20 years after the East Asia crash: is history repeating itself?

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20 years ago this month, a run on the Thai currency triggered a financial crisis that quickly devastated the economy of the entire region, sinking the currencies of Thailand, Indonesia and South Korea and ultimately spreading as far as Russia and Brazil. Far from ‘lessons being learned’, however, history looks worryingly set to repeat itself.

On 2nd July 1997, Thailand’s Prime Minister Chavalit Yongchaiyudh announced that the baht, would be freely floated. The Thai government lacked the foreign exchange reserves necessary to continue pegging the currency to the US dollar – and the result was a collapse of the baht to less than half its former value.

The contagion quickly spread to Thailand’s neighbours as panicked investors began selling off their stocks in other East Asian currencies. Within months, noted the Financial Times on the 2nd January 1998, the crisis had “laid waste to what was once the most dynamic part of the world economy”, leading to a collapse of the currencies of Indonesia, Malaysia, the Philippines, and South Korea. Later that year, the economies of Russia and Brazil were seriously hit by the impact of the crisis on commodity prices, triggering crises of their own.

Across the region, economic devastation reigned. Unable to refinance their debts, companies of all sizes had their loans called in. But the collapse of their currencies meant that the value of these debts – denominated in dollars – had increased exponentially. A wave of bankruptcies drove unemployment through the roof, whilst governments hit by declining tax revenues – and IMF-imposed austerity – were forced to cut back on social safety nets. At the same time, the collapse of currency values led to rapid inflation, forcing up prices of basic essentials such as food and fuel. Poverty rates ramped up – and in Indonesia, the resulting social unrest even led to the overthrow of the government.

What had caused this devastation? In the years preceding the crash, the economies of East Asia had, under IMF tutelage, removed capital controls. This, in turn, had led to an influx of ‘hot money’ into those economies, as low returns in the developed world prompted investors to seek capital outlets elsewhere. As the Financial Times noted in January 1998, “between 1992 and 1996 net private capital flows to Asian developing countries jumped from $21bn to $101bn. …What caused the inflow was largely the search for better returns by investors made insensitive to risk and hungry for profit by the western bull market.” Those investors had been especially encouraged by the 1993 World Bank report “The East Asian miracle” praising the growth those countries had achieved. To keep their exports competitive, they had pegged their currencies to – then undervalued – dollar. But things turned sour when the so-called ‘reverse Plaza accord’ of 1995 brought about a major appreciation of the dollar, decimating the exports of the East Asian economies. It took a while for this to ‘filter through’ to investors, but once it became clear that East Asian currencies and stocks were overvalued, the herd mentality took over. “As usual,” wrote the FT, “mania ended in panic”.

Thailand, Indonesia and South Korea were all forced to take billions of dollars in emergency loans from the IMF – coming, of course, with strict conditions, which exacerbated the crisis. As is standard with the IMF, recipient governments were forced to adopt strict austerity measures, which preventing them from doing anything to stimulate demand. But they were also forced to abolish all barriers on foreigners purchasing assets such as banks and property. As a result, Western capital was able to swoop in and buy up Asian infrastructure – some of the most modern plant and machinery in the world – for pennies on the dollar, as companies unable to meet their dollar debts were forced to sell their assets at rock-bottom prices. As Wade and Veneroso wrote, “the combination of massive devaluations, IMF-pushed financial liberalisation, and IMF-facilitated recovery may have precipitated the biggest peacetime transfer of assets from domestic to foreign owners in the past fifty years anywhere in the world”. For Professor Radhika Desai, this was “the most impressive exercise of US power the world had seen in some time”, providing, in the words of Peter Gowan, “a welcome boost for the US financial markets and through them for the US domestic economy” as “capital flows bypassed emerging-economy financial markets and went directly into the upward-moving US bond and stock markets” (Desai). Western policy had facilitated the crisis, exacerbated it, and profited immensely from it: for, as Peter Gowan has noted, “the US economy depends…upon constantly reproduced international monetary and financial turbulence” – whilst Wall St in particular “depends upon chaotic instabilities in ‘emerging market’ financial systems”.

With the western world poised to ramp up interest rates, could it be that we are again on the verge of just such an episode? The parallels are worrying.

