinancial corporations have $50 billion in bonds that need to be refinanced just next year, 2016. And with export and income declining, foreign capital increasingly unavailable, and interest rates as 14.25%, one wonders how Brazil will get that $50 billion refinanced? If the private sector cannot roll over those debts successfully, then far worse is yet to come in 2016 as companies default on their private sector debt.

Brazil’s monetary policy response has been to raise interest rates, which has slowed its economy sharply. Brazil’s fiscal policy response has been no less counter-productive than its monetary policy. Its fiscal response has been to cut government spending and budgets by $25 billion—i.e. to institute an austerity policy, which again will only slow its real economy even further.

The lessons of Brazil are the lessons of the EMEs in general, as they face a deepening crisis, a crisis that originated not in the EMEs but first in the AEs and then in China. But policies which attempt to stop the capital flight train that has already left the station and won’t be coming back’ will fail. So too will competing for exports in a race to the bottom with the AEs. Japan and Europe are intent on driving down their currencies in order to obtain a slightly higher share of the shrinking global trade pie. The EMEs do not have the currency reserves or other resources to outlast them in a tit-for-tat currency war. Instead of trying to rely on somehow reversing AE money capital flows or on exports to AE markets as the way to recovery and growth, EMEs will have to try to find a way to mutually expand their economic relationships and forge new institutions among and between themselves as a ‘new model’ of EME growth. They did not ‘break the old EME model’; it was broken for them. And they cannot restore it since the AEs have decided to abandon it.

EME Financial Fragility & Instability

Instability in financial asset markets matter. It is not just a consequence of conditions and events in the real, non-financial sector of the economy. Anyone who doubts that should recall that it was the collapse of shadow banks, derivatives, and housing finance practices that not only precipitated the crash of 2008-09, but also played a big role in causing the more rapid and deeper real economy contraction that followed. Financial asset markets have also played a major role in the stop-go, sub normal recovery of the AEs since 2009. Financial assets and markets will play no less a role in the next crash and greater contraction that is forthcoming.

Other examples prior to 2008-09 provide further evidence of the importance of financial forces in real economic contractions. The dot.com tech bust of 2001 and the recession that followed were the result of financial asset speculation. The 1997-98 ‘Asian Meltdown’ crisis was fundamentally about currency speculation. Japan’s crash in 1990-91, prior recessions in the US in 1990, the US stock market crash of 1987, junk bonds and housing crises in the 1980s, the northern Europe banking crisis of the early 1990s—all had a major element of financial instability associated with them. So finance matters.

Declining equity markets are a signal of problems in the real economy, of course. They are also a source that can exacerbate those problems. For example, China’s stock bubble implosion of 2015 is contributing to the further slowing of real investment in China and to the major capital flight now exiting that economy. The capital flight will in turn cause more instability in global currency markets and accelerate financial asset prices in property and other asset markets in the UK, US, Australia and so forth. The China equity market collapse has had, and will continue to have, depressing effects on stock markets elsewhere in the world. The major stock index for emerging markets, the MSCI Index, has declined more than 30% from its highs. Stock markets of major economies like Brazil, Indonesia, and others have all fallen by 20% and more in just the first seven months of 2015. Financial asset deflation is occurring not only in oil commodity futures, but in global equity prices as well.

Falling stock values also mean that corporations may be denied an important source of income—i.e. equity finance—with which to make payments on corporate debt. One of the major characteristics throughout the EMEs is that many of EME corporations have borrowed heavily during the boom and now must continue to make payments on what is now to a large extent ‘junk’ or high yield debt, and high yield debt also borrowed in dollars, from their various sources of income. But raising money capital by means of stock issuing or stock selling is extremely difficult when stock prices are plummeting.

As its currency exchange rate falls for an EME, it means whatever income a company has available now ‘pays less’ of the debt—effectively, the company’s real debt has risen. Rising real debt is therefore an indicator of growing financial fragility as well—there is declining income with which to pay the debt. Falling currency may also make it more difficult for a company to refinance its debt, or force it to do so at an even more expense interest rates. That too reflects growing financial fragility.

Still another financial market is the oil futures market, especially for those EMEs who are dependent on oil production and sales. Oil is not just a product. It is a financial asset as well. And when the price of that financial asset collapses, the income of the oil producer EME also collapses in many cases. Expectations of future oil prices determine current oil prices, regardless of actual supply and demand in the present. So the more prices fall the more professional speculators may drive the deflation further. Creating a global oil commodities trading market has had the result of introducing more financial instability into the global market for oil. Income from oil production may thus be impacted significantly and negatively by financial asset price movements.

Finally, the EMEs are clearly highly unstable with regard to bond markets—both sovereign or government bonds as well as corporate bonds. And in many EMEs much of the corporate debt (and some government debt as in Africa) is denominated in dollars and therefore must be repaid in dollars. As the aforementioned McKinsey Consultant study shows, one half of all the increase in global debt since 2007 has occurred in EMEs and the lion’s share of that has been in private corporate debt. From 2010 to mid-2015 more than $2 trillion in EME bonds have been issued in dollars, with another $4 trillion plus issued in local EME currencies. Asian Bond debt is 113% of Asian economies’ combined GDP, a record high, according to the J.P. Morgan EMBI+ bond index. As more EMEs attempt to address their crisis by raising domestic interest rates, as Brazil and now South Africa have done, that will drive bond prices down dramatically. A general bond price collapse will make stock market declines pale in comparison as to the consequences for global economic stability. And if corporations in the EMEs can’t refinance their mountain of debt at rates they can pay given their declining sources of income, then a wave of corporate defaults will rock the EME and global economy.

Dr. Jack Rasmus
Excerpt Chapter 3, Systemic Fragility in the Global Economy, Clarity Press, January 2016
copyright 2015

posted June 2, 2018
Italian Debt Crisis Erupts–A Greek Debt Crisis Writ Large?

By Dr. Jack Rasmus, copyright, June 1, 2018, from jackrasmus.com

This past week, as the Italian populist party, ‘5-Star’, began to form a government, suddenly the realities of the Italian debt (government and bank) and the 7 year stagnating Italian economy got the attention of media, investors and politicians. 5-Star and its parliamentary ally, the League, campaigned during the recent Italian election on a program to unilaterally stimulate the Italian economy by fiscal policy spending and tax cuts and, if necessary, to leave the Eurozone system in order to take back control of its own monetary policy. Under the Eurozone rules, Italy, like all Eurozone members, gave up independent control of its banking system to the European Central Bank and other pan-national European institutions like the European Commission. Under Eurozone rules, Italy was also limited to a tight cap on its fiscal spending.

With no independent monetary policy and strict limits on its fiscal policy, all Italy could do in a recession or financial crisis, such as 2008-2010, was borrow money from the ECB and the Euro Commission (with help from the IMF–together the three pan-European institutions called the ‘Troika’). As it borrowed its government and private debt escalated. When the Eurozone slipped into a double digit recession in 2011-13, Italy’s crisis deepened. It borrowed still more, to pay the interest on the debt it had previously borrowed–the interest payments going to the Troika, and from the Troika to the northern Europe banks (especially Germany) from which the Troika in turn raised funds with which to lend to Italy (and other economies during the debt crises in Europe 2010-2015).

