Saturday, 25 October 2008

From the threat of a heart attack to the danger of gangrene - economic logic of current exchange rate movements

The violent currency movements that have become the latest phase of the financial crisis show the continuation of the process Socialist Economic Bulletin has analysed which may be described as 'from the threat of a heart attack to the danger of gangrene'. What to look for in each unfolding latest phase of the crisis may be outlined via this metaphor.
In the first stage of the crisis the decline in asset prices, unleashing a violent liquidity crisis, meant that there was a risk that the patient would die immediately from a massive collapse of its most vital organs - its economic heart and the brain. Some of the key, system making, financial institutions entered a state of collapse. This was shown in the wave of bankruptcies and collapse of interbank lending.
This, therefore, triggered the second phase of the crisis. To attempt to ward off immediate death blood and oxygen had to be pumped into the most central organs as rapidly as possible and at any cost. This was the phase of the bank bailout packages - now totaling over $2.5 trillion dollars.
This in turn ushered in the third phase of the crisis. Starved of financial blood and oxygen, in the context of a huge diversion of resources into the central core of the system, gangrene is threatening to set in within outlining parts of the system - weaker companies within the advanced economies and the less economically strong countries as a whole. This is, therefore, producing two phenomena.
The first effect is a renewed stock market crash in the economically advanced countries as it becomes evident many companies will be severely damaged, and some may go bankrupt, due to both the credit crunch itself and the oncoming recession - while the most key banks may be bailed out most individual companies will not. The second is rapid falls in the currencies of the overwhelming majority of developing countries as funds are withdrawn from them due to fear of economic turbulence, or worse.
Two exchange rate blocs are therefore being formed. The first is a high exchange rate block with three key members. The first two, Japan and China, are in this bloc due to their competitive economies as revealed in large balance of payments surpluses. Japan's currency is rising against even the dollar, and therefore against virtually every currency in the world, while China's currency is remaining stable against the dollar and therefore moving upward with the latter against most other currencies.
The third member of the high exchange rate bloc, the US, is a member due to it being a safe haven - whatever the problems of the US it is not going to collapse and therefore funds are withdrawn from other markets to be safe there. This has the effect of temporarily stabilising the core of the system, by relatively increasing the price of dollar priced assets, but at the expense in the medium term of lowering even further the competivity of the US economy.
The second currency bloc is of countries with falling exchange rates. In this are the Eurozone, the pound, Eastern Europe and virtually every economically underdeveloped country. In parts of the latter, starved of financial oxygen, gangrene will threaten develop. Such currency devaluation itself, in the short termm becomes an element of crisis due to making it harder to repay foreign debt.
Death from collapse of the central organs has been warded off for now. But serious problems are developing in the periphery that may also spread infection to the centre.


Martin Slavin said...

This graph from an article in Business Week (US) shows how the growth rates for personal consumption have outstripped those for the rest of the US economy in the last eighteen years.

The article outlines a cool imperialist appraisal of the financial engineering they think will be needed to bring both the US and the world economies back into a productivity viable for America.

They conclude:

"When the U.S. government undertakes fiscal stimulus measures, as it inevitably will, the money should be directed toward funding infrastructure, education, and innovation rather than consumer spending. Politically, maintaining a focus on investment and innovation in the U.S. may be almost as difficult as China opening up its service sector to international competition.

In the end, we may look back at fixing the banks as an easy task compared with changing the direction of national economies. As Japan discovered in the 1990s, notes JP Morgan's Kanno, "until the people really feel the pain, it's difficult to implement the radical policies." Let's hope we move more quickly this time."

How to Get Growth Back on Track, Michael Mandel, Business Week, October 16, 2008

Fixing the worldwide liquidity crunch has revealed a deep-seated and disturbing problem: What looked like fast growth in recent years was in part an illusion created by excess borrowing.

Take a deep breath. The global bank rescue plan is in place, and though the stock market has dropped sharply, the world seems to have avoided another Great Depression for at least the next week or two. Now we have a moment to step back and assess how we got here and where we're going next.

