Friday, 31 October 2008
Thursday, 30 October 2008
What is striking is not the headline 0.3 per cent contraction in GDP. That indicates clearly the US recession has started but it is not a fearful figure in terms of historical comparisons for downturns. What is of historic proportions is the decline in personal income and consumer spending as the overstretched credit balloon contracts.
US disposable personal income dropped at an 8.7 percent annualised rate in the third quarter - the sharpest fall since quarterly records began in 1947. Overall consumer spending fell at an annualised 3.1 per cent, the largest drop for 28 years. Consumers cut spending on durable goods - such as cars, household goods and furniture - at a 14.1 percent annual rate, the biggest fall for 21 years. Even spending on nondurable goods, such as food, which is normally relatively resilient in recession, fell by 6.4 per cent - the sharpest fall for 58 years.
This is really great economic pain for ordinary Americans. The reason is also clear. Median working incomes dropped by 1.1 per cent in real terms between 2000 and 2006, or by about $2,000. Consumers therefore cannot engage in a significant increase in their level of purchases due to increased wages. Instead the rate of consumption growth has been maintained through borrowing.
As the credit crunch bites increased borrowing is no longer possible, and therefore a sharp contraction in consumption takes place. This will be amplified, with sharp falls in income, as unemployment continues to rise.
Taking other sectors of the economy, private investment fell at an annualised rate of 1.9 per cent, with, in a classic pattern for a recession, fixed investment falling even more sharply than consumption, with a 5.6 per cent annualised rate of decline. Within that latter figure residential construction fell at an annualised rate of 19.1 per cent.
Export growth also fell, running at a 5.9 per cent annualised rate compared to an increase of 12.3 per cent in the preceding quarter.
Really striking is the degree to which the US has become a ‘Keynesian’ economy. By far the strongest component of domestic demand was government expenditure - which rose at a 5.8 per cent annualised rate, with federal expenditure rising at an annualised 13.8 per cent.
The world’s most ‘private sector’ economy is being forced to rely on government expenditure to limit the scope of the recession - a point highly relevant to the debate between Labour and Tories in this country.
The political dynamics of this are clear - because the recession will clearly continue for several quarters. Given the biting fall in consumption the unpopularity of the incumbent Republicans is no surprise. But it also means that if Obama wins, unless he is prepared to take rather strong economic measures to aid the population, his popularity is also likely to be undermined fairly rapidly. Clearly the first economic decisions he would take will therefore be very critical.
This post first appeared on the blog Key Trends in the World Economy
It has been one of key goals of Japanese economic policy to attempt to prevent the yen rising against the dollar - unlike the situation with the euro where the eurozone countries have been content to see the euro rise strongly against the dollar.
Japan had succeeded in either keeping the exchange rate of the yen at its 2000 level or even below. Under the impact of the global financial crisis, however, the yen had soared upwards against the dollar rising by 15 per cent since the beginning of September - moving from 108.7 yen to the dollar to a peak of 92.6 yen to the dollar on 24 October.
The specific configuration of Japan's economy is that a highly internationally competitive series of exporting companies, centred in manufacturing, exist in the context of highly uncompetitive small businesses in other sectors that are deliberately protected by the ruling Liberal Democratic Party (LDP) in order to maintain its electoral base. These latter, uncompetitive, firms cannot be used to stimulate the economy and indeed are a major drag on it. The LDP however cannot rationalise this sector without destroying its own support. Therefore, in order to square the economic circle, Japanese economic policy is centred on maintaining a low exchange rate that will allow its exporting manufacturing companies to flourish. When, therefore, Japan saw the rapid rise of the yen it felt economically compelled to intervene to aid the US by driving down the yen through large purchases of dollars - the latter aiding the US.
Over and above this economic imperative is also the political one that the US demands from Japan, in return for militarily protecting it, an accommodating financial policy to support the United States. This political pressure goes in the same direction as the economic one.
As outlined in the previous post such policies have been highly damaging to the Japanese economy but are considered a necessary price to be paid by the LDP.
Wednesday, 29 October 2008
Scared by the rise in the exchange rate of the yen, which was threatening to seriously cut into the competivity and profits of Japan's export industries, the Japanese government openly moved. It was widely leaked that Japanese interest rates, already only at 0.5 per cent, would be cut to 0.25 per cent. Simultaneously the Japanese central bank began to sell yen, and more importantly to buy dollars, in order to try to drive down the yen's exchange rate.
The two moves opened the taps to Japanese money to flow into dollars and the US.
Japan is the country with the second heaviest financial artillery in the world to aid the United States. Its current account surplus is $197 billion a year and it has $997 billion in foreign exchange reserves. Only China, with a $372 billion balance of payments surplus and $1,905 billion in foreign exchange reserves, has greater financial firepower.
This means two considerable resources are now being deployed to attempt to shore up the US banking system. The first is the heavy burden, a major transfer of resources away from US taxpayers, i.e. ordinary people, which is involved in the Paulson bank bail out plan. Now Japan has joined in.
Japan's willingness to give open aid is, of course, a serious addition to US resources to meet the crisis and accounts for the sharp share rises on Wall Street.
Two issues are however still posed.
First, will even the combination of squeezing US taxpayers and Japanese aid be enough to stabilise the US financial system? At least at present the answer is that the situation within the US financial system is stabilised but at the expense of more peripheral parts of the world economic system having the financial blood squeezed out of them.
Second, what will be the consequences in Japan itself? The last time Japan was squeezed to aid the US was after the 1987 Wall Street crash. The reason the US economy was fairly easily stabilised following that crash was that Japan gave aid - in the form of a super lax interest and credit rate policy. The result was Japan's late 1980s bubble economy followed by a now 18 year long share market and property market crash and depression that followed from 1990. It will be interesting to see the price Japan will be forced to pay this time.
'British shares are lower today than 12 years ago. Japanese shares are lower than 26 years ago.
'Tim Bond, the man behind Barclays' Equity-Gilt study, has crunched up-to-date numbers for The Times and come up with some sobering findings. Only investors who put their money to work in 1983 or earlier would have done better placing it in equities than government bonds (gilts). From 1984 onwards, in any timeframe up to the present day, gilts have produced a better total return than shares. Over any timeframe of less than 15 years to the present day, even deposit accounts have produced a better return.
