After what Los Angeles money manager Arnold Silver called "a brutal three days," the question is: What now for the market?
A Wall Street superstar this year who runs Balestra Capital Partners, Jim Melcher, says he's "worried about a recession. Not a normal one, but a very bad one. The worst since the 1930s. I expect we'll see clear signs of it in six months with a dramatic slowdown in the gross domestic product."
Balestra Capital, a $350 million New York hedge fund, was up 3% for the past three market sessions, when the Dow Jones Industrials, spearheaded by widespread declines in financial stocks and fears of more billion-dollar-plus asset write-downs, tumbled more than 677 points, or about 4.5%. The Nasdaq fared worse, skidding about 7%, triggered by across-the-board declines in those fast-stepping technology stocks.
Balestra has increased in value by 175% so far this year, Mr. Melcher tells me. A 9-year-old fund, it has posted compounded annual growth of about 30% since its inception.
Mr. Melcher, a market bear, had some pretty discouraging words. "What I think is not good for the country, but good for me." he says. His basic advice to the country's roughly 80 million stock players: Run for the hills — the worst is far from over. An investor's stock portfolio now, he believes, should be only about half of what it might normally be.
With the housing market in a state of collapse — and he says he believes it is far from over — Mr. Melcher argues that average homeowners will not be able to withstand the kind of recession he sees, given the added burdens of rising energy and food costs, and continued deterioration in the credit markets.
Noting that consumption is already slowing, Mr. Melcher figures sharply rising unemployment is inevitable. Another of his worries is that central banks around the globe, America's included, are debasing their currencies, which is setting the stage for a new round of higher inflation. Our bear figures the next six to 12 months will be awful for investors as the market goes down "pretty substantially." His frightening outlook calls for an additional 20% to 30% decline from current levels. A drop of that magnitude would put the Dow down in a range of roughly 9,100 to 10,400.
Asked how he could conceivably give credibility to such an ominous forecast, Mr. Melcher observes: "I've never seen a market with more risk and what's significant is that risk is not yet priced in."
Given his grim expectations, he says there is no equity market in the world he would play right now. "When the American market goes down, other equity markets around the world should follow," he says.
As of now, his portfolio is pretty much devoid of stocks, save for an exchange-traded fund focused on leading companies in oil services, which he regards as an ongoing growth industry. The ETF, the Oil Services Holders Trust, trades on the American Stock Exchange under the symbol OIH. Although enthusiastic about the industry's growth prospects, Mr. Melcher says he would be reluctant to recommend oil services stock because he believes the price of oil could easily drop 50% in the recession he envisions.
Another danger he sees for the market is the prospect of huge withdrawals of funds from America by foreign investors due to the falling dollar, the credit crisis, and a slowing economy.
At the moment, Mr. Melcher's chief investment strategy is shorting stocks and certain bonds, notably mortgage-backed and junk bonds, through the use of derivatives, put options, and credit default swaps. He is also short ABEX, an index of residential mortgage-backed securities.
His short strategy is largely responsible for his super performance this year, as are his holdings in gold. The fact he's sticking to this strategy is evidence that he firmly believes the chaos in the financial markets is far from over. Mr. Melcher is also gung-ho on several currencies, particularly the Swiss franc and the Japanese yen.
The average investor, he believes, should seek to protect his assets by raising cash, putting money to work in short-term treasuries, and buying some gold (notably through StreetTRACKS Gold Trust, an ETF that tracks the price of the precious metal and trades on the Big Board under the symbol GLD).
Is the world coming to an end? I asked our bear. "I don't think so," he replied, "but as I mentioned, the ingredients are in place for the worst kind of a recession, which means it's the wrong time to own stocks."
The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.
Two officials at leading Communist Party bodies have given interviews in recent days warning - for the first time - that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress.
Shifts in Chinese policy are often announced through key think tanks and academies.
Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is already breaking down through historic support levels.
It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession. It is estimated that China holds over $900bn in a mix of US bonds.
Xia Bin, finance chief at the Development Research Centre (which has cabinet rank), kicked off what now appears to be government policy with a comment last week that Beijing's foreign reserves should be used as a "bargaining chip" in talks with the US.
