Thursday, December 2, 2010

Debt as Modern Slavery (Part 1 of 3)

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Part I – Currency Wars, Chimerican Crisis, and the Debt-based Monetary System

By James Matthew B. Miraflor
Presented to the Southeast Asia Regional Socialism Conference oPartido Lakas ng Masa, together with Transform Asia Gender and Labor Institute, November 27, 2010, College of Social Work and Development (CSWCD), University of the Philippines Diliman

Revised on November 29 and 30, 2010

Warm revolutionary greetings to all of our comrades here. I was tasked to discuss on the debt and the financial crisis. As we know, this is a very difficult topic to talk about, as it is related to the most complicated inventions in human history – banking, monetary system, fiscal policy, and investment practices, among others. No one can pretend that the whole thing is already understood completely, for even its inventors have often been labeled as not knowing what they are doing.

Thus, to make things simpler, it is good to begin with a discussion of the current updates in the global financial and monetary practice. Right now, the United States is conducting what it calls as “quantitative easing” (QE). Simply put, this is simply printing dollars out of nowhere. The Federal Reserve already printed $600 billion to buy securities from the US Treasury. The printing press has now become, to paraphrase Ben Bernanke, the secret weapon of the American economy. This devalues dollar vis-à-vis other currencies, making exports to the US more expensive and favoring domestic producers’ access to US market.

Seen as a form of subtle protectionism and as “revenge” over China’s supposedly “undervalued” currency, it had the effect of depreciating the value of dollar worldwide. For export-oriented economies of the world, this may spell ruination, as it means that American exports will be relatively cheaper. This may have the effect of import-substitution in the United States as cheaper American goods replace goods exported by the manufacturing giants like China and Germany to the US market. In the Philippines, this had the effect of shrinking the relative value of the dollars migrant workers send back home, and compromising Business Process Outsourcing (BPO) companies which earn in dollars.

During the conference. University of the Philippines Diliman - CSWCD.
But beyond QE’s immediate effects lie a more structural cause. It is this cause, which will later be called as debt-based monetary system, that I will attempt to discuss in this paper. Knowing what the systemic impulse behind the production of money is brings us closer to a good explanation on the current phase of the finance capitalist system the whole world is now in. It also allows us to understand alternatives which we may have to implement as a global community if we are to avert financial disaster and transition to socialist alternatives. 

The Emergence of Chimerica

We have to trace the QE strategy with what we call as the emergence in the past two decades an entity called the “Chimerica” – a marriage of China as producer and creditor and United States as consumer and borrower, fusing the two economies in a form of symbiosis. On this perspective, QE is seen as an annulment strategy, delinking US from the Chinese economy by devaluating the dollar and rendering worthless China’s dollar reserves and dollar-based instruments.

But we are getting ahead of ourselves. Let us first see why the marriage had been done in the first place. According to economist Neil Ferguson who invented the term, China was attracted to the Chimerican marriage because it gives potential to propel its economy forward via an export-led led growth. In fact, China was able to quadruple its economy since 2000, quintuple its export, import Western technology and create tens of millions of manufacturing jobs for the poor.

For the United States, it allowed overconsumption – Americans can consume more, save less, and still maintain low interest rates and a stable rate of investment. The US, in fact outspent its national income by a cumulative 45% from 2000 to 2008, a third of which was spent on Chinese goods. On the macroeconomic level, US debt is rising, pegged at $13.8 trillion as of this month – with each citizen having a debt of $44,571.36.

Focus on the US: The need for credit

Let us take a closer look on America. So why is the American people overspending? At the household level, a large part of this explanation is not just increasing consumption, but also decreasing income.

From a Marxist perspective, this is clear. Before the neoliberal era of the 1980s, US workers are benefitting from the concessions they gained from capital. Strong labor unions pushed President Franklin Delano Roosevelt to enact pro-labor provisions of the “New Deal” which lasted up to Nixon’s time, as expanded by Lyndon Johnson’s Great Society.

With Reaganomics, we have seen this concessions dismantled. Labor power was crushed. Minimum wages have been abolished in favor of “competitive” and “market-set” wages. Pensions have been cut, mandatory retirement age has been raised, and social security has been reduced. Flexi-labor has been started, and labor unions which refused saw their jobs being outsourced offshore or contracted in China or India. Government kept wages down by increasing unemployment – forcing workers to be satisfied with decreasing salary by surrounding them with unemployed citizens.  

This is where credit comes in. To address declining wage and prevent under-consumption, the United States ushered an era of credit cards, home mortgage, and other lending instrument to American workers. This resulted in financial boom in the United States. According to Robert Pollin, a contributor for the New Left Review, “wage repression” during the Clinton era resulted into a “financial excess”. Declining labor power translated to increasing financier power.

