As the G20 finance ministers gather in South Korea to defuse tensions in currency markets caused by the fallout of the global financial crisis, there seem to be no quick solutions. Developments point to the fact that contradictions between the US and other powers will only aggravate further.Various economists around the world have been drawing attention for some time to the unbridled printing of money and credit creation by treasuries in US, Japan and other countries struggling through the global crisis. The reserve banks in these countries are competing with each other in credit creation to buy real estate, infrastructure, mineral resources, bonds and whatever else they can grab. This financial grab is happening without an army or occupation. In a way, these financial bailouts constitute a new form of warfare. This phenomenon started in 1990, on a big scale, when the financial and property bubble burst in Japan. The Bank of Japan took steps to enable the country’s banks to get better of their negative assets by supplying them with low-interest credit. The interest rate was reduced to near zero levels. This credit, instead of spurring local demand, was funnelled into arbitrage. Speculators accessed this credit to invest in the bonds of Iceland, for example, which offered 15 percent. So, the Japanese Yen was converted into foreign currencies, pushing its exchange rate down. Speculators borrowed Yen to convert into dollars, euros, Icelandic Kroner, the Chinese renminbi and so on. These were used to buy public and private sector bonds, stocks, currency options and other financial intermediates abroad. When the financial and real-estate bubble burst in the US and Europe in 2008, these countries followed the Japanese path. The US federal reserve flooded the economy with credit. The stated aim was that this will provide more liquidity to banks so that they could lend to domestic borrowers in need. It was said that the “economy would borrow its way out of debt”, bringing about a spurt in real estate prices and reducing home foreclosures. But nothing of this sort happened. The money didn’t reach the borrowers in need. Instead it found its way to foreign economies, thus inflating their exchange rates. The US Federal Reserve has so far created $2 trillion credit for this purpose and is proposing to create another $1 trillion credit over the next one year. It is said that the entire credit has been siphoned off mainly to the BRIC countries: Brazil, Russia, India and China. This is why today we are witnessing an upsurge in the stock markets and appreciation of currencies in these countries. In the case of Japan the currency flow has turned a full circle. Japan is now inundated with Yen inflows. Arbitragers are paying back the Yen that they earlier borrowed so that they can buy even higher yielding but riskier sovereign debt from countries in crisis such as Greece. The Yen has appreciated 12% against the dollar in 2010. Earlier this month, the Bank of Japan announced that it had no choice but to spend $60 billion to buy back government bonds to hold down further appreciation of the Yen. The US has been putting pressure on China to reduce its huge trade surplus. One way that China has tried to reduce the dollar reserves is to buy American companies. The US has blocked this as in the case of CNOOC trying to buy into US oil refinery capacity. The only option left for China is to recycle its dollar inflows into buying US Treasury Bills yielding 1% and whose exchange value is declining. Thus, the present system encourages speculation. An arbitrager would make a killing in investing in Brazil’s 12% government bonds by borrowing from US banks at 1%. Besides the interest arbitrage, he will also gain from the Real’s appreciation. The Real, Brazil’s currency, has appreciated 30% against the dollar since 2009. Countries with huge dollar flows have not gained anything. When a country’s currency appreciates against the dollar, it hits the export industry as is happening in India today. Such currency wars can soon turn into a trade war with countries taking steps to prevent the inflow of dollars. What all this is pointing to is that in today’s capitalist “free market” economy, exchange rates are not determined by commodity trade and purchasing power parity. They are determined by the financial flows and military spending of the big powers. The contradictions between the US and other powers are expected to come to a head in the coming IMF and G20 meetings. The exacerbation of this crisis provides us an opportunity to understand how this crisis has developed over the decades. Prior to 1971, nations settled their balance of payments in gold or silver. Countries had to build their gold reserves through trade surpluses if they wanted to increase their money supply. For example, until 1971, each US Federal Reserve note was backed by 25% gold, valued at $35 an ounce. When countries ran trade deficits or launched military campaigns, interest rates were raised to attract foreign inflows and domestic credit was restricted. The capitalist economies went through a “stop-go” regime. When business expansion led to trade and payment deficits, they raised interest rates to attract foreign capital and slashed government spending, raised taxes and slowed down the economy to reduce trade gaps. There was some control over currency circulation. During World Wars I and II, the US accumulated 80% of the world’s monetary gold, making the dollar a virtual proxy for the gold. But after the Korean war broke out, the payments deficit of the US started increasing. By August 1971, war spending in Vietnam and other foreign countries forced the US to suspend gold convertibility of the dollar, doing away with the gold standard. The suspension of dollar-gold convertibility made the US immune from balance of payments and financial constraints. It could wage military campaigns without worrying about balance of payments. As the US trade and payments deficit increase, countries which accumulate dollar reserves are forced to recycle them into purchases of US treasury securities. In this way reserve banks around the world are actually being forced to fund the US payment deficit, largely arising out of its military expenditures. Every time the US creates more credit, it starts a predatory financial attack on other countries, destabilising their currencies and fuelling speculation. Countries such as Brazil and China are already taking steps to protect their currencies. China has been negotiating bilateral agreements with Russia, Brazil and Turkey to start direct trading using their mutual currencies, bypassing the dollar and euro. With the global crisis continuing and the eurozone in deep crisis, one can only expect the financial war to heat up further.
Posted In: Economy Globalisation Policies real estate buuble G20 meet currency markets gold standard currency convertibility balance of payments crisis