"Of course, China doesn't want any undesirable phenomenon in the global financial order," he added.
He Fan, an official at the Chinese Academy of Social Sciences, went even further today, letting it be known that Beijing had the power to set off a dollar collapse if it choose to do so.
"China has accumulated a large sum of US dollars. Such a big sum, of which a considerable portion is in US treasury bonds, contributes a great deal to maintaining the position of the dollar as a reserve currency. Russia, Switzerland, and several other countries have reduced the their dollar holdings.
"China is unlikely to follow suit as long as the yuan's exchange rate is stable against the dollar. The Chinese central bank will be forced to sell dollars once the yuan appreciated dramatically, which might lead to a mass depreciation of the dollar," he told China Daily.
The threats play into the presidential electoral campaign of Hillary Clinton, who has called for restrictive legislation to prevent America being "held hostage to economic decicions being made in Beijing, Shanghai, or Tokyo".
She said foreign control over 44pc of the US national debt had left America acutely vulnerable.
Simon Derrick, a currency strategist at the Bank of New York Mellon, said the comments were a message to the US Senate as Capitol Hill prepares legislation for the Autumn session.
"The words are alarming and unambiguous. This carries a clear political threat and could have very serious consequences at a time when the credit markets are already afraid of contagion from the subprime troubles," he said.
A bill drafted by a group of US senators, and backed by the Senate Finance Committee, calls for trade tariffs against Chinese goods as retaliation for alleged currency manipulation.
The yuan has appreciated 9pc against the dollar over the last two years under a crawling peg but it has failed to halt the rise of China's trade surplus, which reached $26.9bn in June.
Henry Paulson, the US Tresury Secretary, said any such sanctions would undermine American authority and "could trigger a global cycle of protectionist legislation".
Mr Paulson is a China expert from his days as head of Goldman Sachs. He has opted for a softer form of diplomacy, but appeared to win few concession from Beijing on a unscheduled trip to China last week aimed at calming the waters
Behind all the blather and bullshit about the Federal Reserve's rescue gambits and the machinations of the ratings agencies, and the wiles of foreign sovereign wealth, and the incomprehensible mysteries of markets, and the various weather forecasts of a gathering "recession" is the simple fact that the USA is a way poorer nation than we imagined ourselves to be six months ago. The American economy has been running on the fumes of "creatively engineered" finance (i.e. new-and-improved swindling) for years, and now these swindles are unraveling. In their aftermath, they leave empty wallets, drained bank accounts, plundered retirements funds, boiled away capital reserves, worthless stocks, bankrupt companies, vandalized housing tracts, ruined families, and Wall Street executives who are still pulling down multimillion-dollar pay packages despite running their companies into the ground.
We're burning down the house and kidding ourselves that there is a remedy for it. All the rate cuts and loans to big banks and bank-like corporate organisms, and "monoline" bond insurers, and mortgage mills amount to little more than a final desperate shell game to conceal the radioactive pea of aggregate loss. The losses are everywhere, and when you add up seven billion here and eleven billion there they probably amount to something like a trillion dollars in sheer capital evaporation -- not counting the abstract "positions" that the capital was leveraged onto by the playerz and boyz who mistook algorithms for productive activity.
The shell game may run a few more weeks but personally I believe the timbers are burning. The losses are no longer "contained" or concealable. A consensus has now formed that we're in for a "recession." The idea is that, yes, this seems to be the low arc of the business cycle. Fewer Hamptons villas will be redecorated in the interim. We'll gird our loins and get through the bad weather and when the sun shines again, we'll be ready with new algorithms for new sport-with-capital.
Uh-uh. Think again. This is not so much financial bad weather as financial climate change. Something is happenin' Mr Jones, and you don't know what it is, do ya? There has been too much misbehavior and it can no longer be mitigated. We're not heading into a recession but a major depression, worse than the fabled trauma of the 1930s. That one occurred against the background of a society that had plenty of everything except money. Back then, we had plenty of mineral resources, lots of trained-and-regimented manpower, millions of productive family farms, factories that were practically new, and more than 90 percent left of the greatest petroleum reserve anywhere in the world. It took a world war to get all that stuff humming cooperatively again, and once it did, we devoted its productive capacity to building an empire of happy motoring leisure. (Tragic choice there.)
