Doug Henwood's crisis

[Henry C.K. Liu]

The current global financial crisis is far from over.  Begun in July 1997, it had spread globally since.  The fundaments
behind the crisis, developed over a decade-long period of unregulated globalization, have not been addressed in their
roots. Most of the measures adopted so far by the G7, of which the US is the leader, pulling the so-called G22 by their
noses, have to do with bailing out Western and Japanese banks, and pushing down interest rates to artificially keep high
global stock markets, indicators of financial robustness but usually mis-indicators of economic health.  Wall Street
calls it the Goldilock economy where good news is interpreted as bad and visa versa, by naive investors.
Whether this mess can or should be called a "crisis" is a trivial point, and it deserves the trite response that the
Chinese word for crisis is composed of two characters: danger and opportunity.  The pertinent questions are: danger to
whom and opportunity for whom?
I submit that the danger is to both global market capitalism in it current form and also to the helpless masses of the
open economies of the world.  The balance of danger distribution depends how how the crisis is handled.
The opportunities are for hitherto marginalized socialism and the dis-empowered masses of the whole world.
The current crisis represents a historic opportunity similar to the economic crisis that brought about the 1848
Revolutions, the worldwide movement toward planning after the 1929 collapse, and the optimistic bursts of socialist
achievements immediately after WWII, before such efforts were overshadowed by geo-political issues of the Cold War.
This current crisis, as symptoms of a self-destructive global market capitalistic system, provides the opening for new
socialist solutions.
Alas, socialist economists everywhere have yet rise to the challenge.  They seem to be mired in irrevelent academic
research on distractive details and scholasticism debates of how many angels can dance on the head of a holy pin.
It is time for bold and revolutionary conceptual re-think in the tradition of Marx, to look at the real facts, to
collect and share unbiased data, and to mobilize all positive intellectual and organizational energy to grasp this rare,
passing opportunity a build a worthy new order for the benefit of people rather than capital. Even George Soros, with
whom I do not agree and in whom I have no trust, appears conceptually ahead of many socialist theorists at this
important juncture.
Below is par of my meager yet persistent contribution on the Asian Crises.  Not an economist by formal training, my
views may be dismissed as academically unworthy of attention.  While I welcome any criticism, constructive or otherwise
or even ridicule, I welcome more those who care to join me in seeking to improve our understanding of the real facts in
order utilize our collective intelligence to take the world toward a better destiny.
Lets build on each other's strengths, instead of attacking each other's weaknesses.

The Facts Behind the Asian Financial Crises
by
Henry C.K. Liu
(written in January 1998)

