Could a dragged-out economic crisis lead to world war?

I've been sitting on Stephen Diamond's November 6 essay, The Income Statement v. the Balance Sheet: Will the Economic Crisis Unravel the Long Peace? because I planned to write a book in reply but before the days turn into months here are my thoughts about his concern.

My problem with his discussion is that he's not factoring in the real story behind the economic collapse. In this he's not alone; only a virtual handful of Americans, most of whom relocated to Canada or Switzerland when Nixon shut the gold window, are aware that since the 1970s the major industry in the United States has been U.S. dollar sales to central banks around the world.

The industry is untaxed and run by people who are not elected and thus, are immune to the wrath of voters. This has led to great abuse of the U.S. dollar. Yet the ability of the industry to magically generate billions of dollars without generating runaway inflation insulated the American economy from the worst effects of the onslaught by Japan, Inc. and later from China, Inc. The downside is that the U.S. government's heavy reliance on the industry led to the horribly destructive policy that perpetual debt was highly profitable.

It was only a matter of time, however, before U.S. dollar hegemony would be challenged, which led to the joke that Saddam Hussein signed his death warrant when he conspired to accept euros in payment for Iraqi oil.

The worst downside of the U.S. dollar industry was that it came to substitute for the innovation that drives the kind of technological revolutions that Steve mentions in his essay, and which allows capitalism to function in a healthy fashion. "King Dollar," as Larry Kudlow likes to call it, became a king with feet of clay. The dollar ceased representing the hard work, ingenuity, and freedom of the American people. It became a symbol for a kind of extortion deal, in which countries that could ill afford it had to keep a large amount of their hard currency reserves in U.S. dollars if they wanted to buy OPEC oil and virtually all other key commodities.

The deal began to collapse under the weight of its unfairness, with many oil producers accepting barter or non-dollar payments from the poorest nations by the 1990s, and when a resurgent Russian energy industry challenged OPEC's power.

Yet the more the USD industry came under pressure, the more other nations were expected to carry an ever-leapfrogging amount of U.S. debt. There was no way the situation could continue indefinitely and it finally crashed with the bursting of the last financial-markets bubble.

I mentioned the key role of the USD industry in some of the earliest posts on this blog and warned that hard economic times were ahead for Americans as the industry ran into more and more obstacles. Yet I also noted that once America had gone through a painful readjustment the society would regain its health -- a true health.

The other side of the picture is that some carrying of U.S. debt by other nations is not an unfair burden because it's a de facto tax. Being the world's policeman is an expensive enterprise. That long peace Steve talks about has been mostly courtesy of Uncle Sam the Supercop.

If some readers shriek, 'Supercop? What about Darfur?' -- yes, what about Darfur? The USA wasn't going to lead the charge into Sudan because it was already under fire from almost the entire world for the Iraq invasion. But when we asked the African Union to take the lead with Darfur, then came the rattling of the begging bowl, hemming and hawing because no African leader wanted to a invade a Muslim nation, etc. etc. They wanted the USA to play the fool again, so they could blame all the downsides of an invasion on Uncle Sam.

The downside to weaning the world from American military protection is the specter of mushrooming small wars that could touch off the kind of situation that worries Steve. There is no easy reply to his worry. But the developing world and 'emerging' economies, in particular BRIC nations, are relatively untouched by the economic crises that spun out from the collapse of financial markets in September 2008. Russia has big economic problems, as does China, but so far these are unrelated to the collapse. That situation would change if the crisis continues to drag out.

Again, I think the underlying factor in the economic crisis is a currency crisis. I suspect the latter is the real reason for the hesitation of so many U.S. banks and corporations to part with their big cash positions. If I'm right, then quantitative easing measures won't work. Neither will nationalization of the banks.

Bottom line is that there's nothing spookier, as far as banks and big corporations are concerned, than a looming seismic shift in the international currency regime.