'The hefty premium that supposedly rewards investors prepared to take the extra risk of investing in shares has not paid off for anyone with a time horizon of less than 25 years. In short, capitalism has not been working terribly well of late.'
Read Patrick Hoskin's full analysis here.
Put in terms of analogies, which are never exact, it means the UK faces something as bad as, or more probably somewhat worse than, the early 1990s but not the 1930s. But that should not lead to any illusions as to how bad it is going to get. It will be very very unpleasant as an excellent article in The Times this morning, analysing the latest US economic data, indicates.
Suzy Jagger notes: 'the worst level of [US] consumer confidence since records began in 1967 and the sharpest annual fall in urban house prices on record... house prices across the 20 cities surveyed fell by 16.6 per cent in August compared with the same period the year before.
'The fall is the steepest on record, with Las Vegas, Miami, Phoenix and San Francisco, among others, suffering declines of between 25 per cent and 30 per cent. Economists interpreting the data reckoned that the American housing slump is only half way through with another year to run before there is any glimmer of recovery. August prices slipped 1.1 per cent compared with July, marking five months of uninterrupted declines for the cities surveyed.
'At the same time, US consumer confidence in October slumped to its lowest for 41 years... Ian Shepherdson, chief US economist at High Frequency Economics, described the consumer confidence figures as extraordinarily awful. Americans have all but stopped spending on discretionary items such as cars because they are scared of losing their jobs and anxious about the declining value of their homes... Confidence has also been damaged by the 28 per cent slide in US stock markets over the past two months as the banking system seized up. The fall on equity markets has hit the value of pension pots and investments. Worse, economists are forecasting continued double-digit declines for the US housing market for at least another year.
Dimitry Fleming, US economist at ING, the Dutch bank, said: “Despite a reduction in the number of homes for sale, supply is still enormous. We expect no end to the price declines till end 2009.”'
Read Suzy Jagger's full analysis here.
Tuesday, 28 October 2008
'Cajoled for years to take on Western-style economic liberalism there's more than a wry smile on the faces of some of South America's left wing leaders as George Bush and others step in to save collapsing financial institutions
'The irony has not been lost on the political leaders of Latin America’s insurgent left movements that the governments of Europe and the US are now taking measures that involve far deeper state intervention in the economy than actions they themselves used to harshly criticize when attempted in other regions.' Read the full article here
Monday, 27 October 2008
As everyone is always better informed if they know both sides of the argument, those who are interested in what should best be done locally to protect people from the recession are encouraged to look at both. SEB, of course, will comment further.
It is being widely reported in the media that the Nikkei has fallen to its lowest levels for 26 years - which is, of course, itself a major development. But even more significant, from a technical point of view, is that the Nikkei has broken through its lowest resistance point since the 18 year slide in Japanese share prices began. This opens up the potential for further falls. The Nikkei is now 81.6 per cent below its peak level at the end of 1989.
The Japanese economy is the second largest in the world after the US in current price terms, and the third largest, after the US and China, in real Parity Purchasing Power (PPP) terms. Therefore such a sustained fall in asset prices is in itself extremely important. But as SEB has repeatedly pointed out there is a direct implications in the path the Nikkei has followed for Britain's proposed bank bail out package.
Any assumption that UK bank share prices have reached their bottom, and that bank shares in Royal Bank of Scotland (RBS), HBOS and Lloyd's TSB will threfore be purchased 'at the bottom of the market' by the government in its proposed bail out, is false in principle - as it is not the job of the UK government to be engaging in risk taking by 'share picking' on the stock exchange. But it is deeply dangerous in practice - as the record of international markets shows that it is entirely possible that the prices of the shares in banks which the government is proposing to purchase can fall far below their proposed purchase prices inflicting huge losses on the taxpayer.
As the Nikkei shows share prices have not at all necessarily reached their bottom and they may remain depressed for very many years. That is why the government must stand ready to take over the functioning of any bank which fails, but it must not be putting at risk loosing tens of billions of pounds of taxpayers money in purchasing shares that may well be trading at present far above their real value once all losses are taken into account.
- First, to keep up the demand side of consumption by maintaining incomes - particularly of the average and worst off sections of the population, by maintaining government spending on areas such as health and education, and using any favourable international trends.
- Second to keep up investment - which, in a recession, can frequently only be carried out by state intervention into the economy.
Its elements include:
- To keep up consumption of the ordinary fare paying public by eliminating unnecessary fare increases and by increasing international demand through boosting tourism - which in London is one of its most important important industries.
- To keep up investment through pushing ahead with the big investment programmes won during the two previous Mayoral terms (the £16 billion cross London new underground railway Crossrail, the Olympic Games, the new powers in housing development won by the Mayor), putting the focus in the Olympics back on economic regeneration, stopping the de facto run down of economic regeneration programme by the London Development Agency, and strengthening London's relations with India and China - economies whose relative weight will be strengthened by the financial crisis and are important future sources of foreign investment into London.
1. Reverse the cuts in Visit London's budget and allocate a £5 million a year boost in the next two years to promote London's visitor economy
In a recession London's £15 billion a year visitor and tourism economy is going to be hit. But the decline in the pound's exchange rate means that it is going to be more possible to attract tourists to London - boosting restaurants, theatres and many other London visitor attractions. Experience shows the effectiveness of tourism-marketing campaigns.
Exactly the wrong course is now being taken through severely cutting the budget of Visit London, London's tourism agency and other budgets for the promotion of London.
The cuts already made must be reversed and for the next two years, the likely length of the recession, a temporary extra grant of £5 million a year should be given to Visit London for marketing the city. This will help aid London's hard pressed visitor economy and pay for itself many times over.
2. Abandon the damaging new restrictive planning regime in London
It is going to be difficult to keep up investment in London during the recession. Yet it is vital that as much private sector construction as possible goes ahead. The new restrictive planning regime emerging from City Hall, based on the model favoured by Westminster City Council under Sir Simon Milton, should be reversed. West End retailers and responsible developers should be told they will get strong support for new development. A planning regime must be introduced in the West End and along the route of Crossrail to ensure that London gets the most from the economic opportunities it offers.
3. Speed up the house building programme and support the call for nationalisation of the necessary parts of the construction industry to carry out a large scale government house building programme
The number of new homes being built – including affordable homes – has very steeply and rapidly declined. In such circumstances the public sector must take a more active role. The Mayor should use all the new powers acquired for housing construction and join the call of Jon Cruddas and other MPs that, if necessary, parts of the construction industry should be nationalised to allow a large scale programme of affordable homes to be undertaken.
The policy that 50 per cent of new housing should be affordable housing should be reintroduced - in a recession it will be housing for those on ordinary incomes and the low paid that will be scrapped by developers. The abandonment of the 50 per cent affordable housing policy will therefore be deeply damaging to Londoners. Policies to ensure a strong supply of rented affordable accommodation must be retained.
4. Press on with the big infrastructure projects and reorganize City Hall's business and transport functions
Any opportunity for London to come through this economic crisis in the best shape possible is in significant part due to the big spending on infrastructure projects that were won during the last two Mayoral terms, such as the Olympics, Crossrail and the Mayor's new housing powers. These investment programmes act counter-cyclically to maintain economic activity and generate tens of thousands of jobs. This contrasts with the Tories' "small government" approach which would never have secured Crossrail. The attempt by discredited monetarists to advise the government against this approach should be roundly rejected by the Mayor and the major investment projects should be defended.
Chaos in the new administration is getting in the way of those who can actually run things in London. The professionalism of many managers in London government, whose skills are vital in a downturn, does not allow them to speak out publicly but the chaos that reigns in the Mayoralty is well-known to close observers of City Hall. It is of particular concern that in two key areas during a recsession – transport and business – the mayor's office has put forward no proposals for how to deal with the economic situation. This is bad for London. The mayor needs to reorganise how his office is dealing with transport and business as a matter of urgency.
5. Put the focus of the Olympics back on economic development
The most important reason for seeking to win the Olympic Games was to carry out large scale economic development in east London. This perspective has been eroded by the new administration whose actions have effectively counterposed this objective to a pure emphasis on sport. Even more so in a recession the focus in the Olympics must be put back onto large scale economic regeneration and marketing London internationally - and London government must conduct itself accordingly.
6. Reverse the cut backs in regeneration spending by the LDA and halt the risk to its government funding
The London Development Agency should not be funneling its funds into projects that are already being financed by the boroughs, allowing them to cut their own spending. This means that economic regeneration funding in London will fall by several hundred million pounds a year – exactly the reverse of what is required in a recession. Furthermore this misuse of government funding by the LDA, not using the money for its intended purposes of expanding regeneration spending, threatens to lead to the LDA's funds being severely reduced by the government in the medium term. This must stop and LDA funds must be used for their proper purpose of expanding economic regeneration in London.
7. Strengthen London's presence in the key new emerging markets
The weight of the rapidly growing emerging market economies, above all India and China, is going to increase sharply in this recession and they will emerge from it fastest. London must strengthen the relations it has established with these economies and the Mayor's proposal to cut London's presence in them by scaling back London's offices there must be abandoned.
8. January's above-inflation fares increase can and should be scrapped by returning to taxing polluters
Fares policy on the buses and underground has to be re-prioritised to help ordinary Londoners instead of the Mayor's policy of protecting drivers of gas guzzlers. The cancellation of the £25-a-day CO2 congestion charge on the most gas guzzling cars should be reversed – raising up to £50 million a year. The 'oil for expertise' deal with Venezuela must be reintroduced – gaining London over £20 million a year at current exchange rates.
These measures together will raise over £60 million a year and allow the proposed above inflation fare increase in January to be scrapped, and single bus fares kept down to 90p instead of being raised to £1.
The further new wasteful transport proposals should similarly be abandoned. The plan to squander £13 million a year by replacing bendy buses on routes 38, 507 and 521 with ordinary single and double-deckers should be stopped. The costings for these routes show that the pledge to replace all four hundred bendy buses in London would cost Londoners £60 million a year even with existing types of buses, and this should be abandoned. Even worse, the proposal to introduce a 'new Routemaster', with open platforms and conductors has been shown by independent transport consultants to cost over £100 million a year and should be scrapped.
Further financial costs will be imposed on ordinary fare-paying Londoners if the Western Extension of the congestion charging zone is abolished. TfL have stated that abolition would lose London's transport system around £70 million a year. Even the Evening Standard, which calls for the abolition of the Western Extension, and underestimates the losses from abolition, admits it will lose £14 million a year. The Western Extension of the congestion charging zone must stay not only to reduce congestion but to raise revenue to keep fares down.
These measures will save Londoners over £60 million a year in the short term and will eventually save Londoners around £200 million a year compared to the implementation of Boris Johnson's transport plans. This will permit not only the abandonment of January's above-inflation fare increase but allow fares to be held down by the maximum amount in the coming years.
In a recession far more than economic measures are required. Experience shows that there will be a tendency for crime, or the threat of crime, to increase. The threat of racist attacks will increase, as will the danger of domestic violence against women. The planned reductions in real police spending must therefore be stopped and the cuts in the programmes against racism, and against domestic violence and other threats to women, must be reversed. Measures of environmental protection must continue. But the eight points above are vital to any programme to tackle the effects of the recession in London and they should be implemented at once."
Sunday, 26 October 2008
A recession appears in the form of, although it is not ultimately caused by, a collapse in demand in the economy. However the two fundamental sectors of the economy, consumption and investment, are driven by different factors.
Leaving aside the international sector, and in the present situation the decline in the exchange rate of the pound should increase export demand, private consumption is driven by income of the population, as individual saving is low compared to income, while state consumption (health, education etc) is driven by government decisions. Both do not undergo precipitate declines in a recession.
Investment however, in the present economy, is driven by the private drive for profit - state invesment is too low a proportion of the economy at present to stave off an investment collapse.
It is for this reason that tax cuts to companies are ineffectual in staving off recession. Tax cuts may be used not to increase investment but either in luxury consumption by company owners (dividend payments, bonuses etc) or to increase cash balances without carrying out investment (liquidity preference). Only state spending ensures either that consumption is sustained or, more important, that investment is carried out.
For this reason a state programme of investment, not tax cuts, is the only way to ensure that the fall in investment, and therefore the decline in demand in the economy, is minimised.
'Keynesian over-spending won't rescue the economy'
'Further to your interview with Alistair Darling, we would like to dissent from the attempt to use a public works programme to spend the country's way out of recession. It is misguided for the Government to believe that it knows how much specific sectors of the economy need to shrink and which will shrink "too rapidly" in a recession. Thus the Government cannot know how to use an expansion in expenditure that would not risk seriously misallocating resources.