This new depression, which I call The Long Emergency, will play out against the background of a society that has pissed away its oil endowment, bulldozed its factories, arbitraged its productive labor, destroyed both family farms and the commercial infrastructure of main street, and trained its population to become overfed diabetic TV zombie "consumers" of other peoples' productivity, paid for by "money" they haven't earned.
There is a theory (see Nouriel Roubini's blog) that a reform process will now ensue in the financial realm, new regulation and oversight of the same old familiar activities. This too, I'm afraid, will prove to be wishful thinking. The financial system will not be reformed until it lies in smoking wreckage, and when that "re-form" happens the armature of the re-organizing society will barely resemble the one that the previous burnt-down-house was designed to dwell in. Among other things, it will not support capital enterprise at anything like the scale that we became accustomed to lately. Globalism will be over. The great nations of the world will be scrambling desperately for the world's remaining oil supplies. It will not be a friendly contest, and anyone who thinks that current trade relations and capital flows will continue despite that is liable to be disappointed. (Are you reading this Tom Friedman?)
Long before the mathematical projections of oil depletion play out, the oil markets themselves -- and all the complex operations that they comprise, such as drilling and exploration, and the movement of tankers around the planet -- will destabilize and seize up. We will no longer be any oil exporter's "favored customer." Many of the exporters will enjoy watching us suffer. Contrary to the political platitude-du-jour, the USA will never become "energy independent" in the way we currently imagine. Rather we'll become energy independent by being deprived of imported oil, and we'll be thrown back on our own dwindling supplies -- which means that we're not going to run our system of daily life the way it has been set up to run. When Americans can no longer run their cars on a whim, they will simply go apeshit and you can kiss normal politics goodbye.
The financial system that emerges from this cataclysm, and the economy it serves (which is supposed to be the master of its capital deployment "arm," not its servant) will likely be modest to a degree that will shock and embarrass everyone currently connected with what we have lately called finance. If it even trades in paper, that paper will have to stand for something based in reality, either a productive activity or a genuine asset. It may take decades for this society to even regain the confidence necessary to operate such an elementary system -- or it may not come back at all, at least as far as the horizon lies before us. That's how bad the mischief and the damage has been.
It's not hard to understand why the Bernankes, Paulsons, Lawrence Kudlows and other public representatives of capital keep pretending that everything is under control. On the other side of their pretenses lies disorder and hardship. One wonders, of course, what they really see in their private minds' eyes. Do they actually believe that the statistics issued by their serveling agencies amount to a plausible picture of reality? Are they so lost in their fantasies of "management" that they think they're controlling events?
My guess is that their credibility is spent. In the weeks ahead, nobody will know who or what to believe. We may even run out of questions to ask as we just all collectively stand there in a thrall of wonder and nausea, watching the nation's financial house burn down.
i've been following this gerald celente for a while now, hes a trends forcaster for http://www.trendsresearch.com/ and is widely respected for getting so many of his forecasts spot on. he gets all over the american media, but of course in the usual corporate media format its only for a few minutes.
from wiki; On November 14, 2008, Celente appeared on Fox Business Network and predicted economic depression, tax rebellions, food riots, and more concern for buying food than Christmas presents by 2012 in the United States.[1][12] Celente also has predicted in his Top Trends of 2009 newsletter that governments across the country would be squeezing the little guy for every last dime wherever it could.
Celente also predicts in 2009 and beyond food-producing gardens will become common on people's lawns, as resources generally become more scarce. Celente says to escape the mood of economic depression people will be delighting in entertainment and alcohol. Other predictions for 2009 and beyond include a possible revolutionary advance in renewable energy technologies, miracle cures from stem cell research, a shift toward holistic healing practices, and a crash of the overpriced college-industrial complex.
The "Panic of ’08" will be followed by "The Collapse of ’09." In 2008, when the world’s largest financial firms and equity markets crumbled, Wall Street’s woes preoccupied the media.
In 2009, the focus will broaden to include a range of calamities that will leave no sector unscathed. Next in line is retail, which accounts for some 70 percent of consumer spending, 26 percent of which is holiday sales.
After the numbers are tallied to reveal a dismal retail Christmas, more big chain bankruptcies will follow. Besides leaving masses unemployed, defunct retailers will leave behind thousands of empty stores. Who will rent them? Nobody!
Add to these empties commercial space vacated by defunct financial firms and an array of troubled businesses, from restaurants to architectural firms, to high-tech operations, to offset printers, etc., etc. The inescapable result (that we predicted over a year ago and is only now being discussed in the business media) is a commercial real estate bust that will be costlier, wreak greater havoc and prove more intractable than the residential market decline.
Because most people don’t live and shop on Wall Street, the "Panic of ’08" was viewed by Main Street as if from afar – even though many were losing money. But when commercial real estate crashes, it will hit much closer to home. The depressive atmosphere of thinly shopped, half-vacant malls will strike emotional chords and all the senses.
In office buildings, vacant floors and empty cubicles will dampen the workday spirit of the still-employed; ever-present reminders of laid-off friends and colleagues and of the fragility of employment.
Abandoned, untended business and industrial parks will highlight the already mournful scene. In cities studded with soaring towers and new construction predicated on eternal economic growth, streets lined with "For Rent/For Sale" signs will complement stilled cranes and uncompleted buildings.
As retail and commercial real estate collapse, the credit card sector and all its interrelated processing and back office support businesses will suffer and be forced to scale back. Hordes of consumers who have been living off credit cards and racking up debt to the limit will lack the funds to service their debt… much less pay it off, and they will be forced to default. Given the nearly $3 trillion in consumer debt at risk (excluding auto and mortgage) an inevitable default snowball will add momentum to the in-progress Collapse of ’09.
While we alone predicted the "Panic of ’08" (and even took out the domain name "Panicof08.com" on 7 November 2007), we are not alone in predicting a Depression.
The "D" word is being uttered – in some cases by those who have the most to lose and whose best interests are not served by spreading gloom and doom. "The world and country are in a depression," said celebrity tycoon Donald Trump. He then later softened the blow, downgrading it to a "virtual depression."
"Virtual" to the few who will never have to worry where the next dollar will come from, it will be painfully real and hardly virtual to the multitudes who are and will be worrying. The virally proliferating Greatest Depression is the Trend of Trends for 2009.
Even so, beware! Over the course of free-falling 2009, the word from most official sources will be "recession," and from the few mainstream trophy pessimists, "deep recession."
For example, the oft-quoted naysayer, Nouriel Roubini, New York University professor of economics, forecasts a two-year recession … not Depression. On the sunnier side of Wall Street, the Federal Reserve predicts the US economy will contract only through the middle of 2009 and pledged, "In any event, the Committee agreed to take whatever steps were necessary to support the recovery."
What "steps"? The Bernanke Two-Step? Adjust interest rates or print more money? Neither stopped the credit crisis from worsening, the real estate market from tanking or the stock markets from crashing.
It was Fed finagling, Washington deregulation and Wall Street’s compulsive gambling that created the crisis. To trust or to seriously consider pronouncements, analyses and predictions made by any of these sources is an exercise in willful self-deception. Yet, with pensions, IRAs, 401ks, stocks and mutual funds evaporating, many of those most affected deny reality and take hope that forecasts made by proven incompetents will miraculously restore their losses.
Throughout the many years leading up to what we term the "Greatest Depression," The Trends Research Institute provided copious data and Globalnomic analysis to support our forecasts of economic upheaval. In the past year alone, we have provided so much hard evidence (housings starts, home sales, foreclosures, bankruptcies, bank failures, unemployment figures, stock indices, leading economic indicators, retail sales, etc.) that further elaboration should be superfluous.
Those waiting to hear the "D" word from economic experts, talking heads and TV anchors before taking action will most certainly regret their indecisiveness.
Absent from the economic scenarios ranging from second quarter recovery, deep recession and "virtual" depression are the multiplicity of social, environmental, health, political, emotional/psychological and geopolitical factors that point beyond just Depression. They point to The Decline and Fall of Empire America.
Well before Inauguration Day, Barack Obama was cast as the next Franklin Delano Roosevelt. If he follows in FDR’s footsteps, he could freeze deposits by declaring a "holiday" to stop a run on the banks. While FDIC insurance may cover deposits, even after banks reopen, withdrawal amounts may be restricted. (As the Argentine government did in 2001–2002.)
