Henry C K Liu (Click here for previous parts) This article appeared in AToL on May 24, 2005 The

term "social market economy" was coined by one of German chancellor Ludwig Erhard's close associates, economist Alfred Mueller-Armack, who served as secretary of state at the Economics Ministry in Bonn from 1958-63. Mueller-Armack defined social market economy as combining market freedom with social equity, with a vigilant regulatory regime to create an equitable framework for free market processes. The success of the social market economy made the Federal Republic of Germany the dominant component in the European Union. Focusing on the social aspect, Erhard himself shied away from praising free markets. He felt that social rules of the market-economy game must be adhered to as a precondition in order to prevent unbridled pursuit of profit from gaining the upper hand. Erhard's concept of a socially responsive regulated market economy was based on a fusion of the Bismarck legacy of social welfare and US New Deal ideology of demand management through full employment, price control, state subsidies, anti-trust regulations, state control of monetary stability, etc. It was aided by the infusion of foreign capital through the Marshall Plan. It proved to be effective for rapid and strong recovery of the West German economy via guaranteed access to the huge US market during the Cold War, culminating in the postwar economic miracle (Wirtschaftswunder). Yet Erhard's program bore a close resemblance to the early economic strategy of the Third Reich. The main difference was that while the Third Reich's program was one of economic nationalism, the Erhard program was subservient to US geopolitical interests in the context of the Cold War. By relying on US capital and US markets, chancellors Konrad Adenauer and Erhard accepted the delay of German independence from US domination for more than half a century. In contrast, Nazi economic policy aimed at the reconstruction of the German economy without the need for foreign capital, as a program for total and immediate national independence. Hitler's economic miracle The Nazis came to power in Germany in 1933, at a time when its economy was in total collapse, with ruinous war-reparation obligations and zero prospects for foreign investment or credit. Yet through an independent monetary policy of sovereign credit and a full-employment public-works program, the Third Reich was able to turn a bankrupt Germany, stripped of overseas colonies it could exploit, into the strongest economy in Europe within four years, even before armament spending began. In fact, German economic recovery preceded and later enabled German rearmament, in contrast to the US economy, where constitutional roadblocks placed by the US Supreme Court on the New Deal delayed economic recovery until US entry to World War II put the US market economy on a war footing. While this observation is not an endorsement for Nazi philosophy, the effectiveness of German economic policy in this period, some of which had been started during the last phase of the Weimar Republic, is undeniable. There were major differences between the German situation in 1933 and that in 1945. Not having been a battlefield in World War I, Germany in 1933 was not physically in ruins, as it was in 1945. What lay in ruins was its political and economic institutions. But in 1933, Germany not only did not have the benefit of the Marshall Plan, it was saddled with ruinous war reparations and an inoperative credit rating. What Germany had in 1933 was full sovereignty through which the Third Reich was able to adopt policies of economic nationalism to full effectiveness. In 1945, Germany was deprived of sovereign power and national policies had to be adjusted to comply with US and Soviet geopolitical intentions. Economically, the dependence on foreign investments and credit forced West Germany into an export economy at the mercy of its main market: the United States. After two and a half decades of economic reform toward neo-liberal market economy, China is still unable to accomplish in economic reconstruction what Nazi Germany managed in four years after coming to power, ie, full employment with a vibrant economy financed with sovereign credit without the need to export, which would challenge that of Britain, the then superpower. This is because China made the mistake of relying on foreign investment instead of using its own sovereign credit. The penalty for China is that it has to export the resultant wealth to pay for the foreign capital it did not need in the first place. The result after more than two decades is that while China has become a creditor

to the US to the tune of nearing China's own gross domestic product (GDP), it continues to have to beg the US for investment capital. The period between World Wars I and II, like no other period in modern European economic history, saw the success of centrally planned economies in Germany and the Soviet Union, two major states. The United States as the dominant victor of World War II was determined to perpetuate its hegemony by suppressing national planning everywhere to prevent the emergence of economic nationalism and socialism. It promoted global market capitalism and neo-liberal free trade to keep all other economies subservient to the US economy. It is the economic basis of the Pax Americana. Stalin's New Economic Policy In the Soviet Union, Josef Stalin's planned economy had followed the New Economic Policy (NEP) of 1921-28. NEP was in essence a mixed market economy; the main part of the market was in state possession (banks, industries, foreign trade, etc), while the peripheral part was owned by collective or private entrepreneurs. NEP, while successful, did not give the Soviet economy sufficient growth in the capital-goods sectors (ie coal, steel and electricity, transportation, heavy industry, etc), nor did it provide adequate food for the urban population even as the middle peasantry managed to feed itself. To overcome such structural obstacles and to combat general economic backwardness inherited from centuries