'Furthermore, public expenditure has already risen very rapidly in recent years, and a further large rise would take the role of the state in many parts of the economy to such a dominant position that it would stunt the private sector's recovery once recession is past.
'Occasional slowdowns are natural and necessary features of a market economy.
'Insofar as they are to be managed at all, the best tools are monetary and not fiscal ones. It is inevitable that government expenditure and debt naturally rise in a recession but planned rises in government spending are misguided and discredited as a tool of economic management.
'If this recession has features that demand more active fiscal policy, which is highly disputable, taxes should be cut. This would allow the market to determine which parts of the economy shrink and which flourish to replace them.
'Dr Andrew Lilico, Europe Economics; John Greenwood, Chief Economist, Invesco; Richard Jeffrey, Cazenove Capital Management; Dr Ruth Lea, Economic Adviser, Arbuthnot Banking Group; Trevor Williams, Chief Economist, Lloyds TSB Corporate Markets; Dr Nigel Allington, University of Cambridge; Prof Philip Booth, Institute of Economic Affairs; Prof Tim Congdon, Author, Keynes, the Keynesians and Monetarism; Prof Laurence Copeland, Cardiff Business School; Prof Kevin Dowd, University of Nottingham; Prof Kent Matthews, Cardiff Business School; Prof Alan Morrison, Said Business School; Prof Sir Alan Peacock, Former Chief Economic Adviser, Dept of Trade and Industry; Dr Mark Pennington, Queen Mary College, London; Prof David B. Smith, University of Derby; Prof Peter Spencer, University of York'
The response to such neanderthal economics is simple. Interest rate cuts and tax cuts in no way guarantee that demand will be kept up to avert the fall in investment which most powerfully drives a recession. As Keynes put it, it is like 'pushing on a piece of string'. Only direct state investment and spending will ensure that extra demand is generated.
Certainly the monetarist economists are right that this will lead to an increase in the weight of the state in the economy. But that is exactly what is required in the present situation as the fundamental way to ensure that investment is maintained.
The monetarist economists' view that 'Occasional slowdowns are natural and necessary features of a market economy' has nothing to do with the present situation. Due to Reaganism and Thatcherism we are faced with the potential of a depression/disintegration of the financial system, not a cyclical downturn.
They spell out their Tory/capitalist dogma by writing of the danger that: 'the role of the state in many parts of the economy [would rise] to such a dominant position that it would stunt the private sector's recovery once recession is past.'
Their dogma, in other words, is that that the private sector must maintain its dominant position - not that the economy should recover. At present. only the expansion of the state's role in the economy can best ward off or minimise recession through guaranteeing the continuation of investment. The monetarist economists prefer to maintain the dominant role of the private sector no matter what the damage to the economy.
The monetarists should retreat to their incoherent economic caves. Neither ordinary people nor the economy can afford their obsession with the private sector.
Rowena Mason noted that US hedge funds alone continued to have $1.7 trillion in assets. And that 'Emmanuel Roman, the co-chief executive of Europe’s biggest hedge fund GLG, has warned that thousands of hedge funds are on the brink of failure as the global economy contracts with unexpected severity... Roman... said 25pc-30pc of the world’s 8,000 hedge funds would disappear "in a Darwinian process", either going bust or deciding meagre profits are not worth their efforts.'
She also noted: 'His views were echoed by Professor Nouriel Roubini, a former US Treasury and presidential adviser known for his accurate prediction of financial crises, who estimated that up to 500 hedge funds would fail within months.
'Both men were speaking at the same hedge fund conference in London yesterday, and Prof Roubini said he would not be surprised if the US and other countries soon had to close their stock markets for more than a week to halt descent into "sheer panic".
'The economist warned that the world is heading for a protracted recession that will end the US’s financial dominance.
'"It’s the beginning of the decline of the US financial empire. The Great Depression ended in a massive war. I hope that’s not going to happen but it’s pretty ugly now," Prof Roubini said.
'He added that turmoil over world trade, currency markets and debt is likely to cause geopolitical tensions between the Western world and emerging superpowers such as Russia, China and "a bunch of unstable oil states". '
Roubini's views tend even to the cataclysmic, and in our view jump over several stages in the unfolding of the financial crisis by making comparisons to 'massive wars', but he does get the point about economic developments not being isolated from political events. The Telegraph's economics section is certainly reporting the scope of what is possible, and the breadth of different analyses of it, more widely than many newspapers - which is worth pointing out.
It makes a striking contrast to the Telegraph's political pages.
No one has ever succeeded in eliminating the business cycle and if what we are going through is a cyclical downturn then that is no great surprise and the economy will simply emerge out at the other end. No need to change business as usual.
Thus a group of monetarist economists opine in their letter to the Sunday Telegraph that: 'Occasional slowdowns are natural and necessary features of a market economy'.
The Sunday Times noted: 'Economists said that while Friday’s gloomy third-quarter figures for gross domestic product, showing a drop of 0.5%, had hit the pound, there could be a silver lining in them. "The figures didn’t surprise me,” said Gerard Lyons, head of research at Standard Chartered. “The recession will be significant and it will last for four quarters. But the size of the fall we’ve already seen will spark policymakers into action."' He, however, is not quoted as saying what action is required.
Misunderstandings are not confined to the political right. The Observer for example, to judge by its front page headline, considers that there is no story going on which is bigger than a potentially illegal £1 million donation by a member of the Rothschild family to the Tory Party, while its lead business story is 'America joins UK on brink of recession'. The Guardian's editorial on Saturday read: 'senior figures at the Bank of England admit that a "deep and severe recession" looks increasingly likely, while others talk about a recession that will last for a whole year, with the economy only really recovering by 2011...No one can seriously argue that this will not be a recession; the question is whether it will be a Labour recession.'
With all due respect to the Guardian no, that is not the really decisive question. The really key question is whether there will be a recession or a deep economic collapse - a depression of the type not seen since the 1930s. SEB has explained why from the point of view of economic fundamentals it should be possible to confine the situation to a very severe and unpleasant recession. But that depends on their being extremely firm and decisive action to prevent something worse developing.
One person who does get the point however is Roger Bootle. The Sunday Telegraph notes of his views on the Monetary Policy Committee of the Bank of England that: 'Roger Bootle, managing director of Capital Economics, said: "I don't understand why they are not contemplating a one or two percentage point cut in interest rates. They are very quick to raise borrowing costs but far less daring when it comes to cutting them.