By 2013 Italy’s real economy had collapsed by 10% below 2008 GDP levels, and unemployment rose to near 20%. Italy government’s debt to GDP has risen from 100% in 2008 to 130% by 2017, and its real economy has stagnated since 2013, today still at 5% below 2013. Italy thus has never recovered from the 2008-09 crash and subsequent 2011-13 double dip Europe recession.

To pay for the interest and principal on its rising debt load, Italy was required by the Troika to impose fiscal austerity on its populace. Successive Italian governments extracted the surplus with which to pay its rising debt, causing the Italian economy to stagnate. This vicious debt cycle since 2011 has locked Italy into a debt-imposed recession and stagnation–not unlike Greece and other Euro periphery economies.

Italy was not alone in this self-sustaining debt depression cycle. Greece, and indeed much of the rest of the European southern periphery, found itself in a similar situation. Greece was thrust into what is now a ten year economic depression, with severe austerity imposed on it by the Troika. That depression has still not ended, with Greece’s GDP still 20%-22% below 2008 levels.

The Troika imposed austerity extracted income from Greek society to pay the interest on the debt owed to the Troika, to northern Europe banks, and to international bond investors. The first Greek debt crisis in 2010 was followed by a second in 2012, as more Troika debt was provided to ‘roll over’ and pay the old 2010 debt. The crisis erupted again in 2015, as still more debt was provided to pay for the 2012 debt. Throughout the period, Greek workers, small businesses and consumer households were squeezed to acquire the money capital to pay the Troika-investors-bankers. Today Greek debt as a percent of GDP is virtually the same as it was in 2012. And another round of debt and austerity is now on the agenda starting August 2018, as the 2015 debt deal expires. All that’s changed is that private bankers and investors will now ‘roll over’ the debt this time and repay the Troika (contrasted to Troika debt roll over that repaid the private investors and assumed their debt in 2012). Austerity continues nonetheless; only who gets paid the interest and principal on the Greek debt will change.

(For my book analyzing this history of the Greek debt crisis, see ‘Looting Greece: A New Financial Imperialism Emerges’, Clarity Press, October 2016), and my series of articles on Greece since 2015, including the updates on my blog, jackrasmus.com: ‘Still More Austerity Imposed on Greece’, January 2018 & ‘Greek Debt Crisis: Why Syriza Continues to Lose’, Sept. 2017. See also reviews of the ‘Looting Greece’ book by Seibert, van Maasaker, and Amaral on my kyklosproductions.com website)

What we’re witnessing in Italy now is a repeat of the Greek debt crisis, with a populist government (5-Star) attempting to extricate itself from the economic vice-grip of the Eurozone and its pan-national institutions (European Commission, European Central Bank, IMF) that have served as the institutions for extracting payments to cover the debt it has provided Italy since 2010 to stay afloat (i.e. stagnate) economically. Greece is a microcosm of a new kind of financial imperialism within the Eurozone. Italy is a larger expression of the same financial imperialism at work within the heart of the Eurozone.

Austerity was imposed on Italy as well as Greece beginning in 2010. But being a larger economy, with more sophisticated pro-Eurozone capitalist parties, Italy was kept within the Euro fold and the Italian debt crisis was contained–but no longer. This changed with the election of the populist 5-Star movement and its attempt to assume control of government fiscal and monetary policy.

The case of Italy is more dangerous to the Eurozone than was (and is) Greece. Italy’s government debt is 130% of GDP, but its private sector and bank debt is potentially more destabilizing for the Eurozone. No less than $500 billion in non-performing bank loans hang over the private economy in Italy (nearly $2 trillion still Europe wide). Europe never removed the bad debt from bank balance sheets after 2008. That’s why its economy continually stagnates and is unable to recover fully from the 2008 crash. Recoveries are short and shallow and stagnation (and goods price deflation) is a perpetual problem.

The Euro periphery is even more severely impacted. The European Central Bank’s ‘QE” free money injections since 2015 have not gone into real investment, and especially not been directed the southern periphery where it is most needed. Most of the ECB free money has gone to German, French and other northern Europe banks that didn’t need it, and they in turn have mostly loaned it to Euro financial investors who have sent a good part of it offshore to US markets. Europe stagnates as a consequence.

The crisis in Italy has just begun–and it is occurring as the Eurozone (and UK) economies are again beginning to stagnate, and possibly head for a ‘triple dip’ recession in 2019. The populist 5-Star party, should it be allowed to form a government, is declaring it will not abide by Eurozone rules limiting its fiscal stimulus spending; it is also raising the possibility of assuming independent control of its monetary policy. For the latter, however, it will have to leave the Euro and establish its own currency. Both these policy directions have the Troika and the northern Eurozone elites increasingly worried.

When the Greek populist party, Syriza, came to power in 2015 it also declared it would do the same as 5-Star is now advocating. Within six months, however, the Troika smashed Syriza. The ECB sabotaged Greek banks and drove the economy even deeper into depression by mid-2015 to put pressure on Syriza and get it to back off its policies. Syriza party leaders–Alex Tsipras and Yanis Varoufakis–caved in by the summer 2015. Varoufakis was sidelined in the Syriza by June and Tsipras ignored the Greek referendum he himself had called in July and cut a deal with the Troika to extend Greek debt and austerity measures in August 2015. Ever since August 2015, Syriza and Tsipras have gone along with whatever the Troika has demanded, as more and more austerity was proposed on Greek workers annually with every review of the Greek 2015 debt deal.

All the political parties in Greece have now lost legitimacy, including the once populist challenger, Syriza. Now Greeks are taking to the streets in widespread strikes and demonstrations, as another round of Troika-investor austerity and debt is coming up in August 2018.
The key question is whether the Italian populist party and challenger to the banker-Germany dominated Eurozone system will fall into the same trap as Syriza? The Eurozone elites will attempt to maneuver and put increasing pressure on 5-Star to bring it to heel; to drop its insistence on pursuing independent fiscal stimulus or moving toward re-establishing an independent Italian central bank (and private banking system) and eventual currency. With no fiscal of monetary independence, 5-Star and Italy are at the mercy of the Troika and Eurozone(Germany). What will be a 5-Star government’s fiscal stimulus policy once it forms a government? Will it back off its program to assert independent central bank control–or to leave the Euro if necessary?

The Troika and Eurozone elite will have a harder time taming Italy than it had with Greece. Italy’s private banking system is nearly insolvent. With a $500 billion nonperforming loan overhang, banks like Monte dei Pasche, Banco Populare, Banco BPM, and even Banco Intesa are fragile,if not technically insolvent (aka bankrupt). Efforts to pressure Italy’s new government by withholding lending to Italy’s central bank, and in turn private banks, will only exacerbate the crisis of the Italian banking system further. Moreover, northern Europe banks–especially French banks Credit Agricole and BNP Paribas–are deeply integrated and exposed to Italian banks. Contagion could easily spread from Italy to France and beyond. The Troika-Germany will therefore probably go softer with Italy than it did with Greece initially. It will likely allow Italy to exceed Eurozone fiscal spending caps, and the ECB will likely provide even more debt to Italy’s government and private sector.

