Adonis Diaries

The Third World War is loudly tolling (February 27, 2009)

Dr. Abbas Bakhtiar published in February 23, 2009 on “Information Clearing House“ a valuable review on the current economic situation.  It is unfortunately one of so many technical or what I call mechanical explanations of the troubles but no substantive resolutions attached to it.  I will try first to abrige that article and then offer a few solutions.

“In early February, the International Monetary Fund’s chief Dominique Strauss-Kahn said the world’s advanced economies — the U.S., Western Europe and Japan — are “already in depression”. The UK, Italy, Spain, Korea, Taiwan are in depression. All these States and many more have watched their GDP shrinking sharply. Japan, Ukraine, Ireland, and Iceland have experience shrinking in the two digits. An important fact to remember is that this depression is synchronised and this synchronicity has been made possible by the globalization and accompanying deregulation; the very things that were making workers poorer and the rich, richer. China’s growth rate is estimated to be around 1 percent.

Middle Eastern countries have also been severely affected by the financial crisis. Oil prices that were around 120 dollars last year have come down to around 35dollars this year. Every country has slashed its expenditure with the accompanying slowing growth. For example recently UAE was forced to halt construction projects worth $582 billion or fully 45% of all projects. Dubai’s economy is in free fall, newspapers have reported that more than 3,000 cars sit abandoned in the parking lot at the Dubai Airport, left by fleeing, debt-ridden foreigners (who could in fact be imprisoned if they failed to pay their bills)”. Iranians, Saudis, Iraqis, Kuwaitis and others have also been forced to slow down or freeze many projects. One must not forget that many of these countries’ petro-dollars are re-circulated back into the US and European economies. Those funds are drying-up fast.

Turkey sitting between the Europe and Middle East is also suffering. Turkey has the largest GDP in the Islamic world. Turkey’s GDP was 750 billion in 2008, the GDP of Saudi Arabia was 600 billion dollar for the same period. A once dynamic economy is now negotiating with IMF for help.

The Federal Reserves’ forecast for 2009 shows a contraction of 0.5 to 1.3 percent of the GDP with official unemployment rising to 8.5 or 8.8 percent. Here one should note that this official unemployment rate does not present a true picture, since all those who give-up registering with the unemployment office or are barely working (part-time workers, etc) are not counted as unemployed.

The missing engine of growth

There are four factors that power an economy: consumers, investors, government, and a favourable trade balance. Some economies such as China rely on favourable trade balance and Foreign Direct Investment (FDI) for their growth. For example according to the Chinese Ministry of Commerce, from 1990 to 2007, China received $748.4 billion in FDI. At the same time, since its economic liberalization, China has recorded consistent trade surpluses with the world. For example China has registered trade surpluses of $102 billion for 2005 to $295. billion for 2008. China currently has accumulated nearly two trillion dollars in foreign exchange reserves.

In contrast to the China, the United States has relied on consumers and the government for its growth. U.S. consumers constitute only about 4.5% of the global world population, yet they bought more than $10 trillion worth of goods and services last year. In contrast the Chinese and Indian consumers combined which account for 40% of the global population bought only $3 trillion worth. The U.S. consumer spending shot up to nearly 77% of the economy.

Japan is once again entering another deflationary period. In deflationary periods, consumers spend less and try to save more. The fear of losing one’s job, the psychology of ever decreasing prices, and general feeling of doom act against free spending by the consumers. The Japanese consumption was only 55% of the GDP as much as the Euro zone. So the Japanese and EU consumers cannot help either.

The US consumers have to get used to lower spending levels for at least a decade, if not for good. American’s standard of living is undergoing a “permanent change” – and not for the better as a result of:

• An $8 trillion negative wealth effect from declining home values.

• A $10 trillion negative wealth effect from weakened capital markets.

• A $14 trillion consumer debt load amid “exploding unemployment”, leading to “exploding bankruptcies.”

“The average American used to be able to borrow to buy a home, send their kids to a good school [and] buy a car,” Davidowitz says. “A lot of that is gone.

The diminishing wealth

For people in general, shares act both as saving and investment. The average person buys share in hope of getting better return than the banks. It is also easy to get in and out of the market. The advancements in information and communication technologies, the costs of buying and selling have fallen steadily in the last decade. So now anyone with a computer can buy and sell shares. This ease of entry enticed an ever increasing number of ordinary people to enter the stock markets.

Now the people have been hit by three disasters. First they lost a lot of money in the housing market. Then they were hit with the collapse of the stock markets. Trillions of Dollars, Yens, Euros and Yuans have been wiped-out in a relatively a short time. Then many have lost their jobs and many are uncertain about the future job security. All these have had a tremendous impact on the consumers, forcing many to heavily reduce their consumption, which in turn have begun to affect businesses which in-turn are shedding workers to compensate for the loss of sales and revenues. This is a classical deflationary circle that feed on itself.

The governments’ response to this threat has been to stimulate the economy by pumping large sums of money into the economy. A decade ago, a hundred billion dollar was an astronomical sum. Today we don’t even bother to look at it twice. Today we talk of Trillions. A few hundred billions here and a few hundred billions there soon add up to a few nice trillions; especially the trillions that we don’t have.

