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ECONOMY: Save the Market from Market Forces

Analysis by John Vandaele*

BRUSSELS, Mar 11 2008 (IPS) - Neo-liberalism is slowly fading away. That is, if we define neo-liberalism as an ideology that steadily wants to reduce and belittle the role of government, and promote ever freer markets.

While nowadays almost everybody recognises the market as an interesting instrument, dogmatic market fundamentalism is on the way out. If you want to prevent big trouble, there is really no alternative but that it should be so.

Let&#39s start with the latest upheavals in the financial sector. The sub-prime mortgage crisis in the United States is a classic example of how an almost complete lack of regulation nurtures financial disasters.

Financial companies were allowed to sell mortgage deals which at the start seem cheap but jump to higher rents as the years go on. You really didn&#39t need a lot of fantasy to see trouble ahead: poor families who could not have been supposed to be able to pay these kind of rents, were nevertheless lured into these dodgy packages.

It all contributed to inflating house prices, to what in effect became a housing bubble. That made homeowners feel so rich that they started borrowing money against the inflated value of their houses: that&#39s how the housing bubble also inflated a consumption bubble. We&#39ll have to see what happens with that one.

People having trouble paying their mortgages also could take new loans against the inflated house price to pay their mortgage. That was only possible as long as house prices kept rising. When that stopped, the whole edifice started to unravel.


The financial companies who sold the bad mortgages were able to keep on doing so because the bad mortgages were endlessly repackaged into more and more complex financial products, so-called derivatives, and then passed on to other financial players. These derivatives were actually so complex that even the world&#39s biggest banks got nailed by them – Citibank, UBS, Merrill Lynch, JP Morgan, all lost billions of dollars on these repackaged sub-prime mortgages.

The irony is that some of these crown jewels of U.S. capitalism had to be rescued with money from sovereign funds of China and the Arab world.

What does all this mean for you and me? The practical consequences are that millions of U.S. citizens will be forced out of their houses, and that the ensuing U.S. recession will also affect world growth.

In the UK there was a run on a bank, Northern Rock, because customers believed their money was at risk. It had to be nationalised at a cost of more then 100 billion dollars (in loans and guarantees) of taxpayers money, to make sure its clients didn&#39t lose their money.

We have not seen the end of it. Financial wizards have been knitting all financial sectors together, and so the lack of confidence keeps spreading. Nobody knows where exactly this will end.

The basic tale is by now familiar in the financial sector: regulating authorities refuse or do not dare to step in, and so let a crisis build up. One reason surely is that regulators very often are closely linked to the financial sector, because they have been part of it.

That is true at the national level – many U.S. ministers of finance come straight from Wall Street – but also at the international level. The International Monetary Fund is supposed to keep an eye on the global economy and financial system, but has trouble doing so.

Cees Maas, at the time CEO of ING, an international bank based in the Netherlands and vice-chairman of the International Institute of Finance, the world association of banks, told us at the annual meeting of the International Monetary Fund in 2004: "Before, the IMF and the World Bank used to keep their distance towards private banks. They wanted to demonstrate their independence, they feared being influenced. That&#39s now changed. Contact is much more easy going now: we share the same vision but have a different role."

The problem with sharing the same vision and having a lot of contact is that the public officers may indeed have difficulties keeping their distance. They do not dare to disturb the profit games of the financial wizards – they don&#39t want &#39to take away the punchball just as the party gets started.&#39

And the last two decades the financial sector has been having a lot of parties, especially in the U.S. The profits of financial companies jumped from 5 percent of total corporate profits after tax in 1982 to 41 percent in 2007, even though their share of corporate value added rose only from 8 percent to 16 percent.

Financial companies are worth 27 percent of the global value of all stock exchanges. That is much more than what they contribute to the economy. "The explosion of financial techniques started already in the seventies. Instead of being an instrument, they have become the essence of the U.S. economy&#39, says Geert Noels of the Belgian investment bank Petercam.

The IMF not only is close to bankers, it is also very weak towards the rich countries that don&#39t need its money. Many directors at the IMF saw and see the risks of the enormous disequilibrium between the U.S. and China. Even though in the Articles of Agreement of the IMF, Article 1 says one of the purposes of the IMF is "to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members", the IMF has not been able to lecture these countries into a change of policy.

So the Chinese have been piling up the billions of dollars they have earned with their massive trade surplus with the U.S. Instead of selling these dollars, and changing them to yuan, to use them internally, they have kept them as international reserves, thereby keeping the dollar exchange rate relatively high and that of the yuan relatively low. And in doing so China further exacerbated the trade deficit.

Large parts of these Chinese dollar mountains were then lent back to the U.S. government when it looked to borrow money to finance its own deficit. (Lately part of that cash has been used to buy off shares of U.S. banks in trouble.) So both countries developed a very asymmetrical position: the U.S., with a very low saving ratio, lending dollars, spending more than it earns, thereby stimulating the world economy, especially Chinese exports.

The Chinese economy, with a very high saving ratio, and hence very dependent on exports, running ever bigger trade surpluses with the U.S. and lately also with the EU. The trade deficit with China grows 15 million euro per hour, EU trade commissioner Peter Mandelson said last year.

This trend cannot continue. The question is how it will be reversed. A brutal change of policy could be devastating to the world economy. What would happen to the world economy if the Chinese drop a large part of the more than 1,000 billion dollars they hold as reserves, and in doing so melt down the dollar value? Nobody knows.

Even people who have defended globalisation all along now see the writing on the wall. Read what Martin Wolf, head economist of the Financial Times, wrote on Feb 6. "We have no obvious alternative but to try to regulate the financial sector…A financial sector that generates vast rewards for insiders and repeated crises for hundreds of millions of innocent bystanders is politically unacceptable in the long run.

"Those who want market-led globalisation to prosper will recognise that this is its Achilles heel. Effective action must be taken now, before a still bigger global crisis arrives."

We&#39ve been here before. During the Great Depression, then U.S. president Franklin Roosevelt said that money was too important to be left to bankers. Once again, politics will have to overcome the resistance of the financial world that sees money as a way to make profit. That&#39s why we&#39ve seen this massive financialisation of the U.S. economy with the risks for the real economy ever growing.

That has to change: money is there to serve the economy and society, not the other way around.

There is really no alternative to more regulation, part of it on an international level, so as to make sure that the financial sector serves the wellbeing of its citizens. One particular change of regulation should be that bankers&#39 compensation is related to long-term success of their institution and not the short-term hike of its stock. Once again, rules will have to protect capitalism against itself.

Hence, TINA – the acronym for &#39There Is No Alternative&#39 – is back. Former UK prime minister Margaret Thatcher famously said, "there is no alternative" to the neo-liberal politics she reinvented. Well, now we see TINA is coming back, but this time around it has a completely different content: there is no alternative to more and better regulation. Unless, of course you want to run the risk of a crisis with unpredictable consequences.

*John Vandaele is journalist with the Belgian magazine Mo*, and author of several books on globalisation, most recently &#39The Silent Death of Neoliberalism, 2007.

 
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