This response is not assured, however. It may try to apply its ‘Greek Debt’ strategy to Italy as well. Popular resistance could then spread throughout the Eurozone southern periphery. And that instability will further ensure the Eurozone economy will slip into triple dip recession in 2019–just as this writer is predicting the US economy will do the same.

Dr. Jack Rasmus is author of his latest book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017; and the forthcoming late 2018 book, ‘Taxes, War & Austerity: Neoliberal Fiscal Policy from Reagan to Trump’, also by Clarity Press. He blogs at jackrasmus.com. His twitter handle is @drjackrasmus and his website is http://kyklosproductions.com.

posted May 9, 2018
is the US-China Trade War for Real?

If Trump’s trade policy toward US allies is ‘phony’, by seeking only token adjustments to trade relations, then the US trade offensive targeting China is for real.

While Trump has repeatedly exempted US allies from tariffs (steel and aluminum), pitched ‘softball’ deals (South Korea), and tweeted repeatedly how well negotiations are going with NAFTA, in stark contrast the actions and words of the US toward China and trade negotiations in progress have been ‘hardball’.

Contrary to media hype, the Trump trade offensive targeting China is not a product of just the past few months. It did not arise in early March with an impulsive tweet by Trump or with his attention-getting declaration to impose tariffs on steel and aluminum producers worldwide. The US trade offensive targeting China was set in motion at least a year ago, in spring 2017. It surfaced last August 2017.

The US Plan to Target China

In August 2017 Trump formally gave the US Office of Trade (OUST) the task of identifying how China was transferring US technology, “undermining US companies’ control over their technology in China”, as well as seeking to do so by acquiring US companies in the US. On August 18, 2017, the OUST laid out in writing four charges in a formal investigation it was undertaking, accusing China of actions designed to “obtain cutting edge in IP (intellectual property) and generate technology transfer”. All four charges were intensely technology transfer related.

That August 2017 scope of investigation document and objectives was then reproduced verbatim on March 22, 2018, with expected recommendations, in the 58 page OUST report of March 22, 2018—not Trump tweets or the steel-aluminum tariffs—publicly launched Trump’s trade offensive against China. The main theme of the report was that China was ‘guilty’ of aggressively seeking technology transfer at the expense of US corporations, both in China and the US.

Based on the OUST report of March 22, 2018, Trump announced plans to impose $50 billion in tariffs on 1300 China general imports, ranging from chemicals to jet parts, industrial equipment, machinery, communication satellites, aircraft parts, medical equipment, trucks, and even helicopters, nuclear equipment, rifles, guns and artillery.. Trump may have appeared in March 2018 to have shifted gears in his trade policy—from a general, worldwide steel-aluminum tariffs focus to a focus targeting China trade— but China has been the planned primary target for at least the past year. Trump just set it in motion publicly on March 23, 2018. A confrontation with China over trade had been planned from the outset.

Trajectory of US-China Trade Negotiations

But an announced plan to impose tariffs at some point in the future is not the same as the implementation of those tariffs. Despite Trump’s March announcement, and declaration of $50 billion in tariffs on China goods imports, a delay of at least 60 days must take place before any further definition or actual implementation of the $50 billion by the US might occur—thus giving ample time for unofficial pre-negotiations to occur between the countries’ trade missions. Technically, the US could even wait for another six months before actually implementing any tariffs. To date there has been only talk and threat of tariffs—on China or on US allies. With China, Trump has merely ‘notched an arrow’ from his trade quiver. The bow hasn’t even been drawn, let alone the arrow let fly.

Following Trump’s threat of $50 billion in tariffs, China immediately sent its main trade negotiator, Liu, to Washington and assumed a cautious, almost conciliatory approach. China responded initially with a modest $3 billion in tariffs on US exports. It also made it clear the $3 billion was in response to US steel and aluminum tariffs, and not Trump’s $50 billion. More action could follow, as it forewarned it was considering additional tariffs of 15% to 25% on US products, especially agricultural, in response to Trump’s $50 billion announcement. China was waiting to see the details. At the same time it signaled it was willing to open China brokerages and insurance companies to western-US 51% ownership (and 100% within three years), and that it would buy more semiconductor chips from the US instead of Korea or Taiwan. It was all a token public response. China was keeping its arrows in its quiver.

Following Trump’s mid-March tariff tantrum, behind the scenes China and US trade representatives continued to negotiate. By the end of March all that had still only occurred was Trump’s announcement of $50 billion of tariffs, without further details, and China’s $3 billion token response to prior US steel-aluminum tariffs. From there, however, events began to deteriorate.

On April 3, 2018, Trump defined the $50 billion of tariffs—25% on a wide range of 1300 of China’s consumer and industrial imports to the US. The arrow was being drawn. The list of tariffed items was the verbatim USTR Report’s ‘list’. Influential business groups in the US, like the Business Roundtable, US Chamber of Commerce, and National Association of Manufacturers immediately criticized the move, calling for the US instead to work with its allies to pressure China to reform—not to use tariffs as the trade reform weapon.
China now responded more aggressively as well, promising an equal tariff response, declaring it was not afraid of a trade war with the US. That was a welcoming invitation for a Trump tweet which followed, as Trump declared he believed the US could not “lose a trade war” with China and maybe it wasn’t such a bad thing to have one. Trump tweeted further that maybe another $100 billion in US tariffs might get China’s attention.

China now notched its own arrow, noting it would raise 15%-25% tariffs on the US and responded to Trump’s $50 billion, identifying their own $50 billion tariffs on 128 US exports targeting US agricultural products and especially US soybeans, but also cars, oil and chemicals, aircraft and industrial productions—the production of which is also heavily concentrated in the Midwest US and thus Trump’s domestic political base.

This particular targeting clearly aggravated Trump, disrupting his plans to mobilize that base for domestic political purposes before the November elections. He angrily tweeted perhaps another $100 billion in China tariffs were called for. In response, China declared it was prepared to announce another $100 billion in tariffs as well, if Trump followed through with his threat of imposing $100 billion more tariffs.

Trump advisors, Larry Kudlow and Mnuchin, tried to clean up Trump’s remarks. Kudlow assured the stock markets, which plummeted with the developments, saying “These are just first proposals…I doubt that there will be any concrete actions for several months”.
In reply to Trump’s threat of another $100 billion, China Commerce Ministry spokesman, Gao Feng, declared it would not hesitate to put in place ‘detailed countermeasures’ that didn’t ‘exclude any options’. And China Foreign Ministry spokesman, Geng Shuang, added in an official news briefing, “The United States with one hand wields the threat of sanctions, and at the same time says they are willing to talk. I’m not sure who the United States is putting on this act for”…Under the current circumstances, both sides even more cannot have talks on these issues”.

But all this was still a war of words, not yet a bona fide trade war. To use the metaphor once more: arrows were taken from quivers and bows about to be drawn, but no one was yet prepared to let anything fly.

Through the remainder of April negotiations by second tier trade representatives continued in the background. Meanwhile US capitalists in the Business Roundtable and other prime US corporate organizations added their input to the public commentary process on the Trump tariffs that will continue formally until May 22 at least. Most warned a trade war with China would be economically devastating for their business.