First of all, just as during the years prior to 1997, the past decade has seen a massive influx of capital into the developing world, exacerbated by the British-US-German-Japanese ‘quantitative easing’ (QE) programmes. According to the world bank, “Over the four-year period between mid-2009 and the first quarter of 2013 [ie the first four years of the QE experiment], cumulative gross financial inflows into the developing world rose from $192 billion to $598 billion”, which, it noted, was “more than twice the pace compared to the far more modest increase of $185 billion between mid-2002 and the first quarter of 2006”.  Former foreign secretary of India, Shyam Saran, warned of the potentially destabilising effects of this influx back in 2013: “According to one estimate, about 40 percent of the increase in the U.S. monetary base in the QE-1 phase leaked out in the form of increased gross capital outflows, while in the QE-2 phase, it may have been about one-third. This massive and continuing surge of capital outflows to emerging and other developing economies is having a major impact. Corporations, which have a sound credit rating, are taking on more debt, and increasing their foreign exchange exposure, attracted by low borrowing costs. Their vulnerability to future interest rate changes in the developed world and exchange rate volatility will increase.” The Daily Telegraph has also picked up on this vulnerability, noting that “Nobody knows what will happen when the spigot of cheap dollar liquidity is actually turned off. Dollar debts outside US jurisdiction have ballooned from $2 trillion to $9 trillion in fifteen years, leaving the world more dollarised and more vulnerable to Fed action than at any time since the fixed exchange system of the Gold Standard.” Even the World Bank have admitted that the reversal of QE “is a central concern for developing economies, which have struggled to cope with the surge in financial inflows that they have experienced over the past several years, and are fearful that the renormalization of high income monetary policies will be accompanied by a disorderly sudden stop in capital inflows.” Later in their study, they conclude that “These fears were not unfounded”. Just as during the pre-1997 period, emerging markets are dangerously leveraged, with the influx of ‘hot money’ into the developing world leaving it exceptionally vulnerable to any action that might reverse this flow. And such action is almost certainly on the cards.

On July 18th, the Times’ economics editor Philip Aldrick wrote that “In two months’ time, the US Federal Reserve is expected to begin the next phase in the greatest economic experiment of modern times. America’s central bank has signalled that it may start unwinding quantitative easing in September with the piecemeal sale of the $3.5trn of bonds bought since QE’s 2008 launch. No one quite knows what happens next, but the gloomiest predict another financial maelstrom. One thing is certain. Borrowing costs will rise”. Indeed, he writes, “it’s already happening. Government bond yields, used to price everything from fixed rate mortgages to corporate loans to pension schemes, have jumped. Since June, the yield on ten-year UK gilts has risen from below 1% to 1.275%. The same is happening in US and German bonds.

Against the backdrop of automatic global monetary tightening, a Fed decision to flood the market with more bonds would lift borrowing costs even higher.” In other words, we are entering an era of rising effective interest rates exactly like that which prefigured the 1997 crisis.

A second parallel is that the debts being accumulated in the global South are, again, largely denominated in dollars. In 1997, this was devastating as it meant that, as local currencies dropped in value, their dollar debts effectively escalated by the same amount; had the debts been denominated in local currency, the number of bankruptcies would not have been nearly so large. To guard against a repeat scenario, therefore, the countries hit in 1997 began to issue debt only in their own currency: those wishing to invest would have to first convert their money into the local currency, and only then could they do so. As the years passed, however, complacency seems to have set in: to such an extent that, today, according to the Bank of International Settlements, non-bank borrowers in emerging markets have now accumulated more than $3 trillion in dollar-denominated debt. According to a report published by the Bank last year, “The accumulation of debt since the global financial crisis has left EMEs [emerging market economies] particularly vulnerable to capital outflows. As private sector borrowing has led to overheating in several large EMEs, the unwinding of imbalances may generate destabilizing dynamics.” The report goes on to note that around $340 billion of developing country debt will be maturing this year, “creating a potential default risk if investors start pulling money out of emerging markets”.

All the warning signs are there. Writing for Bloomberg, Lisa Abramowicz wrote in November 2016 that “the debt of developing economies is positioned uniquely for pain.” Noting Adair Turner’s warning that “the large increase of emerging-market debt, much of it denominated in dollars,” is one of the biggest risks in the financial system right now, she added, “All that money is owed to somebody, and a failure to pay it back will cause big ripple effects. So as emerging markets come under stress, bond investors around the world should take note. As the dollar continues to strengthen, it’s not a stretch to see how this developing-market debt selloff can worsen, having far-reaching consequences on markets around the world.”

Others have specifically drawn attention to the parallels with 1997. Reporting on a speech by Bill Dudley, head of the New York Fed, the Telegraph noted that he had “hinted that the Fed may opt for the fast tightening cycle of the mid-1990s, an episode that caught markets badly off guard and led to the East Asia crisis and Russia’s default.” And the above quoted former foreign secretary of India, Shyam Saran, warned that The Asian financial crisis of 1997/98 was, in part, triggered by an earlier version of QE pursued by Japan in the aftermath of the bursting of its property and asset bubble in the early 1990s. Then, too, the large inflow of low-cost yen loans led to the asset price bubbles, inflationary pressures and currency instability in the Asian economies.”

Of course, triggering a new crisis by ramping up interest rates and selling off bonds – precisely at a time when a large portion of developing world debts are maturing – would hurt the West as well. Yet this seems to be precisely what is being planned. Because if a new crisis is inevitable – and I believe the inherent capitalist tendency towards overproduction means it is – it makes perfect sense to time it at a moment when the global South will be forced to bear the brunt. And, even if the US it hit, so long as everyone else is hit harder, that is a net gain for US power. As the Telegraph noted, “The US is perhaps strong enough to withstand the rigours of monetary tightening. It is less clear whether others are so resilient.” And, says Abramowicz, “While bonds globally are posting some of the biggest losses on record, debt of U.S., Germany, Japan and other large economies will eventually have natural buyers that can swoop in and support values.”

Fans of Breaking Bad will remember the memorable scene in which drug lord Gus Fring arrives at the mansion of his arch rival Don Eladio with a bottle of poisoned tequila disguised as a peace offering. Eladio is suspicious, so to prove its purity, Gus drinks the first shot. Whilst the rest of the cartel are poisoning themselves, he heads to the bathroom to make himself sick. After nearly dying, he eventually recovers – whilst his rivals’ corpses  lay strewn around the swimming pool. Is the US hoping to pull the same stunt – choking themselves, but fatally throttling everyone else in the process, so they can swoop in and pick up the pieces? It wouldn’t be the first time.

This article originally appeared on RT.com

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Quantitative Easing – the most opaque wealth transfer in history

 

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“Where did the quantitative easing money go? The answer in a graph” – from Tax Research UK

It appears that the massive, almost decade-long, transfer of wealth to the rich known as ‘quantitative easing’ is coming to an end. Of the world’s four major central banks – the US federal reserve, the Bank of England, the European Central Bank and the Bank of Japan – two have already ended their policy of buying up financial assets (the Fed and the BoE) and the ECB plans to stop doing so in December. Indeed, the Fed is expected to start selling off the $3.5trillion of assets it purchased during three rounds of QE within the next two months.

Given that, judged by its official aims, QE has been a total failure, this makes perfect sense. QE, by ‘injecting’ money into the economy, was supposed to get banks lending again, boosting investment and driving up economic growth. But overall bank lending in fact fell following the introduction of QE in the UK, whilst lending to small and medium sized enterprises (SMEs) – responsible for 60% of employment – plummeted. As Laith Khalaf, a senior analyst at Hargreaves Lansdown, has noted: “Central banks have flooded the global economy with cheap money since the financial crisis, yet global growth is still in the doldrums, particularly in Europe and Japan, which have both seen colossal stimulus packages thrown at the problem.” Even Forbes admits that QE has “largely failed in reviving economic growth”.

 

This is, or should be, unsurprising. QE was always bound to fail in terms of its stated aims, because the reason banks were not funnelling money into productive investment was not because they were short of cash – on the contrary, by 2013, well before the final rounds of QE, UK corporations were sitting on almost£1/2trillion of cash reserves – but rather because the global economy was (and is) in a deep overproduction crisis. Put simply, markets were (and are) glutted and there is no point investing in producing for glutted markets.

This meant that the new money created by QE and ‘injected’ into financial institutions such as pension funds and insurance companies was not invested into productive industry, but rather went into stock markets and real estate, driving up prices of shares and houses, but generating nothing in terms of real wealth or employment.

Holders of assets such as stocks and houses, therefore, have done very well out of QE, which has increased the wealth of the richest 5% of the UK population by an average of £128,000 per head.

How can this be? Where does this additional wealth come from? After all, whilst money – contrary to Tory sloganeering – can indeed be created ‘out of thin air’, which is precisely what QE has done, real wealth cannot. And QE has not produced any real wealth. Yet the richest 5% now have an extra £128,000 to spend on yachts, mansions, diamonds, caviar and so on – so where has it come from?

The answer is simple. The wealth which QE has passed to asset-holders has come, first of all, directly out of workers’ wages. QE, by effectively devaluing the currency, has reduced the buying power of money, leading to an effective decrease in real wages, which, in the UK, still remain 6% below their pre-QE levels. The money taken out of workers’ wages therefore forms part of that £128,000 divided. But it has also come from new entrants to the markets inflated by QE – primarily, first time buyers and those just reaching pension age. Those buying a house which QE has made more expensive, for example, will likely have to work thousands of additional hours over the course of their mortgage in order to pay this increased cost. It is those extra hours that are creating the wealth which subsidises the yachts and diamonds for the richest 5%. Of course, these increased house prices are paid by anyone purchasing a house, not only first time buyers – but the additional cost for existing homeowners is compensated for by the rise in price of their existing house (or by their shares for those wealthy enough to hold them).

QE also means that newly retiring pensioners are forced to subsidise the 5%. New retirees use their pension pot to purchase an ‘annuity’ – a bundle of stocks and shares generating dividends which serve as an income. However, as QE has inflated share prices, the number of shares they can buy with this pot is reduced. And, as share price increases do not increase dividends, this means reduced pension payments.

In truth, the story that QE was about encouraging investment and boosting employment and growth was always a fantastical yarn designed to disguise what was really going on – a massive transfer of wealth to the rich. As economist Dhaval Joshi put it in 2011: “The shocking thing is, two years into an ostensible recovery, [UK] workers are actually earning less than at the depth of the recession. Real wages and salaries have fallen by £4bn. Profits are up by £11bn. The spoils of the recovery have been shared in the most unequal of ways.” In March this year, the Financial Times noted that whilst Britain’s GDP had recovered to pre-crisis levels by 2014, real wages were still 10% lower than they had been in 2008. “The contraction of UK real wages was reversed in 2015,” they added, “but it is not going to last”. They were right. The same month the article was published, real wages began to fall again, and have been doing so ever since.

It is the same story in Japan, where, notes Forbes, “household income actually contracted since the implementation of QE”.

QE has had a similar effect on the global South: enriching the holders of assets at the expense of the ‘asset-poor’. Just as the influx of new money created bubbles in the housing and stock markets, it also created commodity price bubbles as speculators rushed to buy up stocks of, for example, oil and food. For some oil producing countries this has had a positive effect, providing them a windfall of cash to spend on social programmes, as was initially the case in, for example, Venezuela, Libya and Iran. In all three cases, the empire has had to resort to various levels of militarism to counter these unintended consequences. But oil price hikes are, of course, detrimental to non-oil-producing countries – and food price hikes are always devastating. In 2011, the UK’s Daily Telegraph highlighted “the correlation between the prices of food and the Fed’s purchase of US Treasuries (i.e. its quantitative easing programmes)…We see

how the food price index broadly stabilised through late 2009 and early 2010, then rose again from mid-2010 as quantitative easing was re-started …with prices rising about 40% over an eight month period.” These price hikes pushed 44 million people into poverty in 2010 alone – leading, argued the Telegraph, to the unrest behind the so-called Arab Spring. Former World Bank president Robert Zoellick commented at the time that

“Food price inflation is the biggest threat today to the world’s poor…one weather event and you start to push people over the edge.” Such are the costs of quantitative easing.

The BRICS economies were also critical of QE for another reason: they saw it as an underhand method of competitive currency devaluation. By reducing the value of their own currencies, the ‘imperial triad’ of the US, Europe and Japan were effectively causing everyone else’s currencies to appreciate, damaging their exports. This is exactly what happened: wrote Forbes in 2015, “The effects are already being felt in the most dynamic exporter in the world, the East Asian economies. Their exports in US dollar terms moved dramatically from 10% year-on-year growth to a contraction of 12% in the first half of this year; and the results are the same whether China is excluded or not.”
The main benefit of QE to the developing world is supposed to have been the huge inflows of capital it triggered. It has been estimated that around 40% of the money generated by the Fed’s first QE credit expansion (‘QE1’) went abroad – mostly to the so-called ‘emerging markets’ of the global South – and around one third from QE2. However, this is not necessarily the great boon it seems. Much of the money went, as we have seen, into buying up commodity stocks (making basic items such as food unaffordable for the poor) rather than investing in new production, and much also went into buying up stocks of currency, again causing an export-damaging appreciation. Worse than this, an influx of so-called ‘hot money’ (footloose speculative capital, as opposed to long term investment capital) makes currencies particularly volatile and vulnerable to, for example, rises in interest rates abroad. Should interest rates rise again in the US and Europe, for example, this is likely to trigger a mass exodus of capital from the emerging markets, potentially prefigurng a currency collapse. Indeed, it was an influx of ‘hot money’ into Asian currency markets very similar to that seen during QE which preceded the Asian currency crisis of 1997. It is precisely this vulnerability which is likely to be tested – if not outright exploited – by the coming end of QE and accompanying rise of interest rates.

This article originally appeared on RT