of Czarist rule, Stalin introduced central planning as a strategy of national survival. Starting from 1928, the Soviet economy was put under a system of planning whereby all modes of production were socialized and foreign trade was de-emphasized in favor of an autarkic system of domestic demand and supply. The irony was that Soviet central planning adopted much of its effective techniques from successful US experience. It was a system of planning focused solely on unit endresults while externalizing social costs. The key distinction was that the Soviets rejected and bypassed the corporate structure and replaced shareholders with state ownership. Stalin brought about "revolution from above". Its main features were: strengthening of political dictatorship in the name of the proletariat (equivalent to enhancing management authority in the US in the name of shareholders), collectivizing kulak peasants (equivalent to agri-business development in the US), emergency measure authority (equivalent to government bailouts and regulations in the US), introduction of a five-year plan structure (adopted from US corporate strategic planning) and rapid expansion of urban labor force (equivalent to urbanization in the US), and tight state control over agriculture (equivalent to farm subsidy programs in the US), heavy industry (equivalent to defense contracts in the US) and finance (equivalent to central banking in the US). Between 1934 and 1936 the Soviet economy achieved a spectacular economic growth rate that continued despite political purges of Trotskyites between 1936 and 1938. Economic growth was unfortunately interrupted by war in 1941. German invasion of the Union of Soviet Socialist Republics was not independent of apprehension of continued Soviet economic success. Propaganda works. It worked in the USSR, in Nazi Germany, in imperial Japan and in the capitalist US, each to instill in the general public an acceptance of its system as being the suitable one if not the best, despite visible shortcomings. It helped achieve optimal effectiveness and stability in the overall economy in all these countries. Nazi Germany provided another example of successful inter-war economic planning. One of the main differences between the Nazi and the Soviet economic systems was that the Nazis' was a mixed economy with strict state control while the Soviets' was a state-owned economy. Furthermore, being heavily influenced by the ideas of Walter Rathenau (1867-1922), German economic planners did not seek to build anew with revolutionary zeal as the Russians did, but rather to reform, molding the existing form of decentralized capitalism into a more effective centralized system with massive combines to support national aims. The Rathenau factor Rathenau, German industrialist, social theorist, and statesman, was the son of Emil Rathenau (18381915), founder of the gigantic German public utilities company Allgemeine Elektrizitaetsgesellschaft (AEG). He directed the distribution of raw materials in World War I and became minister of reconstruction (1921) and later foreign minister (1922) of the Weimar Republic. He represented Germany at the Cannes and Genoa reparations conferences and negotiated the Treaty of Rapallo in which Germany accorded the USSR de jure recognition, the first such recognition extended to the new Soviet government. The two signatories mutually canceled all prewar and war debts and renounced war

claims. Particularly advantageous to Germany was the inclusion of a most-favored-nation clause and of extensive free-trade agreements. The treaty enabled the German army, through secret agreements, to produce and perfect in the USSR weapons forbidden by the Treaty of Versailles. A Jew, Rathenau was assassinated in 1922 by anti-Semitic nationalist fanatics who opposed his attempts to fulfill warreparation obligations to the Western victors. A strong nationalist who played an important role in Germany's war efforts in World War I, Rathenau was also a strong proponent of postwar international cooperation and his diplomatic initiatives played a key role in breaking Germany's postwar diplomatic isolation. In his writings, Rathenau criticized free-market capitalism and argued that technological change and industrialization were pushing civilization toward a stage of high mechanization, in which the human soul would be under threat. In an attempt to find an alternative to laissez-faire capitalism that did not involve state socialism and Marxism, Rathenau proposed a decentralized, democratic social order, in which the workers would have more control over production and the state would exert more control over the economy. His translated works include In Days to Come (1921) and The New Society (1921). Despite his great contribution to the German economy, Rathenau epitomized the living target of Adolf Hitler's accusation of internationalist Jewish treachery that betrayed the German nation. Hitler's rejection of the loyal nationalist support of the German Jews played an undeniable role in his own defeat. Jewish contribution to the flowering of German economy, culture and civilization had been the strongest in any European nation. Nazi persecution of the Jews was a strategic error more fundamental than the Nazi invasion of the USSR. The emigration of German Jews to the West, particularly to the US, played a critical role in the defeat of Germany in World War II. It is a lesson that the Arab nation in general, and Palestinians in particular, have yet to learn. The economic power of full employment From the very outset of his rule, Hitler, whose main short-term goal was the economic revival of Germany with the help of German nationalist bankers and industrialists, won popular support of the nation. Hitler adopted an aggressive full-employment campaign. Between January 1933 and July 1935 the number of employed Germans rose by a half, from 11.7 million to 16.9 million. More than 5 million new jobs paying living wages were created. Unemployment was banished from the German economy and the entire nation was productively engaged in reconstruction. Inflation was brought under control by wage freeze and price control. Besides this, taking into account the lessons learned during 1914-18, Hitler aimed at creating an economy that would be independent from foreign capital and supply, and be well protected from another blockade and economic war. For Germans, all of the above was proof that Hitler was the one who had not only brought Germany out of economic depression but would take it directly to prosperity with new pride. German popular trust in the Fuehrer rose dramatically. In September 1936, British economist John Maynard Keynes, whose ideas had been credited as behind US president Franklin Roosevelt's New Deal, prepared a preface for the German translation of his book, The General Theory of Employment, Interest and Money. Addressing a readership of German economists, Keynes wrote: "The theory of aggregate production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state, than ... under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that [justify] the fact that I call my theory a general theory. Although I have, after all, worked it out with a view to the conditions prevailing in the Anglo-Saxon countries where a large degree of laissez-faire still prevails, nevertheless it remains applicable to situations in which state management is more pronounced." Keynes clearly understood that the greater the degree of state control over any economy, the easier it would be for the government to manage the levers of monetary and fiscal policy to manipulate macroeconomic aggregates of total output, total employment, and the general price and wage levels for purposes of moving the overall economy into directions more to the economic-policy analyst's liking. The radical Spartacists in Germany regrouped themselves as the Communist Party in 1920. They continued their opposition to the liberal government of the Weimar Republic. From 1923-29, the Communists always obtained about 10% of the seats in the Reichstag. Unlike elitist Italian Fascism, Nazism had a high regard for the German peasant. Unlike Fascist Italy, Nazi Germany, while imposing sweeping government control over all aspects of the economy, was not a corporate state. In four short years, Hitler's Germany was able to turn a Germany ravaged by defeat in war and left in a

state national malaise by the liberal policies of the Weimar Republic, with a bankrupt economy weighted down by heavy foreign war debt and the total unavailability of new foreign capital, into the strongest economy and military power in Europe. How did Germany do it? The centerpiece was Germany's Work Creation Program of 1933-36, which preceded its rearmament program. Neo-liberal economists everywhere seven decades later have yet to acknowledge that employment is all that counts and living wages are the key to national prosperity. Any economic policy that does not lead to full employment is self-deceivingly counterproductive, and any policy that permits international wage arbitrage is treasonous. German economic policies between 1930 and 1932 were brutally deflationary, which showed total indifference to high unemployment, and in 1933 Hitler was elected chancellor out of the socio-economic chaos. The financing of Nazi economic-recovery programs drew upon sovereign credit creation techniques already experimented prior to Hitler's appointment as chancellor. What changed after 1933 was the government's willingness to create massive short-term sovereign credit and the its firm commitment to retire in full the debt created by that credit. Short-term sovereign credit was important to change the general climate of distrust on government credit. The quick rollover of short-term government notes created popular trust within months in German sovereign credit domestically. Hitler told German industrialists in May 1933 that economic recovery required action by both the state and the private sector. The government's role was limited to encouraging private-sector investment, mainly through tax incentives. He expressed willingness to provide substantial public funding only for highway projects, not for industry. Investment was unlikely if consumers had no money to spend or were afraid because of job insecurity to spend money to buy products produced, and Hitler understood that workers needed decent income to become healthy consumers. Thus full employment was the kickstart point of the economic cycle. To combat traditional German fear of the social consequences of appearing better off than their neighbors, Nazi propaganda would psychologically stimulate the economy by developing a lust for life among consumers. Hitler stressed on May 31, 1933, that the Reich budget must be balanced. A balanced budget meant reducing expenditures on social programs, because Hitler intended to reduce business taxes to promote needed private investment. To avoid reducing social programs, a large work program without deficit spending had to be financed outside of the Reich budget. Hitler resorted to "pre-financing" (Vorfinanzierung) by means of "work-creation bills" (Arbeitsbeschaffungswechseln), a classic response of using monetary measures to deal with a fiscal dilemma. Under the scheme of "pre-financing" with work-creation bills, the Reich Finance Ministry distributed these WCBs (three months, renewable up to five years) to participating credit institutions and public agencies. Contractors and suppliers who required cash to participate in work-creation projects drew bills against the agency ordering the work or the appropriate credit institutions. These credit institutions then accepted (assumed liability for payment of) the bills, which, now treated as commercial paper, could rediscount the bills at the Reichsbank (central bank). The entire process of drawing, accepting and discounting WCBs provided the cash necessary to pay the contractors and suppliers. The experience of successful rollover every three months quickly established credit worthiness. The Reich Treasury undertook to redeem these bills, one-fifth of the total every year, between 1934 and 1938, as the economy and tax receipts