Page 4 of
5 THE INTEREST RATE
CONUNDRUM, Part 1 Economics of
denial By Henry C K Liu
denominated in dollars of
falling value that actually makes everyone poorer
in real terms, only that some become poorer, and
more quickly, by comparison. Pathetically,
neo-liberal economists have fallen over one
another hailing the poverty-eradication powers of
market fundamentalism.
The income
equality hoax J Bradford DeLong, an
economics professor at the University of
California at Berkeley and
former Treasury official in the Clinton White
House, attracted mainstream attention by claiming
in a February 2001 paper ("The world's income
distribution: Turning the corner?") that global
income distribution had been trending toward
equality through globalization. Such claims not
only fly in the face of World Bank data on the
Gini coefficient, which measures income equality
in economies, they ignore the fact that all wages
have been falling in purchasing power globally
even if rising nominally, improving statistical
equality as nominal wages in poor economies rise
at the faster rate because they started from a
lower base both nominally and in real terms.
Neo-liberal ideology asserts that
inequality is the result of poverty and that as
poverty is relieved, inequality recedes. This
assertion neglects the possibility that inequality
itself causes poverty, not as calculations in a
zero-sum game, but as a damper on consumer demand
in a global economy plagued by overcapacity.
Globalized trade, rather than domestic
development, has been hailed by neo-liberal
economists as the solution to both inequality and
poverty. Opposition to globalization by the
world's poor has been labeled misguided by the
neo-liberal mainstream that holds monopolistic
sway in the media in defiance of glaring
conditions of poverty on the ground.
The Harrod-Domar model of
development Neo-liberal economists point to
the Harrod-Domar model of economic growth to argue
that unequal distribution of income promotes
faster economic growth and greater employment
because the rich save more than the poor, so that
a greater volume of domestic savings will increase
the supply of capital available for investment;
and the accelerated capital formation will raise
gross domestic product and resulting incomes, a
virtuous cycle feeding back into greater savings.
Thus income inequality, even with widespread
poverty, is regarded as good for development, not
merely as a transitional compromise but as a
permanent structural necessity. This is in essence
the International Monetary Fund/World Trade
Organization model of market fundamentalism since
discredited by factual data.
Even the late
Deng Xiaoping, paramount leader of China's
economic reform, fell for this fallacy and
accepted the need to "let some people get rich
first". Predictably, the word "first" soon
disappeared in Chinese economic policy
deliberations until it was too late. Finally, the
new leadership in China under President Hu Jintao
and Premier Wen Jiabao is at long last addressing
the problem of income disparity both between
people and between regions, but the task is made
more Herculean by the two-decade-long
solidification of a political and bureaucratic
superstructure embedded with powerful resistance
of special interests of those who got rich first
and want to stay more rich permanently.
Notwithstanding that the Harrod-Domar
model may not be operative in a world plagued by
overcapacity from overinvestment and insufficient
demand as a result of income inequality, the model
neglects the fact that under globalized finance
capitalism, even the savings of the rich in the
poor economies are siphoned off to US capital
markets, draining the local economy of desperately
needed capital. The global dollar glut in the
context of dollar hegemony that current Fed
chairman Ben Bernanke mistook for a global savings
glut is the living evidence against the validity
of the Harrod-Domar model of economic growth.
Income inequality in the economies that export to
the United States provides capital formation only
to the US by financing a US capital-account
surplus with the current-account surpluses these
economies earn from trade.
This increases
the cost of capital for the exporting economies,
which have to offer returns drastically higher
than the return they get from US sovereign debt
merely to induce their own capital to come back
home. And even then, capital flows only to the
export sector, to earn even more dollars to pay
foreign capital denominated in dollars, putting
these economies in a perpetual competitive
disadvantage for global capital.
China is
a perfect example of a booming economy caught in
this trap. To look for better returns than its
dollar reserves get from US Treasuries, China is
beginning to pursue so-called "alternative
investment" in higher-risk private-equity firms
while it continues to face a capital shortage in
its rural regions and most non-export sectors.
The GDP-growth mirage By the
mid-1960s, the theory equating domestic
development with growth in gross domestic product
was already not empirically supported by evidence.
GDP attributes profits to the country where
factories or mines or financial institutions are
located, regardless of ownership nationality, even
though profit and investment may not stay there
permanently.
The accounting shift from GNP
(gross national product), which measures total
value added from both domestic and foreign sources
claimed by residents of a country, to GDP has
turned many struggling, exploited economies into
statistical boomtowns, while seducing local
leaders to embrace a global economy while their
countries slide into further poverty.
But
such micro-evidence has been systemically
dismissed by mainstream economics because it goes
against the prevalent macro-paradigm of trade
globalization, which is deemed intellectually
uncontestable and ideologically correct. Moreover,
the evidence goes against powerful economic
interests of the rich economies and is dismissed
as the result of a democracy deficit. By making
the rules of development treat capital as more
scarce compared with labor and thus the more
valuable factor of production, owners of capital
are logically justified in receiving a larger
share of the benefits from development.
Lawrence Summers as chief economist of the
World Bank (1991-93) used a similar economic
argument for dumping pollution from advanced
economies on to developing economies to achieve an
overall lower cost globally. The only problem with
this perverted cost-benefit approach to welfare
economics is that it is not true. Optimum
development requires capital and labor to be
assigned fair and equitable value so that supply
and demand can be balanced and for all human lives
to be treated with equality, because as many
around the world have since recognized, global
warming recognizes no economic or national
borders.
Captive buyers of US sovereign
debt In 1995, after the US Federal Reserve
had started to hike the FFR target the previous
year and sharply curtailed its own purchase of
Treasury bills, triggering the Mexican peso crisis
and a subsequent US slowdown, the Bank of Japan
initiated a program to use its foreign reserves to
buy $100 billion of US Treasuries. China bought
$80 billion. Hong Kong and Singapore bought $22
billion each. South Korea, Malaysia, Thailand,
Indonesia and the Philippines bought $30 billion.
The Asian purchase totaled $260 billion from 1994
to 1997, the entire increase in foreign-held US
dollar reserves.
In 1995, East Asia
claimed 47% of capital flows to all
low-and-middle-income countries. In 1996 alone,
about $100 billion flowed into East Asia, which
Asian central banks had to buy up with local
currencies and invest the dollars in US
Treasuries.
But in 1997, $150 billion
flowed out in the three months after July,
exacerbating the Asian financial crisis by
draining foreign reserves held by Asian central
banks. These recycled dollars pushed up stock
prices in the US both before and after the crisis.
Interest-rate gradualism rendered
inoperative Volcker's new operating
procedure was instituted in 1980, some 27 years
ago. Nowadays, with structured finance, which can
add endogenous liquidity created internally by
risk-management schemes to protect against a
liquidity crunch, a new dimension has been added.
That new dimension is that in stabilizing
the money supply, instead of sending interest
rates down, it will send interest rate skyward
because of fierce competition for money by market
participants addicted to an endless supply of
cheap money, turning the liquidity boom into a
liquidity bust. When the market
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