'"It's a failure of vision by many of the members. Either they think they are in a university seminar or that this is merely a minor slowdown. In fact, they're facing something which might approach the Great Depression.
"They need to be thinking are more boldly about policy. If they aren't careful, the members of [the MPC] will go down as some of the worst monetary policy-makers in history."
Quite. Bootle is spot on. It is why a minimum one percent cut in interest rates is required immediately. And it is why Vince Cable was quite right to say publicly that if the Bank of England is not prepared to take decisive action, in a very short term period, to radically reduce interest rates its independence should be taken away.
Saturday, 25 October 2008
Andrew Klinman is the author of a number of works, culminating in Reclaiming Marx's Capital, which collectively constitute one of the most important recent contributions to Marxist economic writing by definitively refuting the criticism that Marx failed to solve the so called 'transformation problem' of the relation between value and price. He has worked closely with Alan Freeman in this country. As Klinman himself points out, demonstrating internal consistency does not prove whether or not Marx was correct, that requires empirical and other study, but it removes the lame excuse given by right wing economics for ignoring Marx's work on the grounds that it is inconsistent. Klinman sets out his views on the current financial crisis on the website The Commune and in International Socialism.
Rick Kuhn is winner of the 2007 Isaac Deuscher prize for his Henryk Grossman and the Recovery of Marxism. He presents his analysis of the financial crisis on MR zine.
The International Socialist Tendency has presented its view here.
As SEB does not have the resources to follow all the many analyses that are being presented it very much welcomes readers drawing them to its attention both in their own comments or in emails.
From the threat of a heart attack to the danger of gangrene - economic logic of current exchange rate movements
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.
Friday, 24 October 2008
SEB wrote: 'One of the erroneous aspects of media coverage of the government’s plan for the banks is that it frequently implicitly assumes that bank share prices in the future must rise... This leads to wrong evaluation of risk. If bank shares must inevitably rise, after a period of falls that has already taken place, then there is evidently no significant risk for the taxpayer in buying them. If, however, bank shares may fall further, and remain depressed for a prolonged period, then the risk is very great... the assumption of considerable risk... by the government in purchasing shares in RBS [Royal Bank of Scotland], HBOS and Lloyds TSB, rather than standing entirely willing to take over the orderly and guaranteed running of these companies if they prove unviable, is therefore not justified.'
This warning was strongly confirmed by events on the Japanese stockmarket today as these demonstrate the risk of further falls and potential depression in share prices.
The Nikkei fell by a further 9.6 per cent, moving down towards the lowest level since the Japanese stockmarket crash started at the beginning of trading in 1990 - see the graph below.
The Nikkei's previous low, since the share market crash of 1989, was on 28 April 2003 at 7606.88. The Nikkei closed on 24 October at 8749.08 - only 0.5 per cent above the April 2003 figure.
If the Nikkei were to fall below its 28 April 2003 level it would be at a 26 year low. Already the Nikkei has been below its peak for almost 18 years.
As SEB has warned any assumption that shares are being bought in RBS, HBOS and Lloyd TSB 'at the bottom of the market' is therefore not justified. At lunch time today the claim of the Radio 4 lunch time news was that if the government had bought shares in RBS, HBOS, and Lloyds TSB at the agreed prices, respectively, of 65.5p, 113.6p and 173.3p the loss to the taxpayer would already have been £5.5 billion.
The process taking place in Venezuela is usually looked at from a political angle - the 21st Century Socialism project of Hugo Chavez. There is, however, another interrelated dimension - the question of what economic processes underpinned Hugo Chavez coming to office and of the economic policies now being pursued?
A necessary starting point is the economic situation, to be more precise the catastrophic economic situation, which led to Hugo Chavez's election.
The present so called 'Opposition' to Chavez are in fact the previous ruling groups in Venezuela. The reason they lost power is that they produced an economic disaster in Venezuela without comparison in any major country in Latin America - indeed with few parallels in any major country in the world.
The fundamental features of this disaster may be seen in Figure 1, which shows the total growth in GDP per capita of the major Latin American countries between 1950 and 1998 - the year Chavez was elected. In this entire 48 year period GDP per capita in Venezuela rose by only 20 per cent - compared to 65 per cent in Peru, 78 per cent in Uruguay, 83 per cent in Argentina, 149 per cent in Colombia, 178 per cent in Chile, 185 per cent in Mexico, and 224 per cent in Brazil. 
In terms of country comparisons, Venezuela's GDP per capita grew at 0.4 per cent a year throughout this period compared to 1.0 per cent a year in Peru, 1.2 per cent in Uruguay, 1.3 per cent in Argentina, 1.9 per cent in Colombia, 2.1 per cent in Chile, 2.2 per cent in Mexico, and 2.5 per cent in Brazil. These figures alone show that the 'Opposition' in Venezuela represented the greatest group of economic incompetents in Latin America.
Examination of more detailed figures, however, shows that the trends produced by the Venezuelan 'Opposition' were in fact even worse than those shown by the averages for the period.
Figure 2 shows Venezuelan GDP per capita for each year up to 1998, the year Chavez won the election, compared to the 1950 level. It shows not only the extraordinary stagnation of Venezuelan economic development for almost half a century after 1950 but that for the 24 years up to 2003, when Chavez broke the 'Opposition' control of the state oil company
This extraordinary, almost quarter of a century, of declining Venezuela GDP per capita provides the background to the tumultuous political events of this period - the 1989 riots against neo-liberal policies (the Caracazo), the February 1992 attempted military coup led by Chavez, the attempted military coup led by Admiral Gruber in November that year, and the eventual presidential electoral victory of Hugo Chavez in December 1998.
Venezuela had entered the second half of the 20th century as by a huge margin the richest country in Latin America - its GDP per capita was almost three times the average for the eight major Latin American countries considered above. However while the rest of Latin America grew Venezuela stagnated. By 2003 Venezuela's GDP per capita was only 11 per cent above the average for the major Latin American states.
This quarter century of economic decline under the control of the Venezuelan 'Opposition' is shown in Figure 3. This graph shows clearly that what was involved in Venezuela's decline under the leadership of the 'Opposition's' policies was not some individual crisis but a prolonged and total inability to develop the country.
Chavez has already set about meeting many immediate needs of the Venezuelan population through improving health, education, food supply and many other services. What also has to be tackled is the long term economic development of the country.