As we know, the consequences of this have been staggering. The financial capitalists in the United States used these debts to build a whole new gambling economy. Subprime mortgage debts were converted into Special Purpose Vehicles (SPVs) and huge portfolio of Collateralized Debt Obligations (CDO). When the debts aren’t being paid already (they are unsustainable to begin with), this resulted into a into a liquidity crunch that resulted into a catastrophic economy from 2007 up to now.

The United States (US) quantitative easing, and even the earlier $700-billion bailout (through the Emergency Economic Stabilization Act of 2008), does not solve this problem. In fact, it only transferred this debt from the private sector to the government, now saddled with humongous debt and budget deficit – triggering the Republican Party-manipulated Tea Party movement. Debt and credit remains to be the prime mover of American economy.

Focus on China: Currency Regime and Export-oriented Growth

Let us take a look on China and bring our discussion back on the currency regime. Is there a basis on the United States’ claim that China’s currency is overvalued?

We have to remember that the Chinese government’s exchange rate regime is not flexible. For the longest time, it is pegged on the dollar, recently adjusting only through a series of revaluations. In a flexible exchange rate, there is an automatic adjustment according to the balance of trade. Trade deficit increases demand and price for foreign vis-à-vis domestic currency, making the price of foreign goods less attractive to the domestic market which pushes down the trade deficit.

With China’s peg to the dollar for decades, this rebalancing didn’t occur. Trade surplus didn’t decrease the price of dollar relative to RMB, keeping exports to the United States cheap and imports from the United States expensive insofar as China is concerned – and earning China more dollars. Edwin Truman of the Peterson Institute for International Economics gives us an idea how much China’s foreign reserves are: “China’s international reserves as of the end of June 2007 were $1.3 trillion, virtually all of which were in foreign exchange. At the end of 2006, China’s foreign exchange reserves were $1,066 billion, or 40 percent of China’s GDP. In 1992, reserves were $19.4 billion, 4 percent of GDP. They crossed the $100 billion line in 1996, the $200 billion line in 2001, and the $500 billion line in 2004.”

How did China come to accumulate such massive reserves? Much can be explained by China’s extremely strong export economy, which brought successive years of trade surplus and with it, foreign currency. From 1992 to 2007, China's exports grew more than tenfold, a rate far faster than the tripling in the world trade taking place in the same period. In 2004, China was already ahead of Japan as the world's third largest exporter, just behind Germany and United States. In 2007, export growth rose further to 27%, with the WTO predicting that China will finish above US at that year. It is also predicted that China will overtake as the world's biggest exporter by 2008.

We have to see China’s logic on pursuing an export-oriented strategy while maintaining its relatively inflexible exchange rate. This is, in fact, reminiscent of the mercantilist era wherein the primary purpose of public policy is for the economy to gain foreign currency, which is gold at that time. China is undergoing the same period. It does not want its sources of dollars compromised. But we should not see this as phenomenal – Japan was in the same situation until the United States forced it to appreciate the Yen in the Plaza Accord of 1985, resulting to two-decades of contraction for the Japanese economy.

That is why China is always leery of currency appreciation, despite constant calls by the capitalist community. It does not want to follow Japan’s path of decline. But with them gaining so much in dollars, China would have to find a way to “recycle” American dollars and inject it back to the American economy. They did so by buying US Treasury securities. In other words, this means lending it back to the Americans. Debt has been the instrument of China to maintain currency stability.

So when the QE strategy kicked in, the Chinese government looks at its huge reserves of dollars and US Treasury securities and sees a continuous deterioration of value in its coffers. If the US keeps up with its reliance on the printing press, a good part of China’s wealth as lender to the United States might be converted into merely, Mickey Mouse money.

The Debt-based Money System

What explains these phenomena? What narrative successfully weaves these seemingly disparate events in China and the United States?

We see a term which props up everywhere, and that is debt. I then assert that both export-oriented growth and the growing need for credit is but a result of what we can call as the “debt-based monetary system” - a consequence of what economists call as the “fractional reserve banking system”. Now, fractional reserve banking has many other problems. But for now, let us zero in on one. Under this system, money creation requires loans from the banking system, people are required to go into debt in order for any new money to be created.

This is only too obvious in the United States. The Federal Reserve (the Central Bank of the United States) is able to inject money in the system mostly by “loaning” the amount to US Treasury. The same is true in the other Central Banks, even here in the Philippines. Increase in monetary supply accompanies increase in debts and deficits, insofar as domestic currency is concerned. Money is simply debt.