Author’s Note: Suspicious of the soundness of the banking system, I requested to withdraw a substantial sum from our Key Bank account, leaving funds sufficient to cover ongoing business operations. First they tried to dissuade me, then they stonewalled me, and finally they turned openly hostile.
I was forced to sign a series of documents, including one acknowledging that since I was carrying a large sum, I could be the target of a robbery. To enhance that possibility, the teller slammed down the bag of cash on the counter and publicly announced the sum.
Despite repeated requests in the days preceding my withdrawal to get the cash in hundreds, they gave it to me in twenties, making for a bag five times the size and more robber-friendly. When I complained to the bank manager who had processed the request, the response amounted to "take it or leave it."
This will not be an isolated event. If you attempt to withdraw a large chunk of money from your account, negotiate the details in advance and anticipate possible hassle and obstruction.
We’ve heard similar accounts from clients and Trends Journal subscribers who, over the past several months, tried to close out mutual funds, 401ks and assorted sinking equities. They were dissuaded, cajoled, belittled and arm-twisted by brokers desperate to keep their accounts. Many caved in under the pressure, didn’t close them and lost most of what they had.
So, we leave you with a Greatest Depression consideration: How safe is your money? How sound is your bank? At the end of November, Citigroup, once America’s largest bank, was on the rocks. Fifty-two thousand employees were laid off. In just three days, its stock lost more than half its value. Rumors swirled that Citi was so desperate they were looking to sell or split up the company.
Is your money deposited in a local bank whose reputation you can bank on? Are you with a teetering giant or a poorly-managed regional? If either of the latter, it would be in your best interest to assess the risks.
Take some out if you think there is risk; take it all out if you think there’s high risk. You may consider spreading it around and even banking abroad … after all, this is the Global Age.
Gerald Celente is founder and director of The Trends Research Institute, author of Trends 2000 and Trend Tracking (Warner Books), and publisher of The Trends Journal. He has been forecasting trends since 1980, and recently called “The Collapse of ’09.”
Noam Chomsky speaks to Paul Jay on the Obama - Geithner plan. Chomsky says that "they're simply recycling, the Bush-Paulson measures and changing them a little, but essentially the same idea: keep the institutional structure the same, try to kind of pass things up, bribe the banks and investors to help out, but avoid the measures that might get to the heart of the problem."
good article by former IMF chief economist simon johnson
The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.
if you can't be bothered to read the article you can check here for a short video interview with him
Stiglitz Says Banking Problems Are Now Bigger Than Pre-Lehman
Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc.
“In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said in an interview today in Paris. “The problems are worse than they were in 2007 before the crisis.”
Stiglitz’s views echo those of former Federal Reserve Chairman Paul Volcker, who has advised President Barack Obama’s administration to curtail the size of banks, and Bank of Israel Governor Stanley Fischer, who suggested last month that governments may want to discourage financial institutions from growing “excessively.”
A year after the demise of Lehman forced the Treasury Department to spend billions to shore up the financial system, Bank of America Corp.’s assets have grown and Citigroup Inc. remains intact. In the U.K., Lloyds Banking Group Plc, 43 percent owned by the government, has taken over the activities of HBOS Plc, and in France BNP Paribas SA now owns the Belgian and Luxembourg banking assets of insurer Fortis.
While Obama wants to name some banks as “systemically important” and subject them to stricter oversight, his plan wouldn’t force them to shrink or simplify their structure.
Stiglitz said the U.S. government is wary of challenging the financial industry because it is politically difficult, and that he hopes the Group of 20 leaders will cajole the U.S. into tougher action.
G-20 Steps
“We aren’t doing anything significant so far, and the banks are pushing back,” he said. “The leaders of the G-20 will make some small steps forward, given the power of the banks” and “any step forward is a move in the right direction.”
G-20 leaders gather next week in Pittsburgh and will consider ways of improving regulation of financial markets and in particular how to set tighter limits on remuneration for market operators. Under pressure from France and Germany, G-20 finance ministers last week reached a preliminary accord that included proposals to claw-back cash awards and linking compensation more closely to long-term performance.