 Calculated from Angus Maddison World Population, GDP and Per Capita GDP, 1-2003 AD. Angus Maddison is the world's leading authority on long term economic statistics - former head of the Organisation for European Economic Cooperation (OEEC) economics division. He is first professor, and then emeritus professor at Groningen University and remained there until his retirement. Angus Maddison received a royal decoration as Commander in the Netherlands Order of Orange Nassau. All figures in this article are calculated from this source unless otherwise specifically stated.
The attack on Conservative Home writes: 'It's actually a perfectly respectable view that investment packs the greatest economic punch, and can make the biggest difference in circumstances like these. That's why the Bush Administration cut taxes on investment after America fell into recession in early 2001. Ken Livingstone calls for cuts in capital gains tax? Alas not - nationalisation of parts of the construction industry and government 'investment' in major public works projects is more what he has in mind. Given that choice, I suspect measures to help small businesses stay solvent and keep people on will do far more economic good, short- and longer term.'
Actually SEB is strongly in favour of investment when carried out by the private sector as well as the public - it opposes unnecessary luxury consumption by the private sector, not investment. SEB has no objection in principle at all to tax cuts on investment provided it is judged that in an actual economic situation these will actually lead to an increase in investment.
The problem with investment tax cuts is that their effect is indirect and they do not guarantee that investment will actually take place. They permit, they do not ensure. To take an analogy Keynes used in another context, investment tax cuts can be like 'pushing on a piece of string'.
Investment undertaken by the state, however, can be guaranteed to take place as it is under direct government control. This is why, in regard to construction for example, a government programme of house building, which may require nationalisation of parts of the construction industry to implement, is important.
Why do Tories reject the evident economic truth that the most direct and certain way to keep up investment is to undertake state investment? Because that will mean the weight of the state, which is under democratic control, increases in the economy and investment decisions are taken away from private companies. It is more important for Tories that private control should be retained of the economy, even if that means that it slumps, than that economic recovery should take place.
As always Tory dogma gets in the way of economic recovery.
Thursday, 23 October 2008
The huge bank bailout packages that have been announced, amounting to over $2.5 trillion, or approaching 10 per cent of the GDP of the US and Europe, have temporarily succeeded in preventing the complete break down of the interbank lending market - that is, they have headed off the equivalent of a simultaneous heart attack and stroke. But they have done so only by diverting huge quantities of resources into the core of the financial system, and therefore by threatening to cut off the flow to other sections. By these means the patient has survived the first attack but will gangrene set in in areas where the blood supply is no longer operating properly? Will weaker companies, weaker countries, new areas of potential financial problems, go down - struck with shortage of the financial blood supply, that is inability to obtain funds, or able to obtain them only at interest rates, or with political conditions, that are unacceptable?
The hope is that gradually the whole economic circulatory system will gradually start operating again. But whether it will is not yet clear.
One absolutely certain problem that is coming, however, is the US government budget deficit. This was already going to be over half a trillion dollars next year even before the bail out packages. The figures now being discussed, after the bailouts and with a recession starting. are a trillion or more. How will this be funded? And at what interest rate? Will the US have to rely on its own domestic savers purchasing the necessary Treasury bonds - which implies one, higher, interest rate? Or will foreigners join in? That is crucial for the perspective for the US economy next year and the depth of the coming recession.
If, as seems likely, Barack Obama wins the presidential election this question of whether he can negotiate a new financial Yalta will have to be number one item on his economic agenda.
Considering only the domestic components of demand the biggest fall in a recession takes place in investment. Consumers will spend if their incomes are kept up, which is crucially affected by maintaining employment, and can be supplemented by measures such as tax cuts, while government final expenditure is under the government's direct control and can therefore be increased in a counter-cyclical fashion. It is the fall in investment that, in terms of domestic components of demand, therefore most importantly determines how deep the recession is.
The overwhelming priority in fighting recession is, therefore, also to keep the level of investment up. The government is therefore quite right to have been discussing bringing forward major infrastructure projects and initiatives such as that by Jon Cruddas, Frank Dobson and other Labour MPs to call for nationalisation of at least parts of the construction industry to embark on a major government house building programme also address the crucial issue.
The Tory party however has a different agenda - which is not to deal with the recession but to support their own electoral base. That is why the core of their policy response has been to demand tax concessions to small businesses - who by a big majority support the Tories. But this is not the priority for dealing with the recession, as investment is not primarily carried out by small business.
Small businesses will primarily be helped by keeping up the level of demand in the economy and thereby maintaining their markets. There is nothing wrong with the government discussing how to help small businesses in principle, as with Alistair Darling and Peter Mandelson's meeting with the chief executives of major banks today, but it is not the main priority in fighting recession - those are to maintain the level of income of the population and to keep investment up.
Government policy needs to focus on the key issues in fighting recession. It should not allow itself to be sidelined into any agenda which is a Tory political one and not the central one in the present economic situation.
Wednesday, 22 October 2008
But while the situation in the banks in the central core of the international financial system was, at least for the present, being stabilised the financial shocks waves were spreading outwards taking some more acute forms as they went.
Iceland's crisis is well known. An International Monetary Fund team has been sent to attempt to stabilise the Ukraine and Pakistan is also discussing a deal with the IMF. In Argentina the government has announced that it is taking over pension funds and there is fear among financial institutions of a state debt default - the interest rate on government bonds has risen to 31 per cent. Hungary today raised interest rates by three per cent following a 13 per cent fall this month in the forint's exchange rate - given that 66 per cent of Hungary's domestic debt is denominated in foreign currencies such devaluation places great strain on debt repayment.
The financial crisis is therefore logically, spreading from banks, to insurance companies, hedge funds and other financial institutions to now threaten countries.
While breakdown, although not recession, is at least for the present being contained in the central core of the global economy it remains to be seen if this can be achieved on its periphery.
A Note. In light of the importance of the position that China takes on the international financial crisis it is of some interesting to note that the New York Times reports that it refused to bail out Pakistan. The paper notes: 'The thin results from the China trip [by the Pakistan government] were of little surprise to Western donors. Asked about the likelihood of Pakistan winning the direct cash infusion it was seeking, a senior Chinese diplomat was reported by Western officials to have said, “We have done our due diligence, and it isn’t happening.”'
