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Old Thursday, October 13, 2005
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Dollar hegemony against sovereign credit

Global trade has forced all countries to adopt a market economy. Yet the market is not the economy. It is only one aspect of the economy.

A market economy can be viewed as an aberration of human civilization, as economist Karl Polanyi (1886-1964) pointed out. The principal theme of Polanyi's Origins of Our Time: The Great Transformation (1945) was that market economy was of very recent origin and had emerged fully formed only as recently as the 19th century, in conjunction with capitalistic industrialization. The current globalization of markets that followed the fall of the Soviet bloc is also of recent post-Cold War origin, in conjunction with the advent of the electronic information age and deregulated finance capitalism. A severe and prolonged depression could trigger the end of the market economy, when intelligent human beings are finally faced with the realization that the business cycle inherent in the market economy cannot be regulated sufficiently to prevent its innate destructiveness to human welfare and are forced to seek new economic arrangements for human development. The principle of diminishing returns will lead people to reject the market economy, however sophisticatedly regulated.

Prior to the coming of capitalistic industrialization, the market played only a minor part in the economic life of societies. Even where marketplaces could be seen to be operating, they were peripheral to the main economic organization and activities of society. In many pre-industrial economies, markets met only twice a month. Polanyi argued that in modern market economies, the needs of the market determined social behavior, whereas in pre-industrial and primitive economies the needs of society determined market behavior. Polanyi reintroduced to economics the concepts of reciprocity and redistribution in human interaction, which were the original aims of trade.

Reciprocity implies that people produce the goods and services they are best at and enjoy producing the most, and share them with others with joy. This is reciprocated by others who are good at and enjoy producing other goods and services. There is an unspoken agreement that all would produce that which they could do best and mutually share and share alike, not just sold to the highest bidder or, worse, to produce what they despise to meet the demands of the market. The idea of sweatshops is totally unnatural to human dignity and uneconomic to human welfare. With reciprocity, there is no need for layers of management, because workers happily practice their livelihoods and need no coercive supervision. Labor is not forced and workers do not merely sell their time in jobs they hate, unrelated to their inner callings. Prices are not fixed but vary according to what different buyers with different circumstances can afford or what the seller needs in return from different buyers. The law of one price is inhumane, unnatural, inflexible and unfair. All workers find their separate personal fulfillment in different productive livelihoods of their choosing, without distortion by the need for money. The motivation to produce and share is not personal profit, but personal fulfillment, and avoidance of public contempt, communal ostracism, and loss of social prestige and moral standing.

This motivation, albeit distorted today by the dominance of money, is still fundamental in societies operating under finance capitalism. But in a money society, the emphasis is on accumulating the most financial wealth, which is accorded the highest social prestige. The annual report on the world's richest 100 as celebrities by Forbes is clear evidence of this anomaly. The opinions of figures such as Bill Gates and Warren Buffet are regularly sought by the media on matters beyond finance, as if the possession of money itself represents a diploma of wisdom. In the 1960s, wealth was an embarrassment among the flower children in the US. It was only in the 1980s that the age of greed emerged to embrace commercialism.

In a speech on June 3 at the Take Back America conference in Washington, DC, Bill Moyers drew attention to the conclusion by the editors of The Economist, all friends of business and advocates of capitalism and free markets, that "the United States risks calcifying into a European-style class-based society". A front-page editorial in the May 13 Wall Street Journal concluded that "as the gap between rich and poor has widened since 1970, the odds that a child born in poverty will climb to wealth - or that a rich child will fall into middle class - remain stuck ... Despite the widespread belief that the US remains a more mobile society than Europe, economists and sociologists say that in recent decades the typical child starting out in poverty in continental Europe (or in Canada) has had a better chance at prosperity." The New York Times ran a 12-day series this month under the heading "Class Matters" that observed that class is closely tied to money in the US and that "the movement of families up and down the economic ladder is the promise that lies at the heart of the American dream. But it does not seem to be happening quite as often as it used to." The myth that free markets spread equality seems to be facing a challenge in the heart of market fundamentalism.

People trade to compensate for deficiencies in their current state of development. Free trade is not a license for exploitation. Exploitation is slavery, not trade. Imperialism is exploitation by systemic coercion on an international level. Neo-imperialism after the end of the Cold War takes the form of neo-liberal globalization of systemic coercion. Free trade is hampered by systemic coercion. Resistance to systemic coercion is not to be confused with protectionism. To participate in free trade, a trader must have something with which to trade voluntarily in a market free of systemic coercion. All free trade participants need to have basic pricing power that requires that no one else commands monopolistic pricing power. That tradable something comes from development, which is a process of self-betterment. Just as equality before the law is a prerequisite for justice, equality in pricing power in the market is a prerequisite for free trade. Traders need basic pricing power for trade to be free. Workers need pricing power for the value of their labor to participate in free trade.

