Wednesday, October 07, 2009

Dollar 'time bomb' adds to turmoil

The reaction to the global meltdown has so far consisted of so many variations on a common theme: governments deepening their debt to provide backing for too-big-to-fail stricken banks and central banks inventing new money. The single lyric on the hymn sheet is “save the system, return to growth!”

But it hasn’t been enough to do the trick and everyone knows it. The universal collapse in demand, trade and credit is forcing a new round of consolidation on struggling global corporations. The world economy is hanging on a hardly-functioning financial system while the boom on stock markets is a purely speculative bubble.

Every country is affected, and no government is able to act on its own. The only result of any significance from the G20 in Pittsburgh was the recognition that the unfolding global crisis has outpaced, outgrown and outstripped the 30-year-old political arrangements for managing international economic affairs.

There is a time bomb waiting to go off amidst this turmoil. This is the plan to replace the not-so-mighty dollar as the currency used to trade in oil. The dollar would be replaced by a basket of currencies in addition to gold, according to reports. This move would signal the demise of the United States as the world’s leading capitalist economy, which has used the pre-eminence of the dollar to borrow vast amounts to fund the country’s huge trade and government deficits

The October editions of the International Monetary Fund’s World Economic Outlook and the Global Financial Stability Report make for sobering reading. They tell us much about the contradictory forces at work in the economy.

* Reducing excess productive capacity means much higher levels of unemployment are inevitable but this will reduce demand further.
* More intense rates of productivity are needed to reduce costs and restore profitability, but falling prices mean already over-indebted consumers defer purchases awaiting even lower prices.
* More regulation is needed, but the “ability of lenders to diversify funding sources” – like the unregulated derivatives markets at the heart of the crisis – “need to be retained”.
* The financial system must be restored to health, but the reported losses from banks have reached only half the expected levels so far.
* A much greater degree of coordinated government intervention is likely to be needed to support a recovery of production to just a fraction of pre-crisis levels, but can’t continue without rising interest rates strangling that very same recovery.

The global gurus are also pretty sure about one other thing: they’ve no idea if their prescription for “unwinding” the current level of intervention will work, or lead to a new crash. They’re giving no guarantees. This is how they put it: “Given that this is uncharted territory for policymakers, some experimentation may be appropriate to test market conditions. If warranted, reinstatement of some facilities should not be viewed as a setback.”

In other words, they haven’t a clue. You wouldn’t buy a used car from them.

In Britain, Tories and New Labour are vying to carry out the IMF's instructions to slash public spending to pay for bailing out the bankers. Neither party is really letting on about their real intentions, however. Commenting on yesterday’s speech by shadow chancellor George Osborne, the Financial Times noted:

“The effects of these measures – grim though they are – are dwarfed by the scale of the budget deficit. Mr Osborne has announced plans to save £7bn ($11bn) per year by the end of the next parliament, with changes to the pension age – beginning in 2016 – eventually contributing up to £13bn. The budget deficit this year? £175bn.”
Balancing the books will, therefore, require cuts so immense that they will destabilise society and create social upheaval. The state is undoubtedly preparing for such an eventuality and we would be well advised to do the same.

Gerry Gold
Economics editor

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