Saturday, December 29, 2007

globalization, the end game

In the 1990s, the era of permanent global “free trade”, so called, or globalization, was ushered in. Local production workers everywhere, that is in America and abroad, hated it, and protested. Economists loved it because it was more “efficient”. Global trade's most charismatic promoter was probably Bill Clinton. I don't know where, but I think I read some theorist saying that globalization was a permanent beneficial change to the world's economic system. Maybe it was the same train of logic that led philosopher Francis Fukuyama to declare permanent prosperity and peace for the globe in the form of the “end of history”. History, it turns out, is now proceeding to change things at an accelerating rate. And the era of globalization will end a lot sooner than those ideolouges thought. Three powerful trends will seem to conspire to break up the world trade routes (despite the fact that a lot of wealth is created for a few powerful rich magnates and they will try to preserve this system at all costs):
  • Nationalization of Resources
  • Protectionism
  • Capital Controls
In the first place, we are witnessing an era of resource nationalization. Globalization was predicated on the assumption of efficient worldwide commodity markets, and such markets only function with a relative abundance of commodities. One of the curious and most exploitive of the tenants of the GATT talks (so viscously protested in Seattle in 1999) was the idea that all signatory nations had to agree to produce, and sell in open markets, any natural resources they possessed. Efficient production usually occured alongside the environmental degradation of the less wealthy nation. But that is now changing. Nations such as Bolivia, Russia, etc, are finding that they do have to power to regulate and nationalize oil, gas, and mining production.

There have been no shortages of commodities to slow down global economies for a long time, and some economists seem to think shortages are so obsolete they it couldn't possibly occur in the 21st Century. But the trend is for commodities of all kinds to rise in price and value. Scarcity of resources is the coming dynamic and free markets do not love scarcity. This will not just slow down the global trade in the resources themselves, but also affect trade in such manufactured goods which require non-local resources. China, for example, will be limited in its manufacturing by how much energy and copper it can import, now that it is no longer self sufficient. In time even American precious metal mining and energy production will need to be nationalized, if only to keep them out of the control of our creditors.

The second anti-global-trade factor is a slowly building force in the USA. It is simply the demand by citizens to support their domestic production. Protectionism. Now that the the American economy is obviously stumbling and there will be layoffs, and people losing their homes due to mortgage defaults, the government will need to do everything it can to try and keep as many people employed as possible. Even if it is not economically efficient. Social unrest will be a bigger threat than loss of cheap imports. This is the same force that was protesting against globalization in Seattle, but now they will have a much more sympathetic ear from congress. We will very likely see import quotas, tariffs and other abrogations of our trade treaty obligations.

The third trend will hit the global economy with terrible shock waves in the next two years: capital controls. Why economists assume that currency will remain freely exchangeable is baffling to me. The world now runs on fiat currency managed by central banks. This system was created to finance the gigantic economic expansions of the past half century. It is now teetering on the brink of collapse. The huge structure of artifice convinced people that paper money was as good as gold, and it was very effective in the times of plenty that the world has seen. Now that almost all central banks (Switzerland is the sole exception) are inflating their money supply at double digit rates, and the US dollar is in a death spiral, the system is doomed. The plunging dollar has created a global state of emergency: pretty much everything traded internationally is priced in dollars. If no one knows what, if anything, a dollar is worth, how do they know what anything else is worth?

Nations holding US treasury bills will be forced to sell their dollars and no county, including America, will be happy to take them in. Like destitute refugees, no nation will want to give the dollar a home. I have heard people say that because the dollar is the world's reserve currency, and no other currency will serve, it has to stay. I don't buy it. Within a very few years all fiat currency (unbacked by gold or other assets) will not be welcome in international trade. The euro can not save fiat currency either: the European Central Bank is racing America's Fed to inflate concurrently with the dollar. BTW, If you think you will always be able to own stock in that Australian mining corporation.. well I'm saying maybe not, unless you are in Australia. Soon, capital will have to stay closer to home.

This is not to say Saudi Arabia, China and other exporting nations will no longer export oil or goods. They can't do much else after all. Trade will be negotiated between nations under secret terms in guilded state department halls and embassies instead of open electronic trading bourses. Agreements will be made with armies and navies in the background, always the subtle threat of war (historically, most wars have been fought for control of resources and trade routes). Terms of trade will consist of exchanges of hard assets, military services, manufactured goods, or precious metal bullion. Barter between nations is the future of trade, and will be made to secure strategic advantage, not the best price. No nation will want to trade with its strategic rival, except under threat of war or other coercion.

Wednesday, December 19, 2007

a $700 trillion volcano

This is a fascinating essay by Mike Whitney, published at Whitney explains several key items, the most important of which is how "the markets have been transformed by 'structured finance'."
What's so destructive about structured finance is that it allows the banks to create credit "out of thin air", stripping the Fed of its role as controller of the money supply. David Roache explains how this works in an excerpt from his book "New Monetarism" which appeared in the Wall Street Journal:
The reason for the exponential growth in credit, but not in broad money, was simply that banks didn't keep their loans on their books any more-and only loans on bank balance sheets get counted as money. Now, as soon as banks made a loan, they "securitized" it and moved it off their balance sheet.

There were two ways of doing this. One was to sell the securitized loan as a bond. The other was "synthetic" securitization: for example, using derivatives to get rid of the default risk (with credit default swaps) and lock in the interest rate due on the loan (with interest-rate swaps). Both forms of securitization meant that the lending bank was free to make new loans without using up any of its lending capacity once its existing loans had been "securitized."

So, to redefine liquidity under what I call New Monetarism, one must add, to the traditional definition of broad money, all the credit being created and moved off banks' balance sheets and onto the balance sheets of nonbank financial intermediaries. This new form of liquidity changed the very nature of the credit beast. What now determined credit growth was risk appetite: the readiness of companies and individuals to run their businesses with higher levels of debt. (Wall Street Journal)
The banks have been creating trillions of dollars of credit (by originating mortgage-backed securities, collateralized debt obligations and asset-backed commercial paper) without maintaining the proportional capital reserves to back them up. That explains why the banks were so eager to provide mortgages to millions of loan applicants who had no documentation, no income, no collateral and a bad credit history. They believed there was no risk, because they were making enormous profits without tying up any of their capital. It was, quite literally, money for nothing.
Right, money for nothing. Structured finance explains the $681 trillion value of outstanding financial derivatives out there, according to the Bank of International Settlements. Whitney's key point here is that all of this money creation is out of the Fed's control. Adjusting interest rates won't fix the problem. The Fed certainly doesn't want to try to take control of monstrous toxic pile of money either, because then it would surely blow up, not just immediately, but also in their own hands.

If some unscrupulous financiers can come up with a way to generate money out of thin air, they are probably going to choose to generate a whole lot of it, not just a little money. Especially if it is hidden from all oversight and regulation. And in theory this money is risk free. It is insured (via credit default swaps). No doubt. Those insurers will surely pay off, now that the shit is officially hitting the fan. It's not like we have a $700 trillion volcano about to explode or anything..

Monday, December 17, 2007

About time for indictments

I just want to make one simple point, and it is not that complicated. I don't think anything the Federal Reserve Bank can do, this year or in the next six months anyway, can help free up the frozen credit markets. It simply has nothing to do with interest rates.

There is one thing the U.S. Justice Department could do though: a few indictments of fraud would help a lot. I know that white collar criminal cases are never quick to file or prosecute. It took years to bust the Enron executives. I certainly hope we get some soon. Angelo Mozilo of Countrywide Financial would be one good place to start. Definitely the Citibank perpetrators of the sale of the CDOs sold to the three Norwegian townships. That got a lot of press - they should be indicted. There are no doubt hundreds of people who participated in all this fraud. They should do the time. That would restore confidence in credit markets.