recovered. As security for the bills, the Reich Treasury deposited with the credit institutions a corresponding amount of tax vouchers (Steuergutscheine) or other securities. As the Treasury redeemed WCBs, the tax vouchers were to be returned to the Treasury. Hitler increased the money supply in the German economy by creating special money for employment. In the US Banking Panic of 1907, J P Morgan (1837-1913) did in essence the same thing. He strongarmed US banks to agree to settle accounts among themselves with clearinghouse certificates he issued rather than cash and thus illegally increased the money supply without involving the government, and ended up owning a much larger share of the financial sector paid for with his own paper, ironically with the gratitude of the government. The difference was that the economic benefit went to Morgan personally rather than to the nation as in Nazi Germany and the private money was used to save the banks rather than to save the unemployed. Nazi economic experts understood that sovereign credit creation for purposes of job creation posed no inflationary threat and that it would be a far more responsible policy than the conservative approach of tax increases and welfare cuts to balance government budgets. The idiotic policy of monetary restraint

and social-spending reduction to balance government budgets in order to pay foreign debts is still being advocated by the International Monetary Fund (IMF) in debtor nations around the world - except for the United States, the world's largest debtor nation, which uses dollar hegemony as an escape hatch or, more to the point, escape hedge. Redeeming WCBs did burden the 1934-39 Reich budget, but the decline in Reich expenditure for welfare support and other tax subsidies as a result of full employment recovery more than offset the redemption payments. The surplus was then used to reduce public debt and taxes further. There were legal, political and institutional restrictions unique to Germany on the scope of the Reichsbank that virtually dictated resources to WCBs as a way of putting 6 million unemployed Germans back to work. But the principle of WCBs can be applied to the US or China or any other country today to combat unacceptably high levels of unemployment. Alas, this common-sense approach is faced with firm opposition rationalized by obscure theories of inflation in most countries. The real reason is that the banking sector can reap excess profit by treating high unemployment as an externality in the economy that translates high unemployment and low wages directly into corporate profits. The profit from high unemployment is kept in private hands, while the cost of high unemployment is socialized as government expenditure. In 1933, Hitler sought to reassure Germany's business leadership that Nazi rule was consistent with the preservation of the free-market system, because he needed the support of the industrialists. He could buy that support by keeping wages down during the recovery, but any rigorous effort to curb prices and profits would alienate the business community and slow down economic recovery. Instead, Hitler sought to restore profitability to German business through reduced unit cost achieved by increasing output and sales volume, rather than through a general increase in prices (Mengenkonjunktur, niche Preiskonjunktur - output boom, not price boom). Adoption of "performance wage" (Leistungslohn payment on a price-rate basis) increased labor productivity, thereby driving costs down and profit up. Some upward price movements were permitted to adjust price relationships between agricultural and manufactured products and between goods with elastic and inelastic demands, also to prevent price wars and below-cost dumping. These principles of "output boom, not price boom" and "performance wage" could also work in combating inflation today in many economies generally and China specifically. Hitler saved the German farmers from their heavy debt burden through relief programs and through subsidized farm prices. The stable farm income came at the expenses of the middlemen institutions, but Hitler sustained popular support by the provision of living income to consumers. Had Nazi Germany been a member of the World Trade Organization (WTO), this option would have been foreclosed to it. Hitler sought price stability only in sectors critical to the national economy and to the ultimate goal of rearmament. Germany had no overall price policy until the 1936 Four Year Plan, which concentrated economic authority in the hands of Hermann Goering for war production and put an end to regulated free-market policies. Business managers generally make investment and employment decisions based on their judgment of the prospect for new orders. The difference between German economic recovery under Hitler and US economic stagnation under Roosevelt in the 1930s was the degree of uncertainty for new orders for goods. Hitler made it clear that after 1936, a major rearmament program would make heavy demand on German durable-goods and capital-goods industries without the need to export. With that assurance, German industry could plan expansion with confidence. Roosevelt was unable to provide such "confidence" to industry and had to rely on anemic market forces until after the Japanese attack on Pearl Harbor, Hawaii. The Marshall Plan: A Trojan horse for monetary conquest The Marshall Plan grew out of the Truman Doctrine, proclaimed in 1947, stressing the moralistic duty of the United States to combat communist regimes worldwide. The Marshall Plan spent US$13 billion (out of a 1947 GDP of $244 billion or 5.4%, or $632 billion in 2004 dollars) to help Europe recover economically from World War II to keep it from communism. The money actually did not all come out of the US government's budget, but out of US sovereign credit. The most significant aspect of the Marshall Plan was the US government guarantee to US investors in Europe to exchange their profits denominated in weak European currencies back into dollars at guaranteed fixed rates, backed by gold at $35 an ounce.