“It’s an outrage,” especially “in the U.S. where we poured so much money into the banks,” Stiglitz said. “The administration seems very reluctant to do what is necessary. Yes they’ll do something, the question is: Will they do as much as required?”
Global Economy
Stiglitz, former chief economist at the World Bank and member of the White House Council of Economic Advisers, said the world economy is “far from being out of the woods” even if it has pulled back from the precipice it teetered on after the collapse of Lehman.
“We’re going into an extended period of weak economy, of economic malaise,” Stiglitz said. The U.S. will “grow but not enough to offset the increase in the population,” he said, adding that “if workers do not have income, it’s very hard to see how the U.S. will generate the demand that the world economy needs.”
The Federal Reserve faces a “quandary” in ending its monetary stimulus programs because doing so may drive up the cost of borrowing for the U.S. government, he said.
“The question then is who is going to finance the U.S. government,” Stiglitz said.
The demise of the dollar In a graphic illustration of the new world order, Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading
Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars.
In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.
Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.
The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.
The Americans, who are aware the meetings have taken place – although they have not discovered the details – are sure to fight this international cabal which will include hitherto loyal allies Japan and the Gulf Arabs. Against the background to these currency meetings, Sun Bigan, China's former special envoy to the Middle East, has warned there is a risk of deepening divisions between China and the US over influence and oil in the Middle East. "Bilateral quarrels and clashes are unavoidable," he told the Asia and Africa Review. "We cannot lower vigilance against hostility in the Middle East over energy interests and security."
This sounds like a dangerous prediction of a future economic war between the US and China over Middle East oil – yet again turning the region's conflicts into a battle for great power supremacy. China uses more oil incrementally than the US because its growth is less energy efficient. The transitional currency in the move away from dollars, according to Chinese banking sources, may well be gold. An indication of the huge amounts involved can be gained from the wealth of Abu Dhabi, Saudi Arabia, Kuwait and Qatar who together hold an estimated $2.1 trillion in dollar reserves.
The decline of American economic power linked to the current global recession was implicitly acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis may be a recognition of changed economic power relations," he said in Istanbul ahead of meetings this week of the IMF and World Bank. But it is China's extraordinary new financial power – along with past anger among oil-producing and oil-consuming nations at America's power to interfere in the international financial system – which has prompted the latest discussions involving the Gulf states.
Brazil has shown interest in collaborating in non-dollar oil payments, along with India. Indeed, China appears to be the most enthusiastic of all the financial powers involved, not least because of its enormous trade with the Middle East.
China imports 60 per cent of its oil, much of it from the Middle East and Russia. The Chinese have oil production concessions in Iraq – blocked by the US until this year – and since 2008 have held an $8bn agreement with Iran to develop refining capacity and gas resources. China has oil deals in Sudan (where it has substituted for US interests) and has been negotiating for oil concessions with Libya, where all such contracts are joint ventures.
Furthermore, Chinese exports to the region now account for no fewer than 10 per cent of the imports of every country in the Middle East, including a huge range of products from cars to weapon systems, food, clothes, even dolls. In a clear sign of China's growing financial muscle, the president of the European Central Bank, Jean-Claude Trichet, yesterday pleaded with Beijing to let the yuan appreciate against a sliding dollar and, by extension, loosen China's reliance on US monetary policy, to help rebalance the world economy and ease upward pressure on the euro.
Ever since the Bretton Woods agreements – the accords after the Second World War which bequeathed the architecture for the modern international financial system – America's trading partners have been left to cope with the impact of Washington's control and, in more recent years, the hegemony of the dollar as the dominant global reserve currency.
The Chinese believe, for example, that the Americans persuaded Britain to stay out of the euro in order to prevent an earlier move away from the dollar. But Chinese banking sources say their discussions have gone too far to be blocked now. "The Russians will eventually bring in the rouble to the basket of currencies," a prominent Hong Kong broker told The Independent. "The Brits are stuck in the middle and will come into the euro. They have no choice because they won't be able to use the US dollar."
Chinese financial sources believe President Barack Obama is too busy fixing the US economy to concentrate on the extraordinary implications of the transition from the dollar in nine years' time. The current deadline for the currency transition is 2018.