In the first week of May, the Trump trade team of Treasury Secretary Steve Mnuchin, US trade representative, Robert Lighthizer, Trump trade advisor, Peter Navarro and White House director of Trump’s economic council, Larry Kudlow, headed off to Beijing for negotiations. The composition of the US trade team is notable. It reveals deep splits within the US elite, some reflecting Trump interests and others reflecting more traditional elite interests in finance and the Pentagon-War industries. While interests clearly overlapped, the splits reflect differing priorities in the China trade negotiations.

Treasury Secretary, Steve Mnuchin—the US financial sector and US multinational companies doing business in China; China ‘hardliners’, Robert Lighthizer, the current US trade representative, and Peter Navarro, Trump trade advisor—the interests of the Pentagon and US defense sector; and Larry Kudlow, head of Trump’s Economic Council—likely most concerned with the domestic political impact of the negotiations for Trump.

One of the first reports when the two trade teams first met in Beijing last week was from Mnuchin, who reported the negotiations were going extremely well. Mnuchin of course knew that before he left for Beijing. China had already indicated it was going to approve 51% US corporate ownership of China companies in March; and it further signaled it would approve 100% ownership within three more years. US bankers have always wanted a deeper penetration of China and now they’ll have it. They didn’t even have to give up anything to get it. That doesn’t sound like a ‘trade war’, at least not yet. China was cleverly driving a wedge between the bankers-multinational corporations wanting more access to its markets and the Pentagon-War industries faction of the US trade team that want a stop to technology transfer.

But if one were to believe the US press, the US negotiating team came back from Beijing this past weekend empty-handed and a trade war was imminent. If that were true, there would be no reason for China’s chief negotiator, Liu, coming to Washington for further talks later this week, which was quietly announced after the US trade team returned. US-China trade negotiations are thus continuing, notwithstanding Trump tweets and schizophrenic bombast: One day after the US team’s return demanding China reduce its $337 billion deficit by $200 billion by 2020; another day calling China president, Xi Jinping, his ‘good friend’ and expressing optimism about an eventual trade deal.

US-China trade negotiations will almost certainly take months to conclude, if ever, certainly extending well beyond the November 2018 US midterm elections. This delay will put pressure on Trump to quickly come to some kind of token agreements with NAFTA and other trade partner negotiations also underway. A NAFTA deal is likely within weeks. And it will look more like the South Korea ‘softball’ trade deal negotiated by Trump a few months ago than not.

Early agreements before the end of this summer are necessary for Trump to tout his ‘economic nationalism’ strategy and declare it is succeeding before the November elections. One can also expect more ‘off the wall’ tweets by Trump designed to ‘sound tough’ on China trade and negotiations in progress for the same domestic US political purposes. But they will be more Trump hyperbole and bombast, designed for his domestic political base while his negotiators try to work out the China-US trade changes. Yet it’s unlikely Trump wants a China trade deal before the US November elections. There’s more political traction for him to publicly bash China on trade up to the elections.

What the US Wants from China Trade?

What Trump wants from US allies trade partners are token adjustments to current trade relations that he can then exaggerate and misrepresent to his domestic political base as evidence that his ‘economic nationalism’ theme raised during the 2016 US elections is still being pursued. The US traditional elite will allow him to do that, but won’t permit him to disrupt major US-partner trade relations in general. That’s why NAFTA, and later trade negotiations with Europe, will look more like South Korea’s ‘softball’ deal when concluded.

China, on the other hand, is another question. The issues are more strategic. US elites—both the traditional and the Trump wing—want more from China than they want from other US trade partners. With China, it’s not just a question of ‘token’ changes that Trump might then hype and exaggerate for domestic political purposes.

Currently, the US is pursuing a ‘dual track’ trade offensive: seeking token concessions from allies that won’t upset the basic character of past trade relations but will allow Trump to exaggerate and misrepresent the changes for his domestic political purposes, proving to his base that he’s continuing to pursue his promised ‘economic nationalism’. The key to the first track is ‘token’ adjustments to trade. But, in the second track, what the US elite want from China is a fundamental change in US-China trade relations and those changes aren’t limited to token reductions in the US deficit in goods trade with China.

US-Trump trade objectives in its negotiations with China are threefold: first, to gain access for US multinational companies into China markets, especially for US banks and shadow banks (investment banks, hedge funds, equity firms, etc.), but also for US auto companies, energy companies, and tech companies. Expanding US foreign direct investment into other economies is always a main objective of US trade negotiations everywhere. Despite all the talk about goods trade deficits, for the US trade deals are always more about ensuring US ‘money capital flows’ from the US into other economies, than they are about ‘goods flows’ coming from other countries to the US. Access to markets means first and foremost access for US finance capital.

The US second objective is to obtain some visible concessions from China that reduce that country’s goods exports to the US, without China in turn reducing US agricultural and energy related exports to China.

But the main and most strategic objective of the US is to thwart China’s current rate of technology transfer from US companies in China and from China companies acquiring US companies in the US.

The key technology transfer categories are Artificial Intelligence software and hardware, next generation 5G wireless, and nextgen cyber-security software. The US obfuscates the categories by calling it ‘intellectual property’. But it is the latest technology in these three areas that will spawn not only new industries, and whoever (US or China) is ‘first to market’ will dominate the industries and products for decades to come, but the technologies further represent the key to future military dominance as well as economic.

The US is concerned that China may leapfrog into comparable military capability. Already virtually all the new patents being filed in these tech areas are by China and the US. The rest of the world is left far behind. China’s 2017 long term strategy document, ‘China 2025’, clearly lays out its planning for achieving dominance in these technologies over the coming decade. It has succeeded in getting the attention of the US elite, both economic and military.

The US defense sector—i.e. Lighthizer and Navarro—want to stop, or at least dramatically slow, China’s acquisitions of technology related US companies. While tariffs are on paper only so far, the US has been clearly targeting China companies hunting for US acquisitions. Stopping deals with ZTE and Qualcomm corporate acquisitions recently are but the first of more such US actions to come. The US financial-multinational corporation sector want more access to China markets and thus more authority to acquire China companies, whereas the US War Industries-Defense sector wants more limits on China company acquisitions of US corporations.

Trump may want both of these, but even more so he wants some kind of ‘win’ trade deal he can boast to his base about. China will offer a deal conceding on the last two objectives, while holding out on the tech transfer issue.

The contradiction the US faces in negotiations is thus internal. It is that the representatives of the US elite cannot agree on what are the priority changes they want from China. There are at least three US diverging elite interests on the US side, reflecting at least three major objectives sought by the US. That allows China to ‘play off’ one sector of the US elite against the other, giving it a long term advantage in negotiations with the US on trade.

Should the US elite settle for short term concessions from China—allowing for more US financial firms access to China, more US company ownership of Chinese companies, and/or moderate short term gains in China goods exports—but fail to slow China’s technology strategy, then it will represent another ‘defeat’ for the US in relation to China’s growing challenge to US global economic-military dominance. It will represent another success for China, similar in strategic importance to its recent ‘One Belt-One Road’ initiative, its launching of the Asian Infrastructure Investment Bank, the adoption of its currency by the IMF for world exchange, and its current development of an Asian common market filling the gap by the US failure to establish its free trade Transpacific Partnership treaty. Technology parity by China with the US may in fact have a greater impact on US dominance than all the above in the long run.