Yet trade in a market economy by definition is a game to acquire overwhelming pricing power over one's trading partners. Wal-Mart, for example, has enormous pricing power both as a bulk buyer and as a mass retailer. But it uses its overwhelming pricing power not to pay the highest wages to workers in factories and in its stores, but to deliver the lowest price to its customers. The business model of Wal-Mart, whose sales volume is greater than the gross domestic product (GDP) of many small countries, is anti-development. The trade-off between low income and low retail price follows a downward spiral. This downward spiral has been the main defect of trade deregulation when low prices are achieved through the lowering of wages. The economic purpose of development is to raise income, not merely to lower wages to reduce expenses by lowering quality. International trade cannot be a substitute for domestic development, or even international development, although it can contribute to both domestic and international development if it is conducted on an equal basis for the mutual benefit of both trading partners. And the chief benefit is higher income.

The terms of international trade need to take into consideration local conditions, not as a reluctant tolerance but with respect for diversity. The former Japanese vice finance minister for international affairs, Eisuke Sakakibara, in a speech titled "The End of Market Fundamentalism" before the Foreign Correspondent's Club in Tokyo on January 22, 1999, presented a coherent and wide-ranging critique of global macro-orthodoxy. His view, that each national economic system must conform to agreed international trade rules and regulations but need not assimilate the domestic rules and regulations of another country, is heresy to US-led, one-size-fits-all globalization. In a computerized world where output standardization has become unnecessary, where the mass production of customized one-of-a-kind products is routine, one-size-fits-all hegemony is nothing more than cultural imperialism. In a world of sovereign states, domestic development must take precedence over international trade, which is a system of external transactions made supposedly to augment domestic development. And domestic development means every nation is free to choose its own development path most appropriate to its historical conditions and is not required to adopt the US development model. But neo-liberal international trade since the end of the Cold War has increasingly preempted domestic development in both the center and the periphery of the world system. Quality of life is regularly compromised in the name of efficiency.

This is the reason the French and the Dutch voted against the European Union constitution, as a resistance to the US model of globalization. Britain has suspended its own vote on the constitution to avoid a likely voter rejection. In Italy, cabinet ministers suggested abandoning the euro to return to an independent currency in order to regain monetary sovereignty. Bitter battles have erupted among member nations in the EU over national government budgets and subsidies. In that sense, neo-liberal trade is being increasingly identified as an obstacle, even a threat, to diversified domestic development and national culture.

Global trade has become a vehicle for exploitation of the weak to strengthen the strong both domestically and internationally. Culturally, US-style globalization is turning the world into a dull market for unhealthy McDonald's fast food, dreary Wal-Mart stores, and automated Coca-Cola and bank machines. Every airport around the world is a replica of a giant US department store with familiar brand names, making it hard to know which city one is in. Aside from being unjust and culturally destructive, neo-liberal global trade as it currently exists is unsustainable, because the perpetual transfer of wealth from the poor to the rich is no more sustainable than drawing from a dry well is sustainable in a drought, nor can stagnant consumer income sustain a consumer economy. Neo-liberal claims of fair benefits of free trade to the poor of the world, both in the center and the periphery, are simply not supported by facts. Everywhere, people who produce the goods cannot afford to buy the same goods for themselves and the profit is siphoned off to invisible investors continents away.

Trade and money

Trade is facilitated by money. Mainstream monetary economists view government-issued money as a sovereign-debt instrument with zero maturity, historically derived from the bill of exchange in free banking. This view is valid only for specie money, which is a debt certificate that entitles the holder to claim on demand a prescribed amount of gold or other specie of value. Government-issued fiat money, on the other hand, is not a sovereign-debt but a sovereign-credit instrument, backed by government acceptance of it for payment of taxes. This view of money is known as the State Theory of Money, or Chartalism. The US dollar, a fiat currency, entitles the holder to exchange for another dollar at any US Federal Reserve Bank, no more, no less. Sovereign government bonds are sovereign debts denominated in money. Sovereign bonds denominated in fiat money need never default since sovereign government can print fiat money at will. Local government bonds are not sovereign debt and are subject to default because local governments do not have the authority to print money. When fiat money buys bonds, the transaction represents credit canceling debt. The relationship is rather straightforward, but of fundamental importance.

Credit drives the economy, not debt. Debt is the mirror reflection of credit. Even the most accurate mirror does violence to the symmetry of its reflection. Why does a mirror turn an image right to left and not upside down as the lens of a camera does? The scientific answer is that a mirror image transforms front to back rather than left to right as commonly assumed. Yet we often accept this aberrant mirror distortion as uncolored truth and we unthinkingly consider the distorted reflection in the mirror as a perfect representation. Mirror, mirror on the wall, who is the fairest of them all? The answer is: your backside.

In the language of monetary economics, credit and debt are opposites but not identical. In fact, credit and debt operate in reverse relations. Credit requires a positive net worth and debt does not. One can have good credit and no debt. High debt lowers credit rating. When one understands credit, one understands the main force behind the modern finance economy, which is driven by credit and stalled by debt. Behaviorally, debt distorts marginal utility calculations and rearranges disposable income. Debt turns corporate shares into Giffen goods, demand for which increases when their prices go up, and creates what US Federal Reserve Board chairman Alan Greenspan calls "irrational exuberance", the economic man gone mad.