She writes: 'The former US Treasury Secretary, Larry Summers, calls it the "the balance of financial terror". A noted academic, Summers, who served under President Bill Clinton, was referring to the relationship between the US and its newer creditors, such as China, the Middle East and Russia. Foreign countries now own nearly a quarter, some $2.6 trillion, of the total US debt. They also own more than $14 trillion in US assets – that's more than the total US national output.
'By far the biggest chunk of this debt is still owned by the Japanese, with US Treasuries worth $593.4bn. But soaring up the debt table is China, which now controls $518.7bn, more than 8 per cent higher over the past year, and equal to about half of the total $1.2 trillion it holds in reserve assets. Oil-rich states are also snapping up T-bills as though they are going out of fashion – up 29 per cent on the year to $173bn. On top of this, the US has a trade deficit with China in the first six months of this year of $142bn – and it is still growing.
'Behind all the figures lurks some intriguing realpolitik. The success of the US rescue package depends as much on the support of China and the Middle East as it does on the American taxpayer. Ultimately, it is the Chinese and Middle Eastern governments – and their taxpayers, which will decide the fate of the biggest financial rescue plan in history. Indeed, one of the reasons the US authorities say they had to rescue Fannie Mae and Freddie Mac was to reassure the Chinese government that US securities really were secure.
'They are going to have to do so again for this latest bail-out. Apparently one of the first things Hank Paulson, the US Treasury Secretary, plans now the package has gone through is a "road show" in Beijing to explain the rescue and why the US is not going to explode. As the ex-chairman of Goldman Sachs, Paulson has had good relations with China – visiting the country more than 70 times, chairing Tsinghua University's business school and helping the former Chinese president save an area of outstanding environmental importance.
'But Paulson will need to do more than go down on one knee to persuade the more sceptical Chinese – and there are many – that this rescue will work. There are some signs that the Chinese are being co-operative, and this may explain why the dollar has been strengthening during this recent crisis despite such low interest rates.
If they decide not to buy any more of the new debt, or dump existing debt, then the outlook for the US is truly dire. Interest rates will have to be pushed up again to attract new investors. It is a zero sum game: if the foreign holders do pull out then they would only be hurting their own investments.
'We've known for some time that the growth of the emerging economies such as Russia, China and India through globalisation would eventually dilute the power of the US. Philosopher John Gray thinks American political leaders are oblivious to what is really going on. He believes the present crisis is pushing the US into a fall as catastrophic and swift as that of the Soviet Union when the Berlin Wall came down. It's far too early to say if he is right, but what will be really interesting to watch is China's response to this crisis. Will it assert its authority or continue as a peaceful trade partner: the balance of financial terror exchanging debt for toys?'
Pagano's piece is worth reading in full. However it makes one error. The 'balance of financial terror' is asymmetric even if real. China, with a huge and rising pool of savings, in excess of its current domestic investment, is strategically stronger in this area than the US, with savings at a record low level as a proportion of GDP and in the middle of a financial crisis, in such an eyeball to eyeball. It would be surprising if China did not ask for and receive significant concessions if it decides to help out the US economically.
A large amount of what appears in the media about the financial crisis is pure nonesense. To ascribe a financial crash of this magnitude to 'lack of confidence', 'financial spivs', 'short sellers' etc is merely ridiculous. But there are number of commentators whose views are extremely serious. Appearance of these here, and their criticism on SEB, is not a sign of disrespect but on the contrary a compliment. It means that such a viewpoint has serious analysis behind it.
Martin Wolf, chief economics commentator of the Financial Times, is in a sense the doyen of economic journalists. His articles are marked by superb in depth research and tackling the most serious issues with a clear ability to articulate their own presuppositions. Suffice it to say that anything written by him should be read immediately by socialists - although Martin Wolf is, as he clearly states, a liberal who is hostile to socialism. SEB will be looking at some of Martin Wolf's views - his blindspot on China, his understimation of the distortion inherent in markets, but meanwhile SEB readers will find his articles in the FT one of the best possible sources to follow current events.
The latest, in the FT today, considers the process of debt deflation which SEB has looked at in several posts. Wolf notes: 'while the US government (and those of other western countries) are committed to saving the core banking system, the non-bank financial system, including the hedge-fund sector, looks set to implode as financing dries up, with inevitable forced sales of financial assets and further insolvencies.
'This is the reality behind the euphemism, “deleveraging”. This occurs via mass bankruptcy, unless bad private debt is shifted on to the public sector’s balance sheet. “Debt destruction” is a better name. In the US and elsewhere, asset prices, particularly of housing, also continue to fall. Who is going to borrow to purchase such assets? What lender would use such assets as collateral, unless they are protected by generous equity cushions? The credit mechanism is broken. This must be so when spreads on riskier credits are shooting up (see charts). If banks cannot borrow easily, few can.'
Read his article here.
Don't forget as recently as 1971 Richard Nixon declared 'we are all Keynesians now' before all Right-thinking economists declared Friedman and Hayek had 'disproved' Keynes.
But The Times is concerned more radical conclusions may be drawn. It has decided to poll its readers on the following question:
'Did Karl Marx get it right? That's the poser in today's paper. The Prussian has recently been ignored by the mainstream - consigned to obscure curricula as the business world steamed ahead. But as markets plummeted last week, dog-eared copies of Das Kapital started to fly off the shelves.
'Comment Central wants to know your thoughts. Can you hear an 'I told you so' reverberating from Highgate Cemetery? Or are you still using the work of its most famous resident to prop up your television?
'Cast your vote here.'
Doubtless Keynes and Marx are having an interesting discussion in the afterlife about the finer points of economic theory. Here and now socialists should be looking with renewed interest at the views of the two most important left wing economists.
Tuesday, 21 October 2008
Although this is very early days in the economic downturn that is to come this trend so far confirms the analysis in SEB that the likely outcome of this financial crisis is a major recession, accompanied by a significant realignment of the weights of different economies internationally, rather than a real long term economic depression of the 1930s type.
If financial disintegration can be avoided then the centre of attention will shift to who will pay for the huge bailout packages that have been used to stabilise the financial system. The present trajectory is that the cost of the financial crisis will be born by the majority of the population. Increased unemployment, stagnant or declining wages, and possible losses in the direct bank bail out programmes themselves, will transfer income away from the population to recreate profitability in the banks. Financial stabilisation will be gained at the expense of economic and social hardship for the population and political discontent. Unnecessary luxury consumption and military expenditure will remain at high levels while the population suffers. The possibility of socialists in the economically advanced countries is to insist that, on the contrary, the living standards of the mass of the population is maintained and instead luxury and military consumption is cut - which will also require the state intervening more into the investment process to attempt to limit recession.