But there’s more to US-China trade than deficits, market access and even technology transfer. There are Trump’s domestic political objectives behind the China-US trade dispute as well. Trump’s political priority has two dimensions: one is to maximize the turnout of the Republican base in the upcoming midterm November 2018 elections. Trump cannot afford to lose either the House or the Senate, or his agenda on immigration, walls, and deportations is finished. Trump also needs to agitate and mobilize his domestic base as a counterweight to traditional US elite resistance when he fires Mueller, the special counsel investigating his pre- and post-election relationships with Russian business Oligarchs.

Thus multiple objectives are contending among and between the different factions behind the US-China trade negotiations: technology transfer for the military hardliners, market access for the bankers and multinational corporations, and Trump getting relatively quick concessions he can sell to his ‘America First’ economic nationalist domestic political base before November. Which is the priority and which secondary. Market access has already been conceded by China, so the alternatives are a trade war over technology transfer or some token adjustments to goods imports to the US that Trump can ‘sell’ to his base. If the latter, China-US trade negotiations outcomes will look more like South Korea and NAFTA. If the US insists on technology transfer, then arrows will be drawn and let fly.
Only then will it become clear that the current US-China trade negotiations are the opening phase in a real trade war, or just another case example of Trump hyperbole for purposes of pandering to his domestic political base.

Jack Rasmus is author of the book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017. He blogs at jackrasmus.com and his twitter handle is @drjackrasmus.

posted May 3, 2018
Trump’s Phony Trade War (part 1 of 3 part series)

What’s going on with Trump’s trade offensive? There’s a dual track policy underway: One a phony trade war with US allies; the other a potential (but not yet) trade war with China, that may also in the end prove less than a bonafide ‘trade war’ as well.

Trump’s trade team heads off to Beijing this week of May 2018 to attempt to negotiate terms of a new US-China trade deal. The US decision whether to continue the exemptions on Steel and Aluminum tariffs with the European Union occurs comes due this week as well. And this past week Trump also declared “we’re doing very nicely with NAFTA”.

So what’s all the talk about a Trump ‘trade war’? Is it media hype? Typical Trump hyperbole? Is there really a trade war in the making? Indeed, was there ever? And how much of it is really about reducing the US global trade deficit—and how much about the resurrection of Trump’s ‘economic nationalism’ theme for the consumption of his domestic political base in an election year?

One thing for certain, what’s underway is not a ‘trade war’.

Trump announced his 25% steel and 10% aluminum tariffs in early March, getting the attention of the US press with his typical Trump bombast, off-the-wall tweets and extremist statements. The steel-aluminum tariffs were originally to apply worldwide. But the exemptions began almost immediately. In fact, all US major trading partners were quickly suspended from the tariffs—except for China.

By mid-March, Canada and Mexico were let off the tariff hook, even though they were among the top four largest steel importers to the US, with Canada largest and Mexico fourth largest. Thereafter, Brazil (second largest steel importer), Germany, and others steel importers were exempted as well.[1] And Canada, by far the largest aluminum importer to the US, accounting for 43% of US aluminum imports, was exempted for imports of that product.

South Korea ‘Softball’ Trade Template

The Trump administration’s signal to its allies was the US-South Korea deal that soon followed. The South Koreans were pitched a ‘softball’ trade deal. South Korea, the third largest US steel importer last year, was exempted from steel tariffs, now permanently as part of the final deal. So much for steel tariffs. Moreover, no other significant tariffs were imposed on South Korea as part of the bilateral treaty revisions. No wonder the South Koreans were described as ‘ecstatic’ about the deal.

What the US got in the quickly renegotiated US-South Korea free trade deal was more access for US auto makers into Korea’s auto markets. And quotas on Korean truck imports into the US. Korean auto companies, Kia and Hyundai, had already made significant inroads to the US auto market. US auto makers have become dependent on US truck sales to stay afloat; they didn’t want Korean to challenge them in the truck market as well. Except for these auto agreements, there were no major tariffs or other obstructions to South Korea imports to the US. Not surprising, the South Koreans were ecstatic they got off so easily in the negotiations.[2] Clearly, the US-South Korea deal had nothing to do with Steel or Aluminum. If anything, it was a token adjustment of US-Korea auto trade and little more.

So the Korean deal was a ‘big nothing’ trade renegotiation. And so far as US trade deficits are concerned, steel-aluminum imports are insignificant. Steel-aluminum tariffs do nothing for the US global trade deficit. US steel and aluminum imports combined make up only $47 billion—a fraction of total US imports of $2.36 trillion in 2017.

The steel-aluminum tariffs were more of a Trump publicity tactic, to get the attention of the media and US trade allies. And if the tariffs were the signal, then the South Korea deal is now the template. It’s not about steel or aluminum tariffs. But you wouldn’t know that if you listened to Trump’s speech in Pennsylvania. Canada and Mexico import more steel to the US than South Korea. But in a final NAFTA revision they too will be virtually exempted from steel-aluminum tariffs when those negotiations are completed.

NAFTA as South Korea Redux

According to reports of the NAFTA negotiations, most details have already been negotiated with Mexico and Canada and the parties are close to a final deal. Typical of the ‘softball’ US approach with NAFTA—like South Korea—is the US recent dropping of its key demand that half the value of US autos and parts imported to the US be made in the US. That’s now gone. So a deal on NAFTA is imminent. Certainly before the Mexican elections this summer. But it will have little besides token adjustments to steel or autos. Trump threats to withdraw from NAFTA were never real. They were always merely to tell his base what they wanted to hear.

For what Trump wants from NAFTA is not a significant reduction of steel, auto, or any other imports to the US. What the US wants is more access for US corporations’ investment into Mexico and Canada; more protection for patents of US pharmaceutical companies to gouge consumers in those countries like they do in the US; and a shift in power to the trade dispute tribunals favoring the US. He’ll sell the exaggerated token adjustments to his political base, which will applaud his latest, inflated ‘fake news’—while the big corporations and financial elites in the US will silently nod their heads in agreement for the incremental gains he’s obtained for them.

In the most recent development concerning NAFTA negotiations, Trump has extended the deadline for a final revision for another thirty days—a development which means the parties are very close to a final resolution. The revisions will most likely look like the South Korean deal in many details—with quotas (not tariffs) on auto parts trade and more US access for US business investment and token limits on imports to the US.

Launching US-Europe Trade Negotiations: Macron’s Visit/Merkel’s Snub

After NAFTA comes Europe, later this year and in 2019. Like the NAFTA negotiations, Europe deadlines on steel and aluminum tariffs were just extended another thirty days. That’s just the beginning of likely further extensions. Europe will be less amenable to steel, aluminum or any other tariffs than the US NAFTA or South Korean partners. French president Macron’s visit last week to the US should be viewed as the opening of negotiations on trade between the US and Europe. But the European economy is again weakening and France, Germany, the UK and others are desperate to maintain export levels, which is the main means by which they keep their economies going.