The Marshall Plan helped establish the US dollar as the world's reserved currency at fixed exchange rates established by the IMF, which had been created by the Bretton Woods Conference. The Marshall Plan enabled international trade to resume and laid the foundation for dollar hegemony for more than half a century even after the dollar was taken off gold by president Richard Nixon in 1971. While the Marshall Plan did help the German economy recover, it was not entirely a selfless gift from the victor to the vanquished. It was more a Trojan horse for monetary conquest. It condemned Germany's economy to the status of a dependent satellite of the US economy from which it has yet to free itself fully. The Marshall Plan lent Europe the equivalent of $632 billion in 2004 dollars. Japan's foreign-exchange reserves alone were $830 billion at the end of September 2004. In other words, Japan was lending more to the United States in 2004 than the Marshall Plan lent to Europe in 1947. And Japan did not get any benefits, because the loan is denominated in dollars that the US can print at will, and dollars are useless in Japan unless reconverted to yen, which because of dollar hegemony Japan is not in a position to do without reducing the yen money supply, causing the Japanese economy to contract and the yen exchange rate to rise, thus hurting Japanese export competitiveness. West Germany's postwar economy functioned well for several decades, and became one of Europe's strongest. Much of its success was due to the German tradition of strong social welfare that dated back to the days of Otto von Bismarck a century earlier, and the system of co-determination, which gave workers in factories a voice about their management and provided West German industries a long period of labor peace. The economics of the Cold War also gave Germany guaranteed markets in the US. The export-oriented economy received another boost with the creation of the European Economic Community (EEC) by the Treaty of Rome in March 1957. West Germany was one of the EEC's founding members. Since the end of the Cold War, this economic order has been under threat from neoliberal globalization that first attacked the developing economies in Latin America and then the world over. Sovereignty, finance capitalism and democracy Jean Bodin (1530-96), the first thinker in the West to develop the modern theory of sovereignty, held that in every society there must be one power with the legitimate authority to give law to all others. The Edict of Nantes issued by Henry of Navarre, the Huguenot (French Calvinist) chief, who reigned as Henry IV in 1598, was a sovereign edict that laid the foundation of French royal absolutism of the sovereign state. The Edict protected a Huguenot minority, composed mostly of members of the aristocracy, against popular opposition from the Catholic peasants with the support of the papacy. Henry IV was a member of the politiques who believed that no religious doctrine was important enough to justify ever-lasting war. He abjured the Calvinist faith in 1593 and subjected himself to papal absolution, supposedly remarking that Paris was well worth a Mass. He wanted to rebuild France from a war-torn economy caused by religious strife into a prosperous nation, with "a chicken in every pot" for every French family, a phrase borrowed by Roosevelt two and a half centuries later to describe the goal of his New Deal. The Edict to protect the Protestant aristocrats led to the assassination of the converted Catholic king by a Catholic fanatic in 1610. The widowed queen, Marie de Medici, a devout Catholic and scion of the celebrated banking family of Florence, handed control of France to Cardinal Richelieu, who undertook a secular policy to enhance the economic interest of the state with mercantilist measures, by allowing the aristocracy to engage in maritime trade without loss of noble status, and by making it possible for merchants to become nobles through payments to the royal exchequer. This provided a political union of the aristocracy and the bourgeois elite that held the nation together until the French Revolution of 1789. In 1627, the Duke of Rohan led a Huguenot rebellion from La Rochelle with English military support. Richelieu suppressed the rebellion ruthlessly and modified the Edict of Nantes with the Peace of Alais in 1629, by allowing the Huguenots to keep their religion but stripping them of their instruments of political power: their fortified cities, their Protestant armies and all their military and territorial autonomy and rights. Calvinism has been identified by social historians as the driving force behind modern capitalism. The Age of New Monarchy in Europe laid the foundation for the age of sovereign nation-states by placing royal authority to institute a fairer social contract above feudal rights, a development that began