The main international shifts are evident. The US will be weakened, China and India will be strengthened. The leftward shift in Latin America will be placed in an economic situation in which compromise is harder - shifts to the right and to the left may be expected. Significant financial destabilisation will occur in some economically exposed countries - merely within Europe to the financial crisis in Iceland has now been added significant problems in Hungary and Ukraine. Overshadowing all this will be the issue of shifts in alignment between the major economic centres in the US, Europe and Asia. And the depth of the recession itself.
The economic process unleashed by the financial crisis is only at its beginning - not at its end.
In contrast those believing that the crisis was caused by 'abuses of capitalism' were 46 per cent in Germany, 51 per cent in the UK, 61 per cent in Spain, 63 per cent in Italy, 65 per cent in the US, and 67 per cent in France. Those groups or institutions who were believed to have 'complete responsibility' or a 'lot of responsibility' for the crisis among the population of the European Union countries were bankers (80 per cent), Central Banks (70 per cent) and short sellers (64 per cent).
These results give no comfort to the idea that the population of any advanced country is chomping at the bit for socialism as yet. But they do show that very large sections of the population blame important capitalist institutions for the current events. It gives an interesting base line for assessing the situation. The full and detailed results of the poll can be found here.
Sunday, 19 October 2008
But such overvaluation of the dollar also means overvaluation of assets held in dollars in comparison to their real international market values. Eventually economic forces will bring dollar assets down towards their real values, but as they fall in price this destroys the balance sheet of institutions holding them - in turn creating a severe liquidity crisis. This, reduced to essentials, is the mechanism of the present global financial crisis.
Given that the decline in the price of overvalued dollar assets is inevitable, the relatively non-painful way for this adjustment to have taken place would have been a prolonged and gradual decline of the exchange rate of the dollar over many years. But this was strongly resisted by the US - it would have meant increased political discontent in the US as inflation would have risen and living standards would have been lower, and it would have put put economic pressure on the US to cut military expenditure and overseas operations such as the Iraq war. As the net debt position of the US increased large foreign holders of US assets also become concerned about a decline in the value of these holdings due to dollar devaluation.
For these reasons the decrease in the price of dollar assets took place not gradually, and over a prolonged period, but in the intense financial crisis that has gripped the world for the last months.
In the long term the uncompetitive character of the US economy means that there is no alternative to a reduction of the price of dollar assets down towards their real, much lower, values either via dollar devaluation or falls in their nominal values or both. And this will mean the US accepting a reduced role in the world both economically and militarily.
It is greatly to be hoped that the US accepts this decline gracefully, rather than running the risk of plunging the world into a new depression through futile attempts to avoid the inevitable.
There is no point, for example, in other countries lending large sums of money to the US, to prop up the dollar, when in the long run the only outcome of the attempt to avoid the inevitable will be that such countries suffer large losses as either the dollar devalues or the price of dollar assets they hold declines.
In the short term, however, an increase in the exchange rate of the dollar temporarily helps slow the decline in US asset prices, and therefore also slows down the fundamental mechanism of the financial crisis. To show the processes operating the graph below, therefore, shows the exchange rate of the dollar over the last six years. The most recent peak in long term movement of the dollar's exchange rate was on 27 February 2002.
As may be seen, for six and half years the dollar fell with only short term fluctuations. The decline between its peak on 27 February 2002 and its low point in this period, on 22 September 2008, was 23.7 per cent. To indicate the significance of the latter date, the nationalisation of US mortgage insurers Fanny Mae and Freddie Mac occurred on 7 September, the collapse of Lehman Brothers on 14 September, and the nationalisation of US insurer AIG on 16 September. By this point, therefore, the decline of US balance sheets was leading to widespread collapse of financial institutions and explicit panic on financial markets.
From 23 September onwards the dollar reversed course and began to rose rapidly - as may be seen in the graph. By the end of trading on 17 October the dollar had risen by 7.6 per cent from its low. This temporarily stabilised dollar assets in terms of real international prices.
The mechanisms by which the dollar moved sharply upwards will not be known with certainty in detail until figures for US financial flows are published but the most striking feature of this period was massive purchases of short term US Treasury Bonds - which drove up their price so sharply that the interest rate paid on them fell to record levels (if the price of a bond rises the rate of interest it yields falls). Taking closing prices on 17 October, the interest rate on 1 month US Treasury bonds fell to 0.06 per cent, that is virtually zero, and the rate on a 3 month bond fell to 0.79 per cent - that is under 1 per cent. The rate on 10 year US Treasury Bonds remained low at 3.92 per cent.
In short the rise of the dollar coincided with massive buying of short term US government bonds. It would be highly unsurprising if it were discovered that very large purchases of US Treasury Bonds by foreign banks and central banks took place in this period in order to attempt to slow down the long term decline of the dollar and take the immediate heat out of the financial crisis.
In short, two rescue packages were taking place. An open, explicit, one in most countries to save banks. And a hidden one to reverse, in the short term, the slide of the dollar. The two together slowed the slide into the financial abyss.
But this leaves the fundamental problem of the dollar unresolved. To make the US economy competitive the dollar must devalue. Even the nearly 24 per cent devaluation of the dollar up to 22 September 2008 had not brought the US balance of payments into anything resembling balance. As the dollar was overvalued US asset prices themselves remained overvalued.
The rise in the exchange rate of the dollar in the last month will have made this underlying situation worse and, therefore, left the world exposed to future precipitate collapses as dollar assets decline towards their real values. In short, the overvaluation of the dollar leaves the world open to precisely the type of crisis that has gripped it in the last month.
The process that should take place in that situation, and which would form a realistic agenda of the coming summits of world heads of state and government called by George W Bush and others, would be to organise a steady and progressive devaluation of the dollar, thereby accepting the inevitable but allowing this to occur, as far as possible, in an orderly and controlled, as opposed to a catastrophic, way. But that would be for the US to sit down and negotiate the terms of its own decline - precisely what it has refused to do for the last 20 years. But if the US refuses to accept that decline it builds into the foundations of the present economic system the potential of crises whose power has been amply demonstrated in the last month.
The coming international summits are therefore likely to be tense affairs.