We have to see the debt-based monetary system for what it is, because it is crucial to the functioning of capitalist accumulation and finance capital imperialism for a century now. And this begins with the application of interest.

Listen closely to this. We have to remember that all money in any particular economy is debt owed to its Central Bank. This means that for all these debts to be repaid, all money should go back to the Central Bank. But what happens when Central Bank imposes interest rate? It claims from the economy more money than what is actually available in the system. This now explains the eternal scrambling for money in the micro level. The grasping for money in order to pay for interest reveals that there is too few of it. It is only through loaning again to the economy that the Central Banks enable us to repay interest. But this only increases debt, perpetually.

Modern Slavery

The real effect of this has been inhumane. At the macroeconomic level, this explains the constant need for economic growth, because the economy needs to grow if only to pay for the interest. This means extracting more out of nature, or getting more out of labor. Companies, for example, have to keep wages low so it can pay interest from the banks and maintain profit – even if for accumulation only. Wage repression has to occur in order to pay interest. Ask any capitalist what capital accumulation means, and you will begin to understand that in order to expand, he must build his capital stock, not for its own sake, but so he can loan a proportional amount from the banks if he is to pay his maturing debts. Instructive in this sense is the case of Philippine tycoon family of the Lopezes, which was compelled to give up, maybe temporarily, the Manila Electric Corporation (MERALCO) due to maturing debts.

That there are international loan sharks swarming over Southern seas can also be explained by this. The mad scrambling for money back home means that countries have to sort of pass the hot potato to Southern nations. Since all money are owed to Central Banks, when they lend to third world nations through International Financial Institutions (IFI) and bilateral lending institutions, it is actually a relent, so they actually pass the interest rates effectively to the Southern nations. This pushes the South to engage more in export-oriented and/or extractive industries – by balding their forests or ravaging homelands for mining, in order to produce value to pay for the interest of the debt.

To quote Peter Joseph, this is a system of modern slavery. The debt-based monetary system is now the engine of the capitalist system with which it maintains its hegemony. This is the cause of the debt trap that IFIs put Southern nations in (from Latin America to Asia) for a good amount of time decades ago. This is the cause of the financial crisis now as US workers fail to pay their debts. This is the cause of China’s overdrive and the massive exploitation of the environment as the need to earn foreign currency increases. 

Up next, the origins of the debt based monetary system.


Amiti, Mary, and Caroline Freund (2007, September).  “China's Export Boom.” F&D (Finance and Development), a quarterly magazine of the IMF. Vol. 44. no. 3. International Monetary Fund (IMF).

BBC News. (BBC News. 2007, April 12). China's foreign reserves balloon.

Ferguson, Niall and Moritz Schularick (2009, October). The End of Chimerica. Working Paper 10-037. Harvard Business School.

Grignon, Paul (2002). Money as Debt. A short animated documentary film.

Truman, Edwin M. (2007). The Management of China’s International Reserves: China and a SWF Scoreboard. Conference on China’s Exchange Rate Policy. Peterson Institute for International Economics.


Synthesist said...

Hi James, Theoretically, in a capitalist society, any worker can become an entrepreneur and be successful at it using two things you do not count in your model: management skills and technology. The model that you are using is almost neoclassical in the assumption that all labor is of one quality and interchangeable and have only one price. It is a very quaint approach that is not anymore accepted even by evolutionary economists.

Of course, expansion of money supply increases nominal, and not real value. Even Adam Smith, who came before Marx, realized this in the concept of natural price. Real value, once created, must be priced and exchanged on the basis of this true, natural price and not the nominal. And one needs some skills to do this well. If one is wise and prudent, an individual can emerge from a situation of poverty and be well off.

Poverty is not necessarily destiny. And proof is all around us.

At the national level, divergence is also not destiny. It is about policy and the people's choice of governance.

I await your part two.

Belly Surya Candra Orsa said...

Great Blog..!!!! Keep Blogging.... :)

mark said...

"Seen as a form of subtle protectionism and as “revenge” over China’s supposedly “undervalued” currency, it had the effect of depreciating the value of dollar worldwide... This may have the effect of import-substitution in the United States"

It's not that simple. A country cannot simply try to devalue its currency without affecting inflation or try to dampen domestic demand. Given that deflation and a lack of demand in the US economy, such a tact is sensible.

"This is where credit comes in. To address declining wage and prevent under-consumption, the United States ushered an era of credit cards, home mortgage, and other lending instrument to American workers."

Or that export oriented countries like China, Japan, Germany, Korea, etc. flooded the US economy with cheap cash by buying US dollars/treasuries that it held down interest rates artificially low leading banks to try and offer more creative products to get better returns. Sometimes the simplest explanation is the best. Your's is quite a stretch.