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A House of Cards

Sick global economy hit by new contagion

The list of countries hit by the wave of withdrawal of speculative investment capital lengthens by the day. Countries amounting to half the global economy are being forced to spend currency reserves, raise interest rates and consider controls over the movement of capital.

A contagion of capital flight is hitting Argentina, India, Indonesia, Russia, Brazil, South Africa, Hungary and Turkey. A dramatic reversal in the global marketplace, which began in May and is accelerating with every new shock statistic, is forcing the governments of “emerging” economies to savage the living standards for their already low-income populations.

Each country has a different story to tell: worse or better attempts at managing their economies; higher or lower levels of foreign currency reserves; more or less extremes of corruption of government ministers; levels of civil unrest ranging from the benign to insurrectionary. But the source of the crisis invading their borders lies elsewhere, beyond their control. 

Investors on the global financial markets – better known as speculators, or gamblers – were spooked last May by the US Federal Reserve’s announcement of its intentions to begin reducing its $85 billion per month programme of credit creation. The withdrawal of funds – known by the jargon quantitative easing – began soon after and has recently been accelerated.

The Fed will have taken many factors into account in the central bank’s decision to reverse the programme of credit creation which – together with the sharp reduction in take-home pay – has been a key factor in the jobless economic “recovery” following the 2007-8 crash. 

Ballooning levels of “margin debt” figured high among the triggers for the decision.  These are investments made with money borrowed on the expectation that the Fed would continue pumping credit into the economy. Indicators suggested that these investments had reached danger levels, threatening another financial collapse.

China’s central bank is also being obliged to follow a similar path. Having fought the global recession with a huge programme of credit-financed construction of cities, roads and railways it recently made tentative steps in opening its borders to volatile international investors.

Some analysts estimate that foreign financial institutions now have almost $1 trillion tied up in the Chinese economy, either as investment in or loans to corporations. George Magnus, senior independent economist at UBS, says that the Chinese banking system resembles that of Japan during the 1980s in the years leading up to that country’s financial crash.

“If the dollar were to appreciate it could cause problems for those banks that have borrowed in dollars. Anywhere you have a banking system that uses a non-domestic currency, there is a possibility of a mismatch that could cause issues when the value of your liabilities runs away from you,” said Magnus.

In China, which became the manufacturing powerhouse for the global corporations in the last century, growth has slowed for 11 of the last 14 quarters. The Markit/HSBC manufacturing Purchasing Managers Index fell to a six-month low of 49.5 in January, suggesting the overall factory sector contracted again from December.

With 50 being the dividing line between growth and contraction, the omens are very bad indeed for a global economy depending on China sucking in raw materials and components and assembling them for sale back to the richer half of the world.

In the US, manufacturing grew at a substantially slower pace last month as new order growth plunged the most in 33 years. Some blamed the severe weather, as if things will improve along with the seasons. So the world’s two biggest economies are in deepening trouble.
Assessing the long-term prospects for humanity including the impact of environmental degradation and climate change, Christine Lagarde, managing director of the International Monetary Fund, is calling for a new Bretton Woods arrangement.

She said in a BBC lecture that such a meeting was needed to restore economic sustainability and reduce global tensions. She was invoking the spirit of multilateralism and a return to the “brotherhood of man” philosophy promoted by economist John Maynard Keynes at the 1944 meeting in the United States.

To this listener her lecture invoked only the spirit of Humpty Dumpty. She would be better off getting ready for global Meltdown II.

Gerry Gold
Economics editor
5 February 2014

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Daud R Matthews says:

Would it help if money entered circulation by being spent into existence like being distributed to the deserving; pensioners, disabled etc; as opposed to banks distributing it with the attendant interest charge? Wouldn't this "save" money?

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