Europe also wants to keep the Iran Deal in place, which means important exports and trade for it, while Trump wants to end the deal as he’s promised his domestic political base. A tentative agreement may have been reached between Trump and Macron during the latter’s recent visit to the US: Trump will formally pull the US out of the Iran Deal by May 12 but then will do nothing real apart from the announcement—much like the US withdrawal from the Climate Treaty. Europe will continue its trade deals with Iran. The US and Europe will then jointly try to negotiate an addendum with Iran. In short, France and Europe get to keep their business deals and Trump gets to pander to his political base before the elections in November. Like the Europe steel-aluminum tariff exemptions due this week, that announcement will soon follow as well within a week.

While Macron was treated like royalty by Trump during his visit to the US, German Chancellor Merkel, who followed within days, was treated more like a minor partner and snubbed. The snubbing wasn’t about trade, however. It was more about Germany’s refusal to participate in the Syrian bombings, as well as US dislike for the growing resistance in Germany to go along with extreme economic sanctions on Russia. Long run, what the US has always wanted from Germany is to substitute US natural gas imports (which the US now has a surplus due to fracking technology) for Russian gas and for Germany to stop building gas pipelines with Russia. Trump will likely focus on political concessions from Europe while seeking only token changes to imports from Europe to the US. In other words, the content of a US-Europe trade deal may differ from NAFTA of South Korea but the ‘form’ will remain dominated by token adjustments, with little net import reduction to the US.

The UK economy is slowing rapidly, German industrial production has slowed in the last three of four months. And signs are accumulating that globally trade, upon which Europe is especially dependent, is slowing once again. The UK in particular is an economic basket case. Brexit negotiations are in shambles. And the Conservative Party’s days are numbered. Trump therefore will not demand extreme concessions from the UK. Nor will he from the rest of Europe, also now slowing economically—though not as severe as the UK—and important to Trump-US interests in concluding any trade deal with China, providing cover for US policy in the middle East, and with regard to Russian sanctions and US support for a collapsed Ukraine. Politics will dictate token trade adjustments with Europe.

Trump’s Political Objectives

Except for the case of China, therefore, the Trump trade war is mostly tough talking trade for show. Trump wants some token concessions from its US allies trading partners. Token concessions he can then ‘sell’ to his political base in an election year. He’s playing to his ‘America First’ economic nationalist political base, agitating it for electoral purposes next November. He is in election mode, giving campaign speeches throughout the US as if this were September 2016 again. He may also be mobilizing that base in anticipation of the eventual firing of Mueller he plans and the political firestorm that may provoke from the traditional elites in the US. He’s given them massive tax cuts and now some gains from trade negotiations without upsetting the global capitalist trade structure he once promised to do.

Trump is betting that delivering on taxes and trade to the elite will keep enough of them at bay. While delivering on immigration, the wall, and hyped (but phony) trade deals with US allies will convince his ‘America First’ political base he’s delivering for them as well. The so-called trade war is phony because it is designed to produce token adjustments to US trade relations with allies, which Trump will then inflate, exaggerate and lie about to his domestic political base, as they fall for his economic nationalism theme once again.

Is China the Trade Target?

But where does that leave US-China trade? Certainly many believe that is headed for a ‘trade war’. Tit-for-tat $50 billion tariffs have been levied by both the US and China on each other. Trump has threatened another $100 billion and China has said it will similarly follow suit. Even the products to be tariffed have been identified—the US targeted a wide range of imports from China and China in turn targeting US agricultural products and other industrial goods from the US Midwest, and thus Trump’s political base.

Trump’s trade team is by now in Beijing. It represents the major interest groups of Trump’s administration: Treasury Secretary Mnuchin—the bankers and big US multinational corporations. Trade representative hardliners, Robert Lighthizer and Peter Navarro—the Pentagon and US war production industries. And Larry Kudlow the Trump administration’s economic nationalists. Will the Trump phony trade war apply to China as well? Or will it be an actual economic war? Is it really about reducing the US $375 billion annual trade deficit with China? Or about US bankers wanting more access and ownership of operations in China? Or is it about China’s attempt to technologically leapfrog the US in the next generation war-making and cyber security software capability?

The second part of this three part series will address the China-US element of Trump trade policy and strategy.

Jack Rasmus is author of the recently published book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017. He blogs at jackrasmus.com and his twitter handle is @drjackrasmus. His website is http://kyklosproductions.com.

[1] Shawn Donnan, “Trump Softens Steel Stance, With Exemptions for ‘Real Friends’”, Financial Times, March 9, 2018, p. 1

[2] Alan Rapaport and Prashad Rao, “South Korea, Looking to Avoid Tariffs, Agrees to US Trade Deal”, New York Times, March 27, 2018, p. 7.

posted April 19, 2018
Book Review of Jack Rasmus, ‘Systemic Fragility in the Global Economy’, Clarity Press, 2016

SYSTEMIC FRAGILITY IN THE GLOBAL ECONOMY
BY DR. JACK RASMUS
Institute for Critical Thought (ICT), Beijing, China

INTRODUCTION

Most major monetary, fiscal, and macroeconomic economists, and financial institution and capital market experts agree, the global economy and financial system is more systemically fragile than ever before: $10 trillion bank NPLs, $13 trillion Negative Interest Rate Policy (NIRP), rotating financial bubbles – China (private loans $30 trillion), and $152 trillion global debt ($100 trillion private) – 225% GDP.

According to Dr. Rasmus, Global Financial Fragility (FF) is positively related to: total financial asset investment in the system, and with interest rate maturity optimization, elasticity of inside (shadow banking) credit, and available income to service total debt levels; with inflation expectations to the change in total debt levels; with credit default and reinvestment risk; and with fiscal and monetary government subsidies, support, credit facilities, QE, bailouts, etc. (See Appendix).

Financial instability in the global system is reflected in: dueling QEs and currency wars, trouble with large systemic banks (Italian/Deutsche), government and corporate bond bubbles, emerging markets dollarization of corporate debt/liabilities, oil and commodity deflation, energy junk bonds, massive flows into ETFs and U.S. equity markets, flash crashes and high speed trading systems, on-line and peer-to-pear shadow banking-lending networks, Yuan/U.S. dollar devaluation-revaluation-appreciation-depreciation volatilities, BREXIT, EU Entropy, U.S. populous election outcomes, South China Sea aggression, global GDP and trade volume secular downward decline, CAPEX under investment, labor productivity collapse, real wage-income decline-stagnation, commodity goods deflation, etc.

Dr. Jack Rasmus book, “Systemic Fragility in the Global Economy” is another example of the continuing growth of literature showing how fragile the global economic and financial system really is. Dr. Rasmus builds a methodical case of the systematic fragility of the global financial-economic system, and how current central bank economic ideologies and orthodoxy have been deficient and unorthodox.

Their financial-real cycle analysis is poor, their reliance on the Phillips Curve as a policy rule is flawed, they have a linearity bias, measurements of debt-income feedback effects are underdeveloped, they have a misunderstanding of financial asset price determination, their models are missing finance transmission mechanisms, etc.

Their policies have made matters worse, by driving the cost of capital to zero (negative), replacing real assets for financial assets, printing trillions to bail out and purchase bad debt and defective financial products, allowing massive leakage of capital to flow unregulated (shadow banking) across globe platforms, etc.; and all with no real affect on real economic growth, wage growth, labor participation rates, inflation rates, and more importantly standards of living or social welfare.