Let's put it this way: The U.S. and global economies were traveling at high speed along a clear track, like an economic bullet train, when we ran into the unexpected credit crunch. Yes, we took quite a bit of damage, but we didn't derail. Now we come to the big questions: Should we simply clear the track and fix the engine—that is, tighten up government supervision and improve financial regulation—and go on our way? Or were we on the wrong track to begin with?

The bursting of the credit bubble suggests that the U.S. and global economies have a growth problem as well as a debt problem. According to the official numbers, economic growth in the U.S. has averaged 2.7% over the past 10 years. But by BusinessWeek's calculation, U.S. consumers have run up about $3 trillion in excess borrowing and spending over the same period—consumption that was not justified by income growth.

Without that boost, which translated into new homes, cars, furniture, clothing, and the like, U.S. economic growth would have come in considerably lower. The global boom, too, was artificially fueled by out-of-control borrowing by consumers and businesses. "There was a sense of a bubble not just in real estate, but in that the underlying fundamentals were not supporting the market," says Michael Frantz, a Seattle-based managing director at project-management firm Point B, based on his conversations with clients.

More at:

Alun Griffiths said...

THis respected prospective journal was (Feb 2006) and is forecasting other more serious problems for the U.S. Dollar and hence the economy

Martin Slavin said...

It is such easy fun to be engaged in the game of 20:20 hindsight.

Nassim Nicholas Taleb said:

"History is opaque. You see what comes out, not the script that produces events, the generator of history

......The human mind suffers from three ailments as it comes into contact with history, what I call the 'triplet of opacity'. They are:

a. the illusion of understanding, or how everyone thinks he knows what is going on in a world that is more complicated ( or random ) than they realise;

b. the retrospective distortion, or how we can assess matters only after the fact, as if they were in a rearview mirror ( history seems clearer and more organised in history books than in empirical reality ); and

c.the overvaluation of factual information and the handicap of authoritative and learned people, particularly when they create categories – when they 'Platonify.'

From: N N Taleb, The Black Swan, the impact of the highly improbable, 2007, p8, pbk

However two valued recent accounts stand out for me, the first for its clarity, brevity and wit, the second for its prescient accuracy.

1.Capitalism hits the fan a Marxian view.   ( )
  Also available from 'Lenin's Tomb'  ( )
    "Richard Wolff, a professor of economics at U. Mass. Amherst, talks on the current "financial" crisis and capitalism in general. A form of socialism is presented as a possible alternative. This talk was presented by the Association for Economic and Social Analysis and the journal Rethinking Marxism."

A brilliant (and witty) 40 minute lecture about how this crisis emerged from the last 150 years of American economic history.

2.The “Dollar” Crisis, and Us, Loren Goldner, 2004

  “Incredible as it may sound, ever since the late 1950’s, the world economy has been tossing around a “hot potato” of an ever-increasing mass of “nomad dollars” (dollars held outside the U.S.)  whose actual conversion into tangible wealth would plunge the world into a deflationary crash. Even now, few people are aware of the extent to which this “technical” question of “economics” (and in reality a  profoundly social question)  has in fact  cadenced 45 years of world history, erupting into view in key years such as 1968 (dollar convertibility crisis), 1973 (end of the Bretton Woods System), 1979 (runaway global inflation, gold at $850 an ounce) 1990 (Japanese deflation) or 1997-98 (Asia crisis, Russian default, “hedge fund” crisis). We are clearly today at another key turning point, and perhaps (over the next few years) at the long-delayed culmination of the whole story, when that mass of dollars, now grown to gargantuan proportions (the $30 billion of 1958 have become at least $11 trillion today) will be deflated, one way or another.”

viewable at:

This essay draws on the earlier work of Michael Hudson, 'Super Imperialism, the origin and fundamentals of US world dominance', Pluto Press, 2003. See: for an overview