If fiat money is not sovereign debt, then the entire financial architecture of fiat-money capitalism is subject to reordering, just as physics was subject to reordering when man's world view changed with the realization that the Earth is not stationary nor is it the center of the universe. For one thing, the need for capital formation to finance socially useful development will be exposed as a cruel hoax. With sovereign credit, there is no need for capital formation for socially useful development in a sovereign nation. For another, savings are not necessary to finance domestic development, since savings are not required for the supply of sovereign credit. And since capital formation through savings is the key systemic rationale for income inequality, the proper use of sovereign credit will lead to economic democracy.

Sovereign credit and unemployment

In an economy financed by sovereign credit, labor should be in perpetual shortage, and the price of labor should constantly rise. A vibrant economy is one in which there is a persistent labor shortage and labor enjoys basic, though not monopolistic, pricing power. An economy should expand until a labor shortage emerges and keep expanding through productivity rises to maintain a slight labor shortage. Unemployment is an indisputable sign that the economy is underperforming and should be avoided as an economic plague.

The Phillips curve, formulated in 1958, describes the systemic relationship between unemployment and wage-pushed inflation in the business cycle. It represented a milestone in the development of macroeconomics. British economist A W H Phillips observed that there was a consistent inverse relationship between the rate of wage inflation and the rate of unemployment in the United Kingdom from 1861 to 1957. Whenever unemployment was low, inflation tended to be high. Whenever unemployment was high, inflation tended to be low. What Phillips did was to accept a defective labor market in a typical business cycle as natural law and to use the tautological data of the flawed regime to prove its validity, and made unemployment respectable in macroeconomic policymaking, in order to obscure the irrationality of the business cycle. That is like observing that the sick are found in hospitals and concluding that hospitals cause sickness and that a reduction in the number of hospitals will reduce the number of the sick. This theory will be validated by data if only hospital patients are counted as being sick and the sick outside of hospitals are viewed as "externalities" to the system. This is precisely what has happened in the United States, where an oversupply of hospital beds has resulted from changes in the economics of medical insurance, rather than a reduction of people needing hospital care. Part of the economic argument against illegal immigration is based on the overload of non-paying patients in a health-care system plagued with overcapacity.

Nevertheless, Nobel laureates Paul Samuelson and Robert Solow led an army of government economists in the 1960s in using the Phillips curve as a guide for macro-policy trade-offs between inflation and unemployment in market economies. Later, Edmund Phelps and Milton Friedman independently challenged the theoretical underpinnings by pointing out separate effects between the "short-run" and "long-run" Phillips curves, arguing that the inflation-adjusted purchasing power of money wages, or real wages, would adjust to make the supply of labor equal to the demand for labor, and the unemployment rate would rest at the real wage level to moderate the business cycle. This level of unemployment they called the "natural rate" of unemployment. The definitions of the natural rate of unemployment and its associated rate of inflation are circularly self-validating. The natural rate of unemployment is that at which inflation is equal to its associated inflation. The associated rate of inflation is that which prevails when unemployment is equal to its natural rate.

A monetary purist, Friedman correctly concluded that money is all-important, but as a social conservative, he left the path to truth half-traveled by not having much to say about the importance of the fair distribution of money in the market economy, the flow of which is largely determined by the terms of trade. Contrary to the theoretical relationship described by the Phillips curve, higher inflation was associated with higher, not lower, unemployment in the US in the 1970s and, contrary to Friedman's claim, deflation was associated also with high unemployment in Japan in the 1990s. The fact that both inflation and deflation accompanied high unemployment ought to discredit the Phillips curve and Friedman's notion of a natural unemployment rate. Yet most mainstream economists continue to accept a central tenet of the Friedman-Phelps analysis that there is some rate of unemployment that, if maintained, would be compatible with a constant rate of inflation. This they call the "non-accelerating inflation rate of unemployment" (NAIRU), which over the years has crept up from 4% to 6%.

NAIRU means that the price of sound money for the US is 6% unemployment. The US Labor Department reported the "good news" that in May 7.6 million persons, or 5.1% of the workforce, were unemployed in the United States, well within NAIRU range. Since low-income people tend to have more children than the national norm, that translates to households with more than 20 million children with unemployed parents. On the shoulders of these unfortunate, innocent souls rests the systemic cost of sound money, defined as having a non-accelerating inflation rate, paying for highly irresponsible government fiscal policies of deficits and a flawed monetary policy that leads to skyrocketing trade deficits and debts. That is equivalent to saying that if 6% of the world population dies from starvation, the price of food can be stabilized. And unfortunately, such are the terms of global agricultural trade. No government economist has bothered to find out what would be the natural inflation rate for real full employment.

It is hard to see how sound money can ever lead to full employment when unemployment is necessary to keep money sound. Within limits and within reason, unemployment hurts people and inflation hurts money. And if money exists to serve people, then the choice between inflation and unemployment becomes obvious. The theory of comparative advantage in world trade is merely Say's Law internationalized. It requires full employment to be operative.

............. TO BE CONTINUED .................
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If you prick us, do we not bleed?
If you tickle us, do we not laugh?
If you poison us, do we not die?
And if you wrong us, shall we not revenge?"

William Shakespeare, "The Merchant of Venice"

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