Monday, March 02, 2009

The Trap Of Globalisation

I took delivery at the weekend of 'The Trap' by James Goldsmith. I must say it is a fabulous read in these times and a bizarre peak into the mind of a man who saw it all coming.

The front page has a description of what is in the book, bearing in mind it was written in 1993, it says;

"Rising long-term unemployment, increasing violence, growing poverty in urban slums, environmental deterioration and a general realization that something fundamental has gone wrong...."

Catchy, and all the more scary when you take a look at these words in the current environment.

I also bought 'The Response'. This was a book written to answer criticism from the media and 'professional' economists. This is a shining example of one of the arguments against Goldsmiths negative stance on global free trade:

-European Commission - 1994

'Outflows will, over time, match in flows. If the countries of Asia export more than they import, the excess cash will be invested abroad and ultimately the inflow will equal the outflow suffered by those with a trade deficit'

Norman Macrae, Sunday Times, 12 December 1994

'Suppose (in fun not in realism) that ... all present world-tradable manufactures and services fled to {low-wage countries}.... {They} could then do three things with their export surplus... Either (a) hoard it in foreign exchange; or (b) use it to buy everybody’s ICI's and other principal industries; or (c) buy new goods and services from the West.

Course (a) would be the loveliest for us. {The low-wage countries} would put all their hugely expanded export earnings in America and British and other foreign bonds.... We could then import their nice cheap goods (much reducing our cost of living) at near-nil net foreign exchange drain, and expand our budget deficits.... to create internal jobs and live the life of Riley'

Goldsmith gets this 'lesson in economics' from people who must now be feeling a little silly. His response in 'The Response' was:

'The idea that accounts must balance, and that inflows must ultimately match outflows, is an accountants idea.

But there is a fundamental misunderstanding here. If you make a loss, perhaps because you own a business that is trading unprofitably or because you have made a bad investment, you will not get rid of the loss by borrowing the amount needed to pay for it. You will have avoided or postponed a personal liquidity crisis, but you will still be poorer by the amount of the loss. You will also have to pay interest on the loan.

Alternatively, you might sell your house and rent somewhere else to live. You will have used the proceeds of the sale to pay your debts, but you will remain poorer by the value of your house. And in future, you will have to pay rent.

When the Asian counties, as mentioned by the European Commission, invest their 'excess cash' abroad, normally they do so by buying into businesses or by lending money. The latter normally takes the form either of buying governments debt or of deposits, say in sterling or dollars, in the banking system. Now consider the position of the nations which, unlike the Asian countries, import more than they export and which, as a result, have a deficit as opposed to an excess of cash.

To finance their deficit, businesses or other assets are sold and debt is issued. This puts them in exactly the same position as an individual who sells his house or borrows money to cover his debts. Such a hemorrhage can last only a limited time before ending in bankruptcy....

... The ability to borrow will depend on its (a country's) credit-worthiness, as it does for an individual. And the credit-worthiness of the West is extremely doubtful...

... Far from the 'life of Riley' it is increasing unemployment and impoverishment that the West has to look forward to - unless it changes course, and in time.'

Put simply, Goldsmith's objection to global free trade was, essentially, what has come to pass. He believed that the West was exporting jobs abroad, that the export of these jobs would lead to lower wages and higher unemployment.

What he didn't predict with any great force was that individuals would stave off the consequences of lower earnings by borrowing to invest in the stock market and property as well as increasing traditional credit card and overdraft debt. The increase in markets and property values gave the veneer that the utopia of good returns on investments and low price goods could go on forever.

Such debt was part of the biggest Ponzi scheme of all time, making Madoff look like a cheeky pickpocket from the musical Oliver.

Let’s face it, between 2003 and end of 2007, anyone could get credit for pretty much anything. TV shows in the UK such as 'Bank of Mum and dad' showed wayward kids, sometimes unemployed, who had wracked up £20,000 plus in debts on credit cards and overdrafts, and now were being helped to manage the situation. Adverts in the US showed big SUV's and cars could be bought on leases in the low hundreds of dollars.

Need a mortgage? Don't have good credit, or even the money to put down as a deposit? No problem self-certification 125% mortgage on its way for you sir. Spend the extra 25% on home improvements...

Really, how long did we think this would last? The housing market was the start, we know that.. bankers could securitize no more loans, house prices were getting silly and people could not borrow any more money to keep the merry-go-round spinning.

That is what has exposed the problems that Goldsmith warned of 16 years ago. The credit markets got clogged up and it came to a point where the system ground to a halt. Basically new money stopped entering the Ponzi scheme and those left holding the assets when the music stopped got severely burned, in stocks, houses, bonds even some bank accounts (Landsbanki as an example).

Goldsmith agrees that protectionism is not the antidote to globalisation, but it is simple math to understand that companies will not bring jobs back to high salary and unionized countries when they can have non-unionized cheap labour elsewhere.

The basic tenet of the start of Goldsmith's book, The Trap, is that we have lost site of what science, technology and the economy is there for. These three have been treated as an ends in themselves rather than a tool to enhance the lives of the society they serve and as such this inversion of values is back firing on society as a whole.

If protectionism is not the answer, and global free trade is here to stay, then we must get used to a lower standard of living.

Although the wages earned by those in the West have been won by hundreds of years of negotiation, unionization and civil rights law, our governments, at a stroke, allowed businesses to by pass the cost of these issues and export the jobs they were designed to protect to low-wage economies.

I am coming over all socialist... I think I need to sit down...

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