If you ask, 'What seismic shift? -- ah, that's just it! There is no shift, just a lot of shifting from foot to foot and everyone asking everyone else, 'So, any news about the seismic shift in the currency regime?'

The world is not high school, Mr Obama

My greatest concern at this time is that the leaders in the European Union are trying to rush the Obama administration into making far-reaching decisions. My second greatest concern is that Mr Obama is rushing because he doesn't want to be unpopular.

I have noticed that President Obama has a tendency to confuse the world with high school. The EU is going to have a lot of fun with his view of the world if he doesn't wise up fast.

The goal for the U.S. President is not popularity. The goal is to act in the best interests of the United States, which is the economic engine of the world. No amount of U.S. popularity will save the world if the U.S. falls.

But since the rise of the EU, every time a U.S. administration doesn't do exactly what the EU leaders want, suddenly all over Western Europe half the population turns into streets and shouts Down with the USA.

And the BBC is always on the spot to record the protests for the evening's broadcast, which is global.

Then -- and this is the part I love -- they send armies of Talking Heads to appear on U.S. TV shows, to explain to Americans what steps we can take to stem the tide of anti-Americanism sweeping the world.

Get used to it, Mr President.

A wag observed recently that the economic crisis is "Obama's Iraq." I think the better comparison is the immediate aftermath of 9/11. So much is happening so fast in this war on the global economic meltdown, and on so many fronts, it harks to the storm of government activities here and abroad that arose in the wake of al Qaeda's attack on America.

The comparison falls apart, however, if you consider that the Bush administration was well-settled in place when the attack occurred, whereas Barack Obama moved into the White House in the midst of the financial meltdown.

So I am not happy that the EU -- poked and prodded by our dear allies, the 'Big Three,' Germany, France, and UK -- has chosen the April 2nd Group of 20 summit as the drop-dead date for the United States to have in place a plan for sweeping new regulations. Regulations meant not only to stem the present global economic crisis but also any future ones. And for the US to decide whether to accept the EU plan, in which Gordon Brown has a big part, for saving the world.

Gee, why not also make April 2 the drop-dead deadline for getting a space station on the moon, finding the cure for AIDS, and ending global poverty?

Of course there needs to be an international, coordinated approach to dealing with the crisis, and yes we know that Europe is being hit even harder by the economic crisis than the United States.

But this 'hurry up and sign on the dotted line because the sky is falling' -- c'mon guys.

If there was ever a time for a U.S. President to invoke the raw power of America's hyperpower status, the G20 summit is it. This should be a working summit, a discussion summit, and not the place to agree to regulations that will have a profound affect on the entire world for many decades to come.

Yet not 24 hours had passed since President Obama's address to Congress (and my post warning that something was afoot with Gordon Brown) that he announced the U.S. is preparing sweeping new regulations with the entire globe in mind:

President Obama outlined broad plans on Wednesday to revamp the nation’s financial system.

Obama is seeking a host of new regulations amid a historic meltdown to prevent a future financial crisis.

“We can no longer sustain 21st-century markets with 20th-century regulations,” Obama said following an Oval Office meeting with his top lieutenants and the chairmen and ranking members of the House and Senate panels overseeing the financial industry. [...]

Obama has said he would like to complete an outline on future regulation by a G-20 heads-of-state meeting in London in early April.

Moving legislation through Congress, however, could take more time. House Financial Services Committee Chairman Barney Frank (D-Mass.) has laid out a two-stage process for regulatory legislation that will be a lobbying bonanza, with outside think tanks, advocacy groups, government panels and watchdog offices weighing in with stacks of reports.

Obama, who also met with congressional leaders on his budget Wednesday, said he is trying to avoid both “an oppressive government-run economy” and “a chaotic and unforgiving capitalism.”

The definition of "low-information American" is "Democrat politician." So I'll cut President Obama slack and assume he really doesn't know that if only we'd had an unforgiving and chaotic capitalism, the global economic crisis would have been over by now.