Asia is experiencing sudden financial collapse not because the goods produced in Asia are suddenly unmarketable
worldwide, or Asian management has suddenly become so inept as to incur unforeseen losses in Asian companies.  It is
certainly not the inevitable outcome of alleged inherent defects in Asian values, as anti-Asian analysts have claimed.
Rather, the collapse is the result of an abrupt rupture in the unregulated global system of financial markets.
Beginning in the early 1960's, with the growth of Euromarkets where banks in one European country could take deposits
and make loans in currencies of other countries, the tight controls of international flow of capital set up by the
Bretton Woods system of fixed exchange rates after World War II were effectively bypassed.  Drawing lessons from the
1930 depression, economic thinking prevailing immediately after the War had deemed international capital flow
undesirable or unnecessary.  When the fixed exchange rate system finally broke down in the early 1970's, the developed
countries abandoned capital controls officially. In the late 80's, many developing countries followed suit.  In the last
decade, daily turnover of foreign exchange grew over one hundred fold to over US$1.5 trillion from US$190 billion.  By
1996, some US$350 billion of private capital flowed into emerging markets, a seven fold increase in 6 years.
For the past two decades, technical imbalances between interest rates set by different central banks for funds in
different currencies distorted capital flow around the world.  The resultant inflow of capital into Asia through
inter-linked financial markets around the globe outstripped the region's viable absorption rate.  Financial institutions
took advantage of low cost funds denominated in currencies of select countries, namely Japan, Germany and the United
States, to make loans at higher interest rates denominated in local Asian currencies.  These institutions sought to
strategically profit from recurring technical imbalances in global finance by assuming currency risks.  Economist name
this development as international arbitrage on the principle of open interest parity.  In banking parlance, this type of
activity is known as "carry trade".
This abusive speculation was by no means limited to emerging economies.  Corporation in developed economies routinely
engaged in global financial and stock market speculation at the expense of sound production strategies. The public
announcement of plans to open new factories in Asia predictably lifted share value in home markets, regardless such
factories risked being loss-makers, for the loss would be more than covered by the increase market capitalization.
Corporate borrowers in Asia, attracted by low rates in some foreign currency loans, have also assumed currency risks, at
times even bypassing local banks to borrow directly overseas.  Borrowers, anticipating asset inflation brought by run
away growth, also succumbed to the irresistible temptation of borrowing short term to finance long term projects, thus
adding to the risk they assumed.  Simultaneously, many Asian banks have taken local currency deposits at low saving
rates (in Hong Kong at times at negative interest rates) to invest overseas in risky foreign currency instruments
yielding higher returns, engaging in carry trade.  Local banks in turn have replenished the depleted local capital pool
with low-cost foreign currency loans from international banks, taking on both economic and currency risks.
Borrowing low and lending high is the basic business of banks and there is nothing wrong with it if the activities occur
within a well regulated market of a bank's domicile community.
With the advent of global banking however, the unregulated internationalization of finance has created perilous systemic
stress.
Banks began to act as international loan brokers, profiting from interest rate spreads between local and foreign funds,
often booking the risk premium added to weak currency interest rates as legitimate loan profits.  These banks also began
to maximizing their profits by maximizing loan volume, abrogating their traditional economic function as responsible
financial pillars of local economies to ensure the productive allocation of capital.  In time, local banks de-coupled
their business self-interest from the economic impacts of their loans on the local economies, because they hedged the
risk in such loans by passing it to overseas hedge funds which became the real loan originators.  Western and Japanese
international banks in turn provided funds to the local broker  banks in Asia whose credit ratings were considered
acceptable because the borrowers' exposures were hedged by instruments designed to transfer risk to other international
institutions.
In effect, the widespread transfer of business risks into currency risks forced the governments of the affected
currencies to become lenders of last resort.  This is the real effect of Hong Kong's and other Asian currency peg to the
US dollar.
Hedging does not eliminate risk, it merely passes risk along to other parties.   In fact,  complex hedging schemes, with
the effect of reducing the risk exposure of individual lenders and inflating the credit worthiness of the hedged
individual borrowers, when widely practiced, actually increase systemic risk exposure, initially of regional financial
systems and ultimately of the global system.  Yet the soundness of financial institutions continue to be assessed
singularly and insularity within national borders, while financial markets have become intricately linked globally.  A
poor credit rating seldom means the denial of credit.  It only means a higher interest rate which actually attracts more
eager lenders who rationalize that the high risk has been compensated for by the increased rate.  Through extensive
hedging, private financial risks have been largely socialized globally.  The ingenious layering of protection against
risk, while providing comfort to individual players, buys such comfort at the expense of the security of the total
global system.  At some point, the strained circular chain breaks at the weakest link and panic sets in.  That break
occurred in Thailand on July 1, 1997.
Because of this circular system of global hedging, the current economic crises in Asia inevitably will spread
worldwide.  The regional crises, each with unique local characteristics, are merely early symptoms of a ticking global
time bomb constructed out of the complex calculus of  inter-linked financial markets in which countless individual
credit risks are legally masked as sound transactions through sophisticated hedging.  Derivatives, financial instruments
which derive their value from other underlying financial instruments or benchmarks such as stock indexes or exchange
rates, are the cards in the fragile house of cards built by a financial specialty known as ?structured finance?.
International finance in recent years has been saturated with disastrous and scandalous abuses that clearly and
repeatedly epitomize the deficiencies of the unregulated global inter-linking of financial markets.

 Speculators have been blamed for precipitating the run on Asian currencies that started the financial crises.  Yet
speculation and risk management are two sides of the same coin.  At the opposite end of a prudent hedge, a speculator is
required.  In a structurally flawed system, perfectly honorable businessmen or institutions individually true to high
ethical and financial standards, can unwittingly participate in systemic games of dubious value.  Data on the now
6-months-old Asian financial crises show that currency hedging individually by sophisticated businesses and alert
government bodies, domestic and foreign, as protective measures against foreign exchange exposures in both debts and
revenues, have been mostly responsible for the sudden currency turmoil in the region.  In international finance, a game
of musical chair in financial risk is in full force in which the players are handcuffed together through inter-linking
hedges.  This game can cause serious systemic rupture when the music stops.  It is time for world leaders to propose
plans to deal realistically with the serious situation, and stop denying its existence.

Henry C.K. Liu

Hinrich Kuhls wrote:


> Left Business Observer #86: "It may be that the worst of the world
> financial crisis is over."
>
> This sentence and the article which is introduced by this sentence are of
> course quite another thing than an announcement of the end of the world
> financial crisis.
>
> For socialist politics it has been and still is of high relevance to
> identify which stage of the economic cycle we are in. Hence the topic I am
> missing in the latest issue of LBO is a discussion whether the high turning
> point of the 10th post-WWII economic cycle of the US economy has been
> passed or not.
>
> I think it is evident that the answer to this question will end
> speculations in the nature of the current critical situation of both the US
> and the international capitalist economy.
>
> And what's a better place to discuss the topic which stage the demiurg of
> the world market is in than an US mailing list?
>
> Hinrich Kuhls
>
> At 09:53 28.11.98 -0500, Louis Proyect wrote:
> >In the latest issue of Left Business Observer, Doug Henwood announces that
> >"the worst of the world financial crisis is over." Leaving aside the
> >question of whether the underlying economic crisis is over, one is must ask
> >what Doug's definition of crisis is. If the world's markets are at record
> >levels, including the battered Asian markets, but the level of economic
> >activity is at Great Depression levels for most of the world, then does the
> >term "crisis" have relevance?