Now we face a classical problem: the increasing budget deficits. Exactly when the economy is contracting and tax receipts are falling, the government expenditure is rising rapidly. In addition, the governments are buying bad debts and trying to spend more on whatever they can in order to arrest the increasing unemployment and stimulate the economy. These large sums have to come from somewhere. They can be borrowed or money can simply be printed. The problem is that some governments are opting for both.

So how can the US continue its deficit spending? By issuing treasury bonds and other security certificates of course. Both public and foreign governments buy these securities which are guaranteed by the US government. Foreign central banks alone held $1.76 trillion dollars in US treasuries. The combined holdings of Treasuries and agency securities by foreign central banks at the Fed totalled $2.573 trillion, up $11.223 billion”.

The coming inflation

So far the foreign governments and businesses have been willing to buy US debt, but with the current economic downturn things are beginning to change. In the last 5 years China has spent as much as one-seventh of its entire economic output buying mostly American debt. However, with the sharp slowdown in its economy, China is finding it difficult to keep buying. China has also come-up with its own $600 billion stimulus plan. This along with the falling trade surplus and the falling tax receipt will make it exceedingly unlikely that China can keep financing part of the US government’s deficit spending. The same applies to other countries as well.

As the economic downturn continues we can see two things: the interest on US treasuries increase substantially to make it attractive and or printing money. Printing money is not so farfetched as many would like to believe. Already countries that cannot find willing lenders are resorting to this. The Bank of England voted unanimously earlier this month to seek consent from the government to start the process of quantitative easing (means printing money) by buying gilts and other securities. With interest rates at 1%, printing money is likely to increase inflation.

It is especially appealing for the US government to print money since inflation means a real value reduction in debts. With mounting trade and budget deficit and decreasing tax receipts and the shrinking of the number of willing lenders, US government may not have any choice but to print money.

All governments are reducing their interest rates to historic lows and at the same time spending a lot of money that they don’t have. It will take at least two more years for the economy to stabilise (meaning an arrest in decline rather than outright growth). Once that point is reached we will begin to see the effects of the loose monetary policy: a tremendous rise in inflation which can be accompanied by low economic growth or in other words stagflation.

The current economic crises have left many countries’ local banks with foreign currency loans that they find difficult to repay in that currency. This and the possibility of defaults have made these countries a good target for speculators. If such an attack starts, many countries will automatically have to devalue their currencies (even more than they already have) or try to defend their currencies. In either case this may trigger yet another crisis that may actually destroy a good portion of many economies around the world.

Even if we assume that no more nasty surprises will appear in the next two years and the economies stabilise, we are left with the reduced levels of consumption around the world, especially in major economies. So there will be a dearth of market for the goods and services produced by others. In absence of the US, the question will be: which country or countries are able to increase demand to such a degree as to trigger a recovery; that most likely will be accompanied with high inflation?”

Dr. Abbas Bakhtiar (Bakhtiarspace-articles@yahoo.no) is sugesting a second “Bretten Woods” agreement where we can address the existing problems and restructure the world’s economic system, otherwise we will face protectionism, low economic growth, and even trade wars. Dr. Bakhtiar failed to offer a blue print on what to agree on.

I suggest the folowing: 

First, the developed States have to agree on another tangible standard (like gold) for currencies.  Gold would not do because the US has abolished it in 1967 because all the gold in the world could not sustain the huge amount of paper dollars circulating or intended to circulate around the world.  The alternative is a basket of depleting minerals that are essentials for manufacturing and production.  The processed minerals do not have to be rare but very essentials for development.  The US can agree to this idea since it has huge reserves in many important minerals.

Second, all the States that can account for at least 3% of all curency circulation should join an “International Money Printing Council” with tight control and monitoring creteria.  Any combined States with over 40% of cash money shares in the global market should have a veto power.

Failing a convincing and sustainable agreement for monetary stability the Third World War is altready in the planning stage as the easiest and quickest way out of that morass.  Only in major wars do printed money with no tangible backing has mythical values.  No, the next region for the war scene is not Iran: no European or US soldiers want to fight in this “cursed region”.  It won’t be Afghanistan: if Afghanistan was worth it then Bush Junior would not have invaded Iraq before stabilizing Afghanistan.  It won’t be North Korea: it is bordering China.  The batlefield will not be in any area bordering Russia.  It won’t be the Congo River zone: no Western soldiers is about to step in this infested and contagious disease plagued region with AIDS consuming 30% of the population.

The next world war is in Sudan. Sudan is a continent by itself and rich in all kinds of raw materials, oil, and water and land to sustain the world agricultural needs.  No, the superpowers will not directly fight one another. The war will last to the last Sudanese and any lame African soldiers that participate in the war. Egypt might get a tiny share of the spoil of the new colonial powers simply because it was impotent to secure its backyard.  Egypt and the Arab States are feeling the heat and scrambling; it is kind of too late.