OVERVIEW

The first part of the book is an overview of the five major economies as of 2016; the second part addresses the nine major variables that drive systematic fragility.

These factors are the definition of fragility:

1) The relationship between debt (levels, rates of change, etc.),
2) The ability to service debt (forms of income and price as a determinant of income),
3) Terms and conditions of debt servicing (covenants and term structure of rates).

Dr. Rasmus defines fragility as: the mutual inter-determination of these three variables; moreover, the variables function within the three main sectors of the economy: household consumption, business (financial and non-financial), and government sector.

The debt-income-terms of servicing, mutually determine each other within the three sectors. The three sectors are also mutually determinative of each other; there are feedback effects between the three sectors, as well as within them.

Fragility is measured as a quantitative index variable. By producing a leading index of fragility, it can forecast imminent systemic instability events. A time series (cross-section, factor analysis, data mining, simultaneous equation) regression analysis is needed of all nine (three within each of the three sectors) to determine the weights, and causal interactions. This can be done via machine learning (AI) and neural network analysis. This work is being prepared, and is ‘a work in progress’.

OUTLINE

In the first part of the book, Chapters 1 -to- 6, are an overview of the degree of fragility as of 2016, in the major economies: Europe, Japan, China, Emerging Markets, and U.S.; and Chapters 7 -to- 15 are a consideration of the main drivers of financial instability: slowing investment and deflation, explosion of money-credit-debt, shift to financial assets and restructuring of financial markets, structural change in labor markets, and central bank and government fragility, the key being the change in financial structure and investment.

The third part of the book, Chapters 16 -to- 18, is a critique of mainstream economics, Keynsian and Classical economic theory, Marxist and Minskyan economics, and the failure of these theories to address financial variables in post-modern macroeconomic-monetary policy theory, models and analyses.

In Chapter 19, Dr. Rasmus, offers his own Theory of Systematic Fragility, as of 2016; where it is Central bankers and massive liquidity injections that are fundamental originating causes of systemic fragility, but these alone do not completely explain fragility.

Stagnation and Instability in the Global Economy

In the U.S., China, Japan, Europe there is a coordinated effort to correct the failures of capitalism (under investment, employment, consumption, price stability, etc.), and the response by all central banks have been the same, a constant injection of massive amounts (trillions of U.S. Dollars, Yen, Euros, Pounds, Yuan, Peso, Rubble, etc.) of liquidity (credit) to back-stop, set a support, and prop up asset prices.

However, this leads to asset price bubbles and asset price collapse (financial/currency crisis/stagnation/deflation/under employment-investment), crisis more frequent since 1995 (Peso Crisis, Thai Baht, Russian Default, Y2K/911, Housing Bubble, Financial Crisis, etc.), and global central bankers (governments) now do not have the balance sheets to deal with future crisis; and have not fixed the real problem underlying the economy, they have only created a monetary illusion of policy effectiveness: dead-cat bounce recoveries, emerging market currency collapse, Japanese perpetual recessions, Europe’s stagnation, and China’s asset price hyper-inflation and debt crisis.

The perfect example of this financial-economic fragility is Japan.

Japan’ Perpetual Recession

Over the last 17 years (1990 – 2017), the Bank of Japan (BOJ) implemented aggressive forms of unorthodox monetary policy (Negative – Nominal/Real – Interest Rate Policy/Quantitative Easing): printing massive amounts of money, buying massive amounts of sovereign-corporate (infrastructure) bonds, driving bonds yields negative, and driving domestic investors/savers (negative effective rates), and financial institutions (disintermediation), literally crazy.

Japan will be the ultimate experiment in monetary-fiscal policy mistakes, as they will have to resort to even more extreme measures to try to get themselves out of their existential structural crisis. The ultimate fiscal-monetary response could be, with unintended political-economic-cultural consequences, from a massive and coordinated debt forgiveness, by both fiscal/monetary authorities, is unknown and untested in modern monetary history.

Japan is extremely fragile, as at some point they will not have the tax revenues to service the sovereign debt payments, and will theoretically fall into default, and will ask for forgiveness, not from bond holders, but from the BOJ, that owns the majority of the debt.
Not only is Japan’s economy and financial system extremely fragile, but so is Europe.

Europe’s Chronic Stagnation

The actual European Central Bank (ECB) structure (dominated by Germany – Bundesbank) is a major impediment in its ability to respond to current crisis: fiscal austerity, inability to devalue the Euro, fear of hyper-inflationary trends, and misspecification of monetary policy targets (inflation, productivity, employment, wages, and exchange rates).

Poor performance (contagion), bank crisis (runs on banks), social unrest (extreme right-wing populism), massive debt issuance, and deflation (liquidity trap/collapse of money velocity) is the costly (stagnation) result of policy mistakes. This – along with the lack and hesitant response to bank runs in Spain-Greece-other EU countries – has had a significant negative impact on ECB independence and credibility, in regards to the ability to respond to future financial and economic crisis.

Not only is Europe’s economy and financial system extremely fragile, but so is China.

China: Bubbles, Bubbles, Debt and Troubles

The Asian Contagion of the late 1990s required massive bank and corporate bailouts (recapitalizations). The 2000s, witnessed a modernization of the Peoples Bank of China (PBOC), as a central banking institution through banking reforms, conversion of State Owned Entities (SOEs) to private-public firms (privatization toward a more Japanese Keiretsu system), pushing for more export-oriented policies (higher-value commodities-services), and larger government sponsored infrastructure projects (commercial-residential-dams-roads-power plants, etc.).

Excessive industrial and monetary policy is unsustainable, and will have significant negative externalities on the global economy. The next financial crisis, in China, will come from the excessive extension of credit from both fiscal and monetary authorities, and will come from government and corporate bond market defaults, as the system is severely over-leveraged. China is using more and more debt to fix bad debt problems, and the simulative multiplier-accelerator effect on the economy is deteriorating (decelerating) quickly.
Systematic fragility is not only experienced at the microeconomic (country/market) level, but manifests at the macroeconomic (systemic/systematic/institutional) level.

Trends in Systematic Fragility

Systematic fragility is made up of financial, consumption and government fragility; and intra-sector fragility, is caused by debt levels (rate of change), income (servicing of debt), and terms and conditions of servicing of debt. Transmission mechanisms between these factors and sectors are price systems (financial/commodity), government policy (monetary/fiscal), and psychological expectations (investors/consumers).

What is important, is fundamental forces and enabling factors driving fragility are: the end of Bretton Woods, central bank managed float systems, ending of international capital controls, the liquidity explosion, debt escalation, financial asset investment shift, and the rise of the new global finance capital elite; and financial deregulation, global digital-network technology, financial engineering (derivatives) revolution, highly liquid financial markets, financial restructuring and emergence of the shadow banking system.

Globalization, technologicalization and deregulation/integration is accelerating capital flows and accumulation, and concentration of capital to targeted and non-targeted markets across the world, fundamentally restructuring markets and institutions. This process is continuing at a rapid pace, and depending on the recipients, is economically, financially and politically (institutionally) destabilizing, destructing and deconstructing liberal-democratic-capitalism.