There has been so much government intervention in financial markets here and abroad that it'll be a miracle if the world pulls out of the worst part of the economic crisis by the start of the next decade.

There is no solution for this problem until everyone throws in the towel and finally admits that Ayn Rand was completely right; that will happen only with a profound transformation in consciousness that might be slated for the year 3,001 CE.

Until then, we'll have to bump along with governments playing mechanic whenever their regulations produce economic chaos. Of course this always results in more government regulations. But we're trying for least harm here. And that means the United States shouldn't rush to do things the EU way.

I want to show you something. Here is the list of the G20 members. (There are two G20s -- one is the "major economies" and the other is "developing nations;" the meeting taking place in London on April 2 is the G20 major economies.)Watch carefully; don't blink:

In 2009, there are 20 members of the G-20. These include the finance ministers and central bank governors of 19 countries:

Argentina
Australia
Brazil
Canada
China
France
Germany
India
Indonesia
Italy
Japan
Mexico
Russia
Saudi Arabia
South Africa
South Korea
Turkey
United Kingdom
United States

The 20th member is the European Union, which is represented by the rotating Council presidency and the European Central Bank.

So that's why they don't describe the G20 members as "nations;" it's because the European Union is a bloc of nations.

Looking at our map of the world we see that Italy, France, Germany and the United Kingdom are in Europe and the EU. That means the EU Big Three are twice represented at the G20 summit, which gives them tremendous clout.

If you say, 'Hey, no fair' -- there is no 'fair' from the EU point of view when it comes to wringing concessions from a hyperpower. That's their excuse and they're sticking to it: the USA is a hyperpower and so we need to eke out a little patch of bipolarity in the world.

The EU viewpoint studiously overlooks the fact that the big bad hyperpower has made it possible for Western Europe to recover from two world wars in relative peace and raise a very powerful trading bloc that is America's biggest trade competitor.

I think even before he was in office President Nicolas Sarkozy proposed that the EU nations take on responsibility for defending themselves. The proposal went over in Europe's major capitals (including Paris) like bacon at a bar mitzvah. Why spend money on defense when those governments can rely on the USA for defending them, which frees up the European governments to support massive social welfare programs?

So I don't want Democrats writing me to complain that not all their politicians are low on information. Virtually every Democrat politician points to Western Europe's social welfare programs as a model for the United States.

Earth calling Democrats: You want the European Social Welfare model applied to the USA? In that event, who's going to take on the responsibility for defending the US -- not to mention Europe and the Middle Eastern oilfields -- if the US follows the European welfare model? China? Guatemala? Or should we ask the EU and their flotilla of rubber duckies to patrol the oceans?

Where was I? The Hill's report on the Obama administration's scurrying to concoct new regulations is a handy guide to the kind of regulations being considered.

With regard to the EU plan, a UK Guardian report from February 16 sketches the broad outline of Gordon Brown's plan for saving the world from economic catastrophe, present and future. I suggest you use the report, which I have posted below, as a handy program guide for Brown's speech to the U.S. Congress on March 4.

Is it a good idea to give more funds and power to the IMF? There's no choice about adding to their coffers. They're having to bail out a number of European nations and before the global downturn is over they'll probably have to bail out half of Africa.

With regard to increasing the IMF's power: I would rather see the IMF take the heat than the USA for the mistakes and friendly fire that are to occur in the fog of war against the global financial crisis.

So while I want to see all the details before saying yes, I am in favor of handing the IMF some I repeat some regulatory powers.

As for the rest of Mr Brown's proposals: he's trying for more integration and control of the globalized financial markets so to prevent another falling-dominoes scenario. This, on the argument that all the markets are inextricably entwined.

But you can argue, as Phillip Blond has (see my post of yesterday), that it was the lack of firewalls to protect domestic financial markets that turned the housing mortgage crisis into a global series of cascading catastrophes.

