Understanding our Heaving World Economy
It is easier to talk globalization than to foresee the consequences of bringing together, globalized and deregulated, societies at vastly different stages of development. Putting lions and lambs in a single fold may sound ecumenical, but the flow of the lions’ gastric juices will alert them to the opportunities in the arrangement. And in no time the surviving lambs will have learned the score. So, indeed, has it come to pass.
And there is a flaw in the orthodox prescription for fixing such problems: more of the same. In the world today just about everything that can seems to be going wrong while thinking is imprisoned in the tight matrix of dominant interests. We must then turn to the rich variety of approaches of economic theory’s great pioneers.
And astoundingly, the most helpful of these is none other than Adam Smith, whose very name has been nailed to the mast of free-market dogma. Smith made use of at least three theories of value, depending on the problem addressed. When concerned with basic human relations, he harks back to "rude state of society that precedes the accumulation of stock and the expropriation of land" to formulate a labour theory of value: "if it usually costs twice the labour to kill a beaver as it costs to kill a deer, a beaver will sell for twice as much as a deer." You can sense in that passage the experience of countless Scots who after the Union of the realms had begun running their empire for the English. It also suggests the current globalization of the world economy that brings together devastatingly highly developed metropoles with primitive subsistence economies.
When Smith shifts to the cost of production theory of value, this initial collision has given way to assimilation into the market system. Accountants are busy adding up cost columns. A third value theory that he uses is not of "embodied labour" as in the labour theory of value, but "commanded labour," the amount of labour that you can hire with the proceeds of a commodity sale.1 When you read of China entering the WTO with labour costs one-tenth of Japan, and 200 million unemployed and underemployed, you appreciate the relevance to us today of Smith’s third value theory.
We have only begun our investigation of the Globalized and Deregulated (G&D’d) economy. Yet it should already be apparent that the official price theory that identifies value with the latest price and declares the market self-balancing, excludes questions about the sustainability of a G&D’d system. To cope with class strife, 19th century marginal utility theory was brought in with a burst of misplaced mathematics. It turned its back on the sphere of production and presented all players from workers to bankers doing the same thing: maximizing his satisfactions. What is taken to be unemployment, is redefined as workers’ preference for leisure in their parlours over working for the wages offered.
In the perspective of Smith’s third value theory, the case of China shifts the decimal point of our cost reckonings one space to the left. That reduces production costs by factor ten even before the higher multipliers of economic process have clicked in to shift the decimal point to the right in profits.
Today slippers produced in China at a cost of $2 and delivered to San Diego at $3, retail at $10, and dominate the American market. What is significant is that 70% of the low ultimate price goes not to the Chinese producers (workers and capitalists) but to the American distributors. And that price spread by its very magnitude engenders further, often still greater spreads, right into the speculative financial level. And it is these cumulative mark-ups that shed light on our present plight.
What we are confronted with in the 1:10 wage spread between China and Japan is due to two social systems placing vastly different values on "average labour." From time to time those values may be drastically revised – whether due to contact with other cultures, or internal social reshufflings. That must not be confused with the "inflation" or "deflation" of a passing market imbalance. I have called such processes "social revalorization."2 To block it, while introducing the heavy-lifting that the new international market demands, is ruinous for such societies. Ignoring the social costs of destroying previous subsistence economies can be fatal.3
But that is precisely what P&G has wrought. The Third World is brought into the market system not only as a producer, but as a consumer and a borrower, subject to foreign bankers who, organized into international institutions, use debt as a weapon to veto positive social revalorization, and replace it with negative social revalorization. Rather than stabilize, this has often widened the spread between living standards in Third World countries and the First. Compare the spread between the annual rewards of the CEO of Citicorps – $26 million a year plus options in his company – and the producer of the slippers that one or the other of his subsidiary companies may finance – from the production of those slippers in China to their purchase by the ultimate consumer financed at credit-card rates. And the debt – especially in an international regime that proclaims interest rates the sole blunt tool for stabilizing the economy – is more effective than an army of occupation for blocking the necessary social revalorization for underdeveloped countries being dragged into the modern market.
To procure the foreign exchange to service its foreign debt, such underdeveloped countries must increase their exports. This leads to the ruinous prices due to the current oversupply of staples such as coffee and food crops. These do, however, help check inflation in the lender lands. The loan conditions of balanced budgets rule out the use of the central banks of the debtors even for the creation of additional credit to finance infrastructures requiring little foreign exchange – primitive housing, and primary education. World Bank projects that are supposed to be carefully vetted for deleterious environmental and social effects are rushed through without such studies because the country has urgent need of foreign exchange to service previous debt.
The resulting influx of depressed cheap commodities into the advanced countries retards and even reverses social revalorization there. Entire lines of production – shoes, cheaper textiles and clothes, for example – have come close to being wiped out. This has kept commodity inflation low and has made it possible to keep interest rates relatively low in the US – vital to the deregulated banking system that now extends into every aspect of stock market activity.