The US discussed the trend briefly at the G20 summit in Pittsburgh; the Chinese Central Bank governor and other officials have been worrying aloud about the dollar for years. Their problem is that much of their national wealth is tied up in dollar assets.
"These plans will change the face of international financial transactions," one Chinese banker said. "America and Britain must be very worried. You will know how worried by the thunder of denials this news will generate."
Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars. Bankers remember, of course, what happened to the last Middle East oil producer to sell its oil in euros rather than dollars. A few months after Saddam Hussein trumpeted his decision, the Americans and British invaded Iraq.
Understanding the Financial Crisis Graham Turner is the founder of GFC Economics and the author of ‘The Credit Crunch Housing Bubbles, Globalisation and the Worldwide Economic Crisis’. He spoke to NLP’s Alex Doherty about the global recession and differing responses to the economic crisis.
Could you describe for us why the world financial crisis occurred?
To some, the world financial crisis was triggered by the failure of the US authorities to comprehend the consequences of allowing Lehman Brothers to fail. Letting Lehman go under certainly roiled financial markets, and led to a huge increase in borrowing costs for companies, contributing directly to the rise in unemployment in many countries.
While the collapse of Lehman Brothers was undoubtedly mismanaged, the causes go much deeper. The build-up in debt preceeding the failure of Lehman Brothes and also Bear Stearns in the spring of 2008, is the obvious cause of the crisis. But even now, many still fail to ask the question - why was the build-up in borrowing tolerated? It was hardly a state secret. Many economists warned of the consequences of rising debt levels. It is not true - as the Queen claims - that no one saw this coming. Those who railed against leverage were simply ignored, because the profits from speculation were too tempting.
But even that does not go to the heart of the problem. Profits were high during the boom, but as Marx warned, this can delude policymakers and business leaders from understanding the source of their good fortune. Many thought they were being clever, that there was a new paradigm. In reality, debt was the panacea for a long term decline in corporate profitabiltiy. The assault on organised labour and globalisation had driven down labour costs. Without the rise in personal sector borrowing, it would have been difficult for consumers to absorb the flow of goods and services being produced. Economic growth would have been very subdued, perhaps non-existent. Inflation would have been negative. So to summarise, the financial crisis was a crisis of corporate profitabilty.
What is your view of the way in which the Brown government in the UK has handled the crisis?
Initially, I was very critical, because there was little recognition - within the Bank of England as well as the Government - that the housing market could implode. But the Bank of England did shift gears quickly after the collapse of Lehman Brothers. As the election draws near, it can certainly be said that the combination of aggressive rate cuts and quantitative easing have helped to prevent a worse recession. Unemployment has not yet risen to the levels seen in the early 1980s or early 1990s.
The goverment was also right to take Lloyds TSB and RBS into the public sector. The banks had to be nationalised. However, I do think the goverment should have taken greater control over the running of these banks. They have been too eager to return the banks to the private sector, rather than seeing this as an opportunity to completely change the role of banks within the economy. There has been too much emphasis on returning to business as usual. These banks could, and still should, be used to support industry and the policy of interventionism now being advocated by Mr Mandelson. Afterall, they are still very dependent upon the state for their survival.
How has the crisis been handled in the United States?
Less effectively. Ironically, in pure real GDP terms, the US would appear to be doing rather better than most other countries, including the UK. But if you dig a little below the surface, one can see the US is in deep trouble, worse than the UK. The housing crisis remains far from resolved. For example, the serious delinquency ratio for US homeowners - mortgage arrears of more than 90 days - has continued to rise. Across the US, the serious delinquency ratio climbed to 4.58% at the end of December, according to the Mortgage Bankers Association. Freddie Mac, one of the two large lenders nationalised by the US administration early in the crisis, recently reported a rise in its serious delinquency ratio to a fresh high in January.
Attempts to forestall repossessions are failing. Foreclosures are running at record levels. Efforts by the US administration to persuade banks to modify loans are falling well short of expectations. Too often, banks find that borrowers are so far into negative equity, that modifications are either impossible, or unprofitable.