Financial product innovation and advancements in the use of technology for trading purposes, is accelerating the shift from real to financial asset investment – and with the rise of global equity, debt, and derivative markets – is changing the institutional structure, and exacerbating the fragility and instability, of the global financial system.

Central Banks and Fragility

Central banks bailed out the private banking system, and will again – along with other strategic affiliated institutions, corporations, businesses and brokerages – by printing massive amounts of fiat currency (seigniorage), to buy (defective/defaulted) securities product (derivatives), accumulate more sovereign-corporate-personal debt, with even more crowding out effects, and with no real eventual long-term impacts on real economic growth, wages, and productivity; and social welfare or standards of living.
Only asset prices bubbles and a massive redistribution and concentration of wealth will occur. Global capital markets, financial institutions, governments, businesses, and consumers are sitting on an extremely fragile system. This is obvious when looking at the level of government debt, service.

Government Debt and Government Fragility

It is estimated, between the U.S Federal Reserve Bank, Bank of England, and European Central Bank, $15 trillion direct liquidity injections, loans, guarantees, tax reductions, direct subsidies, etc. have been used. If you add in China and Japan, the total gets to as high as $25 trillion, and if you add in other emerging country (Asian, Latin America, and Middle-East) central banks, the total gets as high $40 trillion. Add in inter-temporal substitution (opportunity costs) over 40 years, we are looking at hundreds of trillions of debt, and debt service.

What perpetuates this reliance on debt, and debt service, is the misconception of valid economic theory and analysis, and its real application.

Failed Conceptual Frameworks of Contemporary Economic Analysis

It is obvious, global monetary and fiscal policy responses have made the global financial and economic system even more fragile, and eventually insolvent and bankrupt, and modern central banking is ineffective and has put us into a perpetual liquidity trap, the velocity of money has collapsed. There is no money going into real long-term (capital budgets) assets, only short-term financial assets (equity, fixed-income, ETFs, derivatives, structured products, crypto-currencies, etc.).

This has led us into the contradiction of macroeconomic theory, monetary policy and central banking: liquidity-debt-insolvency nexus, the moral (immoral) hazard of perpetual bail-outs, growing concentration of wealth at the extremes, growing perception that Negative/Zero Interest Rate Policy (N/ZIRP) can fix under-investment in capital (human/physical) and deflationary (disinflationary) trends, and that current banking regulation-supervision is bad for the economy, financial services (institutions) industry, and for institutional and retail investors (savers) in the long run.

And unfortunately, these techniques and tools have been used by other Global Central Governments and Banks (BOJ/ECB/BOE/PBOC), with similar, disastrous, and disappointing outcomes. The focus is on saving the financial institutional system in the short-run, using extreme and un-orthodox monetary policies (tools), with a lack of concern or understanding of long-run economic, social, cultural, and political consequences and outcomes. This is the true reflection, of failed conceptual frameworks, of contemporary economic analysis.

A Theory and Application of Systematic Fragility

Dr. Rasmus presents a true theory (model), of Systematic Fragility, a proxy for instability, a measure and quantitative score, used to forecast financial instability events, measuring pre-post-crash-recession cycle phases, it is a simultaneous equation-solution, the weights and factors are non-linear relationships, and are determined through the use of machine-learning (AI) algorithms, that adjust the factors, equations, and outcomes in real (continuous) time.

For example, over the last 10 years, the Fed accumulated over $4.5 trillion in bank reserves/balance sheet (bonds), made up mostly of mortgage backed securities and U.S. government Treasury notes and bonds, the average size of the balance sheet prior to the financial crisis was $500-to-$800 billion. Since these were mainly reserves creation, and an addition to the monetary base, and not really the money supply, the policy effects (QE/(Zero-Negative Real Interest Rate policy) have been mute.

The real cause of deficient real-macroeconomic performance, is a collapse in the velocity of money, driven by alternative forms of money creation and flows across the globe (cryptic-digital currencies-shadow banking, etc.); the lack of fiscal labor market policy to lower under-employment and raise labor market participation rates; and resolve to solve other social, cultural, political and economic disruptions. Making it now impossible to conduct monetary policy.

With the U.S. fiscal debt totaling over $22 trillion (interest payments +$1.0 trillion per year), the Feds Balance Sheet totaling $4.3 trillion, the potential for continued -perpetual war (defense spending) and entitlement expenditures, and political and policy uncertainty (next Federal Reserve President) there is little room for monetary and fiscal solutions to fight the next financial and economic crisis.

Neoliberal new-classical macroeconomic theory is flawed, at best, as it relies on the primacy of central bank monetary policy, tax structure shifts, free trade theory, running of twin deficit systems, allows for major labor market restructuring, leading to wage compression, drives toward privatization of public goods and institutions, and fiscal austerity, and financialization-fiscalization of elites, institutions and products.

CONCLUSIONS

Most major monetary, fiscal, and macroeconomic economists, and financial institution and capital market experts agree, the global economy and financial system is more systemically fragile than ever before.

According to Dr. Rasmus, shows us that global Financial Fragility (FF) is positively related to total financial asset investment in the system, and with interest rate maturity optimization, elasticity of inside (shadow bank) credit, and available income to total debt levels; with inflation expectations to change in total debt levels; with credit default and reinvestment risk; and with fiscal and monetary government subsidies, support, credit facilities, QE, bailouts, etc. (See Appendix).

Government policies have made matters worse, by driving the cost of capital to zero (negative), replacing real assets for financial assets, printing trillions to bail-out and purchase bad debt and defective financial products, allowing massive leakage of capital to flow unregulated (shadow banking) across the globe, etc.; all with no real effect on real economic growth, wage growth, labor participation, inflation, standards of living or social welfare.

These failures and fragility are reflected in increased volatility in social and economic indicators, capital market pricing and investment risk, and resulting reductions risk-adjusted returns, inefficient allocation investment capital and resources, and falling employment and real income growth rates, standards of living and overall social welfare.

The conclusion, if this system of unorthodoxy continues – and I believe it is too late to address the systemic and systematic risks associated with the economy, government, and central banking – exposes the economy, financial institutions and capital markets, to failure, again, at an ever higher social price.

The reality is our economic and financial system are extremely fragile, and we are facing ever higher systematic-systemic credit default (illiquidity) risk, and another severe financial crisis, great recession and depression, as our tools and system are ineffective and broken.

By Dr. Larry Souza
April 1, 2018
Dr. Souza has 27 years of experience in commercial and residential real estate economic research; and is Real Estate, Financial and Investment Economist for: Pillar6 Advisors, LLC; Johnson Souza Group, Inc.; CapitalBrain.co, and GreenSparc. Dr. Souza holds degrees in: accounting, finance, economics, public administration, information systems and political science; and Doctorate in Business Administration (DBA) with a concentration in Corporate Finance, and his dissertation is titled: Modern Real Estate Portfolio Management (MREPM): Applications in Modern (MREPT) and Post-Modern (PMREPT) Real Estate Portfolio Theory. He has been teaching college level finance, economics and real estate courses for the past 22 years, and is currently a full-time adjunct professor in the School of Economics and Business Administration (SEBA) at Saint Mary’s College (SMC) of California.

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