The increased spread resulting from the influx of Third World commodities and the transfer of less skilled industrial production there has set the stage for a hyperinflation of financial values in the First World. The shifting of back-office data processing to English-speaking countries like Ireland and India has had a similar effect. The increased cost spread has provided some of the economic space that made possible our late record stock market boom. Such mega-spreads are immediately capitalized and transmuted into stock market valuations. While it lasts, it is in effect a huge increase in our money supply.
The devaluation of a currency can serve a country as poison or cure depending on who has the power to impose it. For decades Japan kept its currency low as part of a policy kit without which its miraculous comeback after WWII would have been unthinkable. On the other hand by insisting on free capital movements on countries with stressed currencies that must meet the payments on their foreign debt the IMF can force a devaluation that will deliver to them imports at lower prices.
The mild warnings of Alan Greenspan, chairman of the Federal Reserve System about the "irrational exuberance" of the stock market were slapped down by Wall St. spokesmen. He was reminded, on dubious authority, that his business was to watch for commodity inflation, not to comment on the level of share prices.
Unbridled greed battens on growing spreads between Third World export prices and First-world prices and profits. These in turn, extrapolated into the future, are capitalized for present value on the stock market. But this powerful phenomenon is subject to a ratchet effect – it can’t be reversed without bringing down the assumptions on which it rests. Carried to its logical conclusion, it strives to the exponential curve in which the rate of growth of the function’s value equals the value the function already reached. That in turn says that not only the rate of growth, but the rate of growth of the rate of growth and all further derivatives of that rate to infinity fill the same condition. That, however, is the pattern of the exponential function, the mathematics of the atomic bomb.4 The slightest shortfall from what has already been incorporated into stock market prices must inevitably to lead to a total collapse of the fictitious structure. The Hiroshima bomb in the perspective of those who designed it rather than a disaster was a success. Likewise, properly understood, the meltdown of the high tech boom could only lead to a similar climax. It was indeed a confirmation of COMER’s forecasts.
The ratchet effect at the core of exponential stock market valuations also explains the crumbling of the morality in financial circles. Not only was near-exponential rate of growth of corporation profits seriously believed to exist, but the rewards of others based on this model were imitated with blind devotion.
That explains the epic cooking of the books of public corporations in so many ingenious ways. And the public’s accepting of market share as a substitute for the traditional price/earning measures of corporation health. And many, many other examples of misdirected talent.
The Dead Rat Under the Floor Boards
What is rarely recognized is that this exponential model of stock-market valuation swells the money supply. As long as the fiction of its reality persists, it can serve to buy women, wine and song every bit as well as gold or gold-backed credit did of yore.
The extent of the prodigy was made possibility by the form of the 1991 bail-out of our banks, which was carried out in stealth. In some countries like Canada and New Zealand it took the form of the total discontinuance of statutory reserves. In others like the United Kingdom and the US they were reduced effectively to 1% or less.5 That means that the leverage of the banks moves towards infinity.
It is true the Bank for International Settlements Risk-Based Capital Requirements imposes certain limits, but these are measured against the banks’ capital, not against the cash they hold. Capital is raised by banks in cash but is not allowed to remain long in that sterile form. It is lent out or otherwise invested. And such investments in Canada and the US are mostly entered at their historic rather than their market value. No matter where we start unraveling the mystery of how so huge a bubble could have been allowed to form, we end up with the great Mother of All Secrets. It played an important part in making possible the inordinate scale of the recent stock market bubble. Unless we get to the bottom of that "Dead Rat Under the Floor-boards" we shall be doomed to experience a replay of it on an even greater scale.
1. Smith, Adam (1922). An Inquiry into the Nature and Causes of the Wealth of Nations. Vol. 1. London: Methuen & Co. Ltd., pp. 34, 49-50, 54.
For gap in labour costs between China and other East Asian countries see "Confirmation in the Wings" in the previous issue of ER.
2. Krehm, William (1975). Price in a Mixed Economy – Our Record of Disaster. Toronto, p. 99.
3. Little, Bruce. "Global economy weakens in year," The Globe and Mail. Toronto, 5/11:
"[According to the Conference Board of Canada] ‘South America has experienced one debacle after another. While most of the economic difficulties are homemade, especially in Venezuela and Argentina, the region’s woes have been aggravated by plummeting world commodity prices, especially for coffee. An 80% decline since 1987 in the wholesale price of coffee is contributing to social meltdowns affecting an estimated 125 million people,’ but retail prices have dropped only about 30%."
4. Krehm, William (2002). Towards a Post-Autistic Economy – A Place for Society at the Table. Toronto: COMER Publications, p. 99.
5. In the US for the required reserves that average about 3% include the till cash that banks hold for their operations (and hence not really available collateral for the near-money they create).
— from Economic Reform, December 2002