Wednesday, January 27, 2010

George Soros Lecture 10/30/2009 — The Way Ahead

George Soros Lecture 10/30/2009 — The Way Ahead

Below is a link to a lecture given by George Soros at the Central European University in October 2009. In it he articulates the current state of the global financial economy, and a clear notion of how we can move forward to restructure it. Anything in brackets are my own comments. You can watch the lecture here:

Here are some of the highlights:

  • We are at a moment in which the range of uncertainties is unusually wide.
  • What makes this financial crisis different from previous ones [i.e. the Japanese real estate bubble, or the Great Depression] is that this crisis involves the entire world.
  • The magnitude of the credit and leverage (debt) problem today is more than double what it was when the stock market crashed in 1929.
  • In spite of that, this time the financial system was not allowed to collapse [so far…]
  • The recovery is liable to run out of steam, possibly followed by a double-dip recession in 2010 or 2011.
  • The prevailing mood is far removed from reality; this is characteristic of far-from-equilibrium situations when perceptions tend to lag behind reality.
  • The disarray in the international financial system is matched by instability in international relations; the New Order that will eventually emerge will not be dominated by the U.S. to the same extent as the old one.
  • Financial markets are a branch of history, greatly influenced not just by economic theory, but also by politics, which establishes the rules and conditions in which the market operates.
  • There are two tiers to the international financial system: the center and the periphery. Those countries who can borrow in their own currency constitute the center, and those countries whose borrowing is denominated in one of the hard currencies constitute the periphery. While the rules for borrowing are similar for both tiers, if the center becomes endangered, then preserving the system takes precedence over all other considerations [especially consideration for the people in the periphery countries].
  • Previous international financial crises originated in debtor nations, whose bailouts were securitized by the banks, leading to harsh measures placed on the people of those nations, as well as financial discipline and bailouts of banks whose collective failure would have endangered the system.
  • The financial crisis of 2007-2008 was different because it originated at the center, and the periphery countries were drawn into it only later. The IMF did a good job in managing this crisis, which began mainly in the private sector.
  • The failure of Lehman Brothers was a game-changing event, leading to a crisis of faith in the system, and financial markets ceased to function. Countries in the center interceded, effectively guaranteeing that no other institutions whose failure could endanger the system would be allowed to fail.
  • That’s when it spread to the periphery, because those countries couldn’t provide equally credible guarantees. But the center pumped money into the system, engaging in deficit financing to simulate the global economy on an unprecedented scale, and the current view is that the situation is stabilizing, slowly returning to “business as usual”.
  • This is likely not to be the case; the system is broken, and cannot be put back together again. This is because it was based on a premise that allowed financial capital to move around freely in the world, making it difficult to tax or regulate. This put financial capital in a privileged position. Governments had to pay more attention to the requirements of international capital than to the aspirations of their own people. But this system ended up to be very unstable because it was based on the false premise that financial markets can be safely left to their own devices. This is why it broke, and why it can’t be put back together again.
  • Global markets need global regulations. But the current regulations are rooted in the principle of national sovereignty as the ultimate source of authority. This gives rise to financial protectionism, which is at odds with a global financial system.
  • Thus a new regulatory system that is international in scope needs to be created from scratch.
  • In the current picture, the U.S. stands to lose the most, and China stands to come out as the greatest winner.
  • The U.S. has been the de facto international currency ever since the second World War, and it has derived immense benefit from that position. But starting in the 1980s, it has built up an ever-increasing account deficit, which along with the excessive amount of private-sector debt [households, mortgages, etc.] has lead to this crisis. The banking system has suffered, and now needs to earn its way out of a hole. In commercial real estate and leveraged buyouts, the blood-letting is still to come.
  • Because of these factors, the American consumer will no longer serve as the motor for the world economy.
  • China, on the other hand, has been largely insulated from the financial crisis, being seen as an external event that has hurt exports, but left its financial, political and economic system unscathed.
  • China has discovered a remarkably efficient method of unleashing the creative, acquisitive, and entrepreneurial energies of the people, who are allowed to pursue their self-interest, while the state can cream off a significant  portion of the surplus value of their labor by maintaining an undervalued currency and accumulating a trade surplus. So China is likely to emerge as the big winner.
  • At the same time, China’s command-and-control economy must also avoid social unrest if it wants to remain stable, and needs to keep its economic growth rate at a minimum of eight percent in order to create new jobs for a growing workforce. Its internal stimulus programs can be a smaller motor for the world economy. This is a tectonic shift, as other countries reorient themselves towards the source of positive impulses. This may not be permanent or irreversible, but it represents the most predictable and significant trend in the global political economy.
  • While China is practicing “state capitalism”, the rest of the world is currently under the auspices of the “Washington Consensus” of “international capitalism.” These two systems are in competition with one another. Each has its pros and cons. The Washington Consensus has failed – international capitalism in its present form has proven itself inherently unstable because it lacks adequate regulation. It’s also highly unjust because it favors the ‘haves’ over the ‘have-nots’.
  • At the same time, an international system based on state capitalism would inevitably lead to conflicts between states. The first signs of conflict are already beginning to surface, because, ironically, China is repeating the mistakes of the colonial powers in dealing with the countries that are rich in natural resources, just at the time when the colonial powers have learned from their past mistakes and are trying to rectify them. In order to gain access to natural resources, China is dealing with the rulers, and neglecting their people. This helps oppressive and corrupt regimes to stay in power. [China is quick to rebuff any objections to this approach from ex-colonial powers who did the same thing not to long ago.]
  • This has pushed China into dealing with those countries that the international financial institutions have shunned… Burma, Sudan, Zimbabwe, the Congo, Angola and Guinea are examples.
  • China prefers to expand on a bilateral basis, dealing with each country individually rather than with the international financial system. It does this at the same time as it is pegging its currency to the U.S. dollar, which keeps it very low, allowing the Chinese government to harvest the fruits of cheap Chinese labor through its undervalued currency. China is also promoting the use of Special Drawing Rights (SDRs) rather than the U.S. dollar as the basis for an international currency.
  • A new multilateral system based on sound and fair global principles is required, rather than trying to change the existing system, which is mired in existing legal and power structures which are very difficult to change. It would bring those countries who are in ascendance to the table as equals, and relinquish power of those countries who were powerful back when the existing system was created, but who are no longer as powerful.
  • We do need an alternative financial currency to the U.S. dollar such as SDRs, which are denominated in a range of national currencies. This would remove the dollar’s special and unfair advantage, but it could be done very slowly, and with that alternative, the dollar could still re-establish itself as the preferred single reserve currency, provided it’s prudently managed.
  • SDRs can be used to allow the international creation of money, which would be useful at times like the present.
  • Both the U.S. and China would benefit from such a strategy, if their leadership were far-sighted enough to see that neither will survive under the current circumstances… and both need each other in any kind of future world order.
  • The U.S. economy, as well as democracy, is in deep trouble in America. The financial crisis has inflicted hardship on a population that doesn’t like to face harsh realities. President Obama has deployed the confidence multiplier and claims to have contained the recession. If there is a double-dip recession, the population will become susceptible to all kinds of fear-mongering and populist demagogy. If President Obama fails, the next administration will be sorely tempted to create diversions from troubles at home, and that could be very dangerous for the world.
  • What is needed is the recognition by the U.S., China, and the world, that the system is broken and needs to be reinvented. Every country must rise to the occasion and do the difficult political work of changing their own sovereign systems to create a world that works for everyone. It is no exaggeration to say that the future of the world depends on it.

No comments: