The Financialization of America and Currency Wars in China

We have been describing this phenomenon of the outsized growth of the financial component of the US economy and the distortions which this has produced throughout society for some time. Kevin Phillips description seems sound, and his talk "Bad Money" listed in the 'Apertifs' section of this blog. Greta Krippner of UCLA has a decent description as well.

Change is clearly in the air with the ascent of the candidacy of Barrack Obama. Our macro forecast from 2005 predicted the Bush Administration would take its policies to such an extreme that they would likely bring down the Republican party for many years, similar to that which occurred in the 1930s. The Republicans did not regain power until Eisenhower after the War.

Trends tend to extremes and then correct. Let's see if we get a solid Democratic lineup in the Executive and the Congress. We're not saying this is what we prefer; we are trying to assess the likely impacts of exogenous events on the economic environment. But change is in the air.

Currency War - The China Weekly

We can't help but note in passing that one of the best selling books in the emerging economy of the People's Republic of China is Currency Wars by Song Hongbing.

The thesis of this book is that: "the financial history of the world is simply a tale of conspiracies seeking domination and the uneven distribution of wealth in favor of the rich. He concludes that China should be prepared to fight ‘bloodless wars’ waged by evil forces like the US Federal Reserve aimed at destroying China’s economy.”

[this translation is poor] "Song is not denying his view that all Chinese families should produce 3% -5% of revenue to purchase gold in kind, to add their wealth with insurance, because when real turbulence come, we can guarantee wealth, rather than any government-issued letter with notes. In fact, when the government trusted, issued currency is valuable, and when the government was not strong sense of trust, it will devalue the currency, or even worthless."

Despite being dismissed as a conspiracy whacko by the Western press, his ideas seems to be finding fertile ground with millions of Chinese. His analysis seems naive given his reported concentration on the role of the Rothschilds as the center of the banking cartel, which is probably the stuff of the fringe Internet. We are not comfortable commenting on this or on the book further because there are no English translations to be found, even though it is in the top ten best sellers in China. We'll reserve our opinion until the translation is available in whole, but note again its huge popularity in China.

If millions of Chinese families start acting on his prescriptions for a gold and silver based producing economy with a strong yuan we'll call that irony enough to give any financial elite a headache.

Financialization is a relatively new term used to discuss the emergence of a new form of capitalism in which financial markets dominate over the traditional industrial economy.

Greta Krippner of the University of California - Los Angeles has written that “financialization” refers to a “pattern of accumulation in which profit making occurs increasingly through financial channels rather than through trade and commodity production.”

More popularly, however, financialization is understood to mean the vastly expanded role of financial motives, financial markets, financial actors and financial institutions in the operation of domestic and international economies.

In his 2006 book, American Theocracy: The Peril and Politics of Radical Religion, Oil, and Borrowed Money in the 21st Century, American writer and commentator Kevin Phillips presented financialization as “a process whereby financial services, broadly construed, take over the dominant economic, cultural, and political role in a national economy.” (page 268).

Change is in the air for financial superclass
By David Rothkopf
The Financial Times
Published: May 15 2008 19:26

Of the world’s elites, none has flown higher than those who have led the financial community. The re-engineering of international finance has been one of the transformational trends of our times – in just a quarter-century, capital flows became massive, instantan­eous and controlled by a new breed of traders representing a handful of major financial institutions from a few countries. Their rewards have transcended any in history as shown by an estimate by Alpha Magazine that the top hedge fund manager last year made $3billion.

The concentration of power has also steadily grown. The top 50 financial institutions control almost $50,000bn (£25,600bn) in assets, roughly a third of the global total. Ten thousand hedge funds are estimated to account for 30-50 per cent of all equities trading worldwide but the top 100 control 60 per cent of hedge fund assets. When crises arise, regulators have been forced to seek the collaboration of the heads of the biggest institutions on a more or less voluntary basis. Typically, of the few they approach, the key executives are in the US and Europe, underscoring the transatlantic nature of this elite.

Change, however, is in the air. The history of elites is one of their rising up, over-reaching, being reined in and supplanted by a new elite. Several recent developments suggest that the financial crisis could signal the high-water mark of power for this group.

First, the crisis is prompting a re-regulatory drive. The power of financial elites had been evident in their ability to argue that global financial markets and markets in new securities should remain “self-regulating” (how many of them would hop into a self-regulating taxicab?), then when crisis comes – as with mortgage-backed securities – these champions of less government involvement have then persuaded governments to cauterise their wounds.

Now, however, there are encouraging, if preliminary, signs of a push towards more effective collaboration between governments – the first steps towards creating the much needed checks on global markets that exist within nations. This could erode the agility of financial elites to play governments off against each other, with the weakest regulator setting the rules.

Second, the credit crisis is exacerbating the emerging backlash against corporate excess . Elites make billions on markets whether they go up or down and their institutions win government support while the little guy loses his home. Multinational chief executives 30 years ago made 35 times the wages of an average employee; today it is more than 350 times.

The crisis has focused attention on the obscene inequities of this era – the world’s 1,100 richest people have almost twice the assets of the poorest 2.5bn. There are signs of open and growing anger at this, as we have seen this week in the Netherlands with calls to address bonuses, and the attack on the world’s financial markets as “a monster that must be tamed” from Horst Köhler, the German president.

Third, the accumulation of financial reserves in the Persian Gulf, Russia and China underscores that the centre of gravity in global finance is also shifting. If gas prices remain high and Asian growth strong, sovereign wealth funds, which are concentrated in these regions, are forecast to surpass $15,000bn within a few years. The top creators of great new personal fortunes are in China, India and Russia. It seems unavoidable that the transatlantic elite that have been the habitués of Davos will be rivalled in influence by the Asian contingent – a group that has as little appetite for the Alpine gabfest as for the values and priorities of the western financial superclass.

So, are we at the beginning of the end of a golden era for transatlantic financial elites? Perhaps, but elites cede power reluctantly and there are signs of an effort to stave off decline. There is now a recognition of the need to accept some global market reforms to avoid more invasive legislation. Far-sighted leaders such as Tom Russo, Lehman Brothers vice-chairman, have actively encouraged changes in the way markets are supervised. Institutional investors could play a role by demanding more sensible pay packages from money managers. The rise of Asia probably cannot be resisted. But by recognising that there are public interests to which they must respond, the financial superclass can stall the fate of previous elites. To succeed at that they must shun their arrogant “leave-it-to-the-market” explanations for the inequality they have helped foster.

The writer is author of Superclass: The Global Power Elite and the World They are Making, and is a visiting scholar at the Carnegie Endowment for International Peace

The Worst of the Credit Crisis May Not Be Over - Scholes

Scholes, Nobel Laureate, Says Credit Crisis May Not Be Over
By Vivien Lou Chen and Thomas R. Keene

May 16 (Bloomberg) -- Myron Scholes, chairman of Platinum Grove Asset Management LP and 1997 winner of the Nobel Prize in economics, said the worst of the crisis in credit markets may not be over.

``From my perspective, I think that we don't know if the storm has passed or if we are still in the eye of the storm,'' Scholes said in an interview with Bloomberg Radio yesterday. ``Are there other shoes to drop and new events or new shocks that will come to the fore?''

Scholes's warning reflects financial markets that Federal Reserve Chairman Ben S. Bernanke this week said remain ``far from normal.'' Financial institutions have been reluctant to lend to each other, driving up bank borrowing costs, since a flight from risk in August sparked by defaults on subprime mortgages.

``In my view, this is probably as bad or worse than the 1989-1990 crisis and may even rival the worst crisis we've seen since the end of the Second World War,'' Scholes said. Former Fed Chairman Alan Greenspan has also said the turmoil is the most ``wrenching'' since the war.

Scholes, 66, and Robert Merton won the Nobel Prize for economics in 1997 for their work in valuing options. His firm, Platinum Grove, is based in Rye Brook, New York.

To contact the reporters on this story: Vivien Lou Chen in San Francisco at vchen1@bloomberg.net; Thomas Keene in New York at tkeene@bloomberg.net

The Roots of Our Financial Crisis: False Stewards and Careless Greed

Critics of derivatives often raise the specter of the failure of one dealer imposing debilitating losses on its counterparties, including other dealers, yielding a chain of defaults. However, derivatives market participants seem keenly aware of the counterparty credit risks associated with derivatives and take various measures to mitigate those risks."

"The use of a growing array of derivatives and the related application of more-sophisticated methods for measuring and managing risk are key factors underpinning the enhanced resilience of our largest financial intermediaries."

"…the success [of derivatives] to date clearly could not have been achieved were it not for counterparties' substantial freedom from regulatory constraints on the terms of OTC contracts. This freedom allows derivatives counterparties to craft contracts that transfer risks in the most effective way to those most willing and financially capable of absorbing them." Alan Greenspan, 2003

So, Sir Alan just was not aware of the potential for a single counterparty to inflict systemic risk on the broader markets? How could he have known this. This is why he opposed the imposition of almost any regulatory oversight on the derivatives markets and hedge funds. He just didn't know, right?

Is this why he could argue with a straight face that a lack of margin requirements or minimum capital rules on derivatives positions would "promote the safety and soundness of broker-dealers, by permitting more financing alternatives and hence, more effective liquidity management."

Or one might ask, did he know of the danger, but just did not care for whatever reason?

"Had the failure of LTCM triggered seizing up of markets, substantial damage could have been inflicted on many market participants, including some not directly involved with the firm, and could have potentially impaired the economies of many nations, including our own." Alan Greenspan in 1998 Fallen Star: Greenspan's Testimony Before Congress on the Fed's involvement with LTCM

As Charles R. Morris observes in his brilliantly entertaining and informative book "The Trillion Dollar Meltdown"

"In other words, counterparty surveillance works fine, so long as you're willing to accept the occasional crash of the economies of many nations. But given the enormous rewards that accrue to top-of-the-food-chain players... true market-believers may find that a cheap enough price."

In other words if you are counting the profits as enormous personal riches to your own small elite class, and accruing the losses to Other People's Money (OPM), the public trust, and all holders of US dollars, its a reasonable arrangement to promote if you are a dishonorable pigman or a willing servant to same.

Financial Relativism: Fraud by Any Other Name....

Let's speak plainly for once, Chairman Bernanke.

The US financial system degenerated under the collateralized debt origination model in which super-compensated bankers and brokers used unreliable mathematical models to create complex and opaque packages of dubious quality debt which they sold to most of the major institutions in the world.

Our words to be sure, but a paraphrase of Paul Volcker's testimony to Congress yesterday, as he deviated from his prepared text.'

More simply put, it is a Ponzi scheme.

Now that the game is collapsing, the bankers that gained enormous, fantastic wealth while it was running are now looking for their shareholders, the public, and in many cases their victims to bear the losses and repair the financial system and the banks themselves while they safely hold their personal gains.

All up and down the line, from the loan originators to the bankers who created the bundles to the broker salespeople to the regulators and the Fed, everyone turned a 'blind eye' to the fraud as it occurred. Time and the justice system may sort out the degrees of guilt. We will see the spectacle of highly paid very experienced businessmen claiming utter ignorance of their own companies as we did with the role model for the neo-capitalists - Enron.

The banks were central to the scheme from the inception as they spent years and many hundreds of millions of dollars to overturn Glass-Steagall to allow this coup de grâce to be delivered to all holders of US dollars. PBS Frontline: The Long Demise of Glass-Steagal