The housing market did stablise during the second half of last year. But that was in response to huge fiscal initiatives, including a tax credit for homebuyers. That is due to end in April, and already, there are signs that turnover in the housing market is turning down again. With such a backlog of foreclosures and a huge inventory of repossessed properties, prices may start to turn down again. And with interest rates already close to record lows - 0.25% - the Fed’s only option will be more quantitative easing.
Politically, that might prove rather difficult for the Fed to sell, even though it is nominally independent. The budget deficit has not yet shown signs of turning down. There is genuine opposition to quantitative eaisng, even though inflation remains benign.
In short, there is real risk of a double dip, with more banks failing, and a further contraction of credit pulling the economy back into recession.
It is claimed across the political spectrum in the UK that public spending needs to be curtailed? What is your view?
I don’t think there is a huge amount of room for more stimulus, until the deficit is brought down. But I disagree with those who argue for cuts. The crisis was not caused by the public sector. For the record, the ratio of public spending to GDP under New Labour has averaged 37.1% since 1997. The average for the 18 years of Tory rule from 1979 onwards was coincidentally, 37.1%.
By contrast, tax receipts as a percentage of GDP will be just 35.3% of GDP this year. That is lower than any year of the Tory era. Indeed, the Tory party today seem to forget that under Geoffrey Howe, the ratio of tax receipts to GDP reached 45.5%.
It is quite to clear to me that the deficit should be brought down by higher taxation, particularly on those who seem to be able to avoid paying their way through the use of accountancy tricks.
How do you explain the extreme financialization of the UK economy? Why did the UK’s manufacturing base erode so precipitously as compared with some other European economies?
In short, we embraced liberalisation of the financial sector and a relaxation of capital controls sooner and more aggressively. The financial sector, which was already strong in the UK - partly because English became the language of finance - grew rapidly, and that undermined manufacturing. Strong capital inflows kept sterling elevated. Students were attracted to finance. Finance was eager to sell UK manufacturing to overseas bidders too. The pressure on companies to cut costs from over zealous stock market analysts also accelerated de-industrialisation. And successive governments colluded with banks, believing that they could ignore manufacturers as a strong financial sector was filling the public sector coffers.
What economic policies would you like to see adopted to deal with the crisis?
I support Mr Mandelson’s shift towards a policy of industrial interventionism, but we need to do much more. We have to recognise that the Asian model is part of the problem, and not one to emulate. To be sure, Asian governments support their industry, and we should learn from them in this respect. But we should not embrace their ‘race to the bottom’ mentatility and disregard for labour market rights. These countries also engage in currency manipulation to preserve competitive gains at the expense of trading partners.
While we aim for a rebalancing of the economy, we have to confront countries that run persistent trade surpluses. We need to realise one of Keynes’ important aims, to create an equitable trading system, with adequate controls on capital flows, but also a mechanism for ensuring fair, equitable trade. Without that, extreme competitive pressures will undermine attempts to rebalance our economy away from finance.
This is not turning our back on globalisation. It is a recognition that the current framework does not work. We only have to look at the extreme asset bubble that has emerged in China and the record deflation in Japan to see the logical outcome of the policies being pursued globally today.
Have any economies responded to the crisis in a way that you find admirable?
I am particularly disappointed with the Obama administration’s handling of the housing crisis, which continues to hurt many who might have voted Democrat in 2008. I think by mishandling the policy response, he has oppened the door to a very right wing shift in 2012, more extreme than President George W. Bush.
The Chinese have responded by creating a monster of a housing bubble. Euroland has descended into a squabble over who pays for the debt problems afflicting the ‘peripherals’. Angela Merkel is trying to act tough, but the German authorities were conspicuously silent when the credit bubble was in its ascendancy, saying little about the risks of an implision in countries like Spain, for example. Of the four main economic blocs - the US, UK, Japan and Euroland, the latter is currently performing the worst in GDP terms.
That said, within Euroland, the policy of industrial interventionism, a less aggressive stance on cutting labour costs and better control over the banks has put France in a better position than most. It had a shallower recession than other Euroland countries and is recovering more quickly. It is no surprise that Mr Mandelson is citing France as a model going forward. France used to be criticised for excessive labour market regulation, short working hours and high unionisation, but it is faring the best out of the major industrialised economies, apart from the commodity producers. But these countries are merely riding the Chinese bubble which is liable to burst before long
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