How to set up firewalls for markets that trade both globally and locally? That question should be the top one for Obama's regulatory team, the Federal Reserve, and Congress. The answers they come up with should be America's top contribution to the G20 summit.

As for Gordon Brown's plan to give the G20 a permanent secretariat -- you gotta think like a bunko squad cop to fathom Mr Brown's machinations.

Gordon Brown seeks sweeping reforms to give IMF global 'surveillance role'

By Patrick Wintour, political editor
Guardian; February 16, 2009

Gordon Brown is making reform of the International Monetary Fund, its governance, funding and powers of surveillance, the centrepiece of a 45-day diplomatic drive in an attempt to make the G20 summit in London a turning point in remaking the international economic order.

Brown, in alliance with the Australian prime minister Kevin Rudd, wants to increase the funding of the IMF, speed up a review to give China and India clearer voting rights, and also give the fund powers to direct nation states to respond to its surveillance reports.

He also wants to give the G20 a permanent secretariat, so making it a powerful body overseeing finance and largely eclipsing the G8.

The prime minister is meeting the IMF managing director, Dominique Strauss-Kahn, on Wednesday, the pope on Thursday and the Italian prime minister, Silvio Berlusconi, on Friday, before joining a mini-summit of European G20 members France, Italy and Germany in Berlin hosted by Angela Merkel, the German chancellor.

No 10 angrily denied suggestions that Merkel is lining Brown up to be a new IMF super-regulator. Some officials believe a cabinet member leaked the suggestion.

Britain is chairing the G20, with a summit in London on 2 April to be attended by Barack Obama, and Brown is using the event to advance his long-nurtured plans to reform the IMF. It is a huge test of his diplomatic skills as he seeks to weld conflicting goals and ensure practical proposals emerge rather than rhetorical bombast that fails to assure the markets.

On the IMF, Britain wants to expand its existing lines of credit, so giving "emerging market economies" an opportunity to contribute. Brown has also considered a loan or bond facility funded by Arab states, Japan and China.

He and Rudd also want allocate additional special drawing rights (SDRs) to the IMF's newer members, as agreed in 1997, so giving them access to foreign exchange. SDRs are an official international reserve asset issued by the IMF to its members, who can exchange them for freely useable currency.

Strauss-Kahn has called for the IMF's resources to be doubled $500bn. Brown is also interested in the IMF supporting – through expertise and financing – the creation of a network of national "bad banks" to take on toxic assets.

Finally, he wants to give the IMF a strengthened mandate to provide early warning of weaknesses and advice on remedial policies, similar to those provided by a central bank.

At a seminar on the G20 summit last week Brown argued: "The world lacks a proper early warning system. There is the Bank for International Settlement, there is the Financial Stability Forum, but we have never given anybody sufficient teeth so that their views are treated so seriously that people will immediately have to act when that early warning is given. We still lack the means for financial supervision." The International Monetary Fund, he said, "cannot have a role that is simply commentating on the global economy, it must have a surveillance role that is effective".

He added: "If people feel that the IMF is simply the representative of the richest countries with very little say for the poorer countries, if people think that the World Bank is similarly constructed, then people are going to either seek to have other institutions or going to reject the existing institutions, and of course the danger of that at this time is protectionism."

The aim appears to be develop a "grand bargain" in which there is a greater role for emerging economies such as China in the IMF, and easier access to its financial assistance, in exchange for such countries playing by the global rules and not trying to build up surpluses and reserves as an insurance policy.

Other issues to be addressed include whether hedge funds and shadow banking are brought within the remit of regulation and Brown has also asked Pascal Lamy, the head of the World Trade Organisation, to compile a report for the G20 on the threat posed by protectionism.

Brown now reckons that unless new credit lines are opened, as many as 100 million people will be driven into poverty as a result of the global financial crisis. He has been struck by figures from the International Institute of Finance which said two years ago net flows to the emerging markets were nearly $1 trillion, but that in 2009 this figure will be $160-170bn – a 700% fall in two years.