in the High Middle Ages. The new monarchs presented the institution of monarchy as a progressive guarantor of law and order and promoted hereditary monarchy as the legitimate means of transferring public power. Monarchism was supported by the urban bourgeoisie, as it had long been victimized by the private wars and marauding excesses of the feudal lords. The bourgeoisie was willing to pay taxes directly to the king in return for peace and royal protection from aristocratic abuse. Its members were willing to let parliament, the stronghold of the aristocracy, be dominated by the king who was expected to be a populist. The direct collection of popular taxes by the king, bypassing the feudal lords, gave the king the necessary resources to maintain a standing army to keep the feudal lords in check. These new monarchs revived Roman law, which favored the state and incorporated the will and welfare of the people in their own persons. Direct payment of taxes to the sovereign also ensured that future wars were fought to protect or enhance national interests, rather than at the personal pleasure of the king. The new monarchs ruled by the mandate of the dictatorship of the bourgeoisie, just as communist governments ruled centuries later with the mandate of the dictatorship of the proletariat. It was by protecting the people against abuses from aristocratic special interests that the king protected himself, a principle that escaped Louise XVI of France to his own sorrow. Today, as the institution of democracy is supplanted by control by the moneyed class, democracy will lose its popular mandate. What the US needs is not to spread democracy around the world, but to restore economic democracy at home. Similarly, when the Chinese Communist Party permits neoliberal market fundamentalism to distant itself from its revolutionary mission of protecting the peasant masses from market abuse, it will lose its mandate as the legitimate defender of the dictatorship of the proletariat. What China needs is not political reform to accommodate capitalistic democracy, but a restoration of its revolutionary ideological line in its political institutions and a renewal of populist commitment on the part of its leadership. Political reform driven by flawed ideology is institutional suicide. The new monarchies in Europe, by breaking down feudal tariff barriers within the kingdom, contributed to the rise of the commercial revolution and the development of extended cross-border markets. In the rise of capitalism, the needs of a new military not dependent on the aristocracy had been of critical importance. The standing national armies of the new monarchs required sudden expenditures in times of war that the traditional feudal dues and normal flow of tax revenue could not meet. Private bankers emerged to finance wars by lending money to the kings secured by the right to collect taxes in the future from conquered lands. The medieval prohibition of interest as usury, denounced as the sin of avarice and forbidden by canon laws, faded in practice even as it continued to be upheld by all religions. Luther denounced "Fruggerism" in reference to the bankers of the Holy Roman Empire. Even Calvinism only gradually made allowances on the issue of interest. The new monarchies, caught between fixed income and mounting expenses, were forced to devalue their money by diluting its gold content. They began to borrow from private banks to deal with recurring monetary crises. These monetary crises led to constitutional crises that produced absolute monarchies in Europe and the triumph of bourgeois parliamentarianism in England. The need to find new conquered lands to repay sovereign indebtedness gave birth to imperialism and colonialism, which the Atlantic Charter centuries later categorically rejected in the third of its eight points of "common principles in the national policies of their respective countries on which they base their hopes for a better future for the world". The third point stated that "they [the US and Britain, and later the United Nations members] respect the right of all peoples to choose the form of government under which they will live; and they wish to see sovereign rights and self-government restored to those who have been forcibly deprived of them". German rearmament to defend neo-imperialism Notwithstanding the high-sounding rhetoric of the Atlantic Charter, the outbreak of the Korean War in 1950 provided a propaganda opening for the US to impress on its submissive Western allies in the United Nations that international communism was a clear and present danger to residual Western imperialism and colonialism in the Third World. Under president Harry Truman, the US began to abandon its wartime anti-colonialist posture and to solicit the help of European imperialists, particularly the British and French, to support its global war on communism. Colonel Harry G Summers Jr, US Army (retired), in an article in Military History magazine titled "The Korean War: A fresh perspective", pointed out that during a post-Cold War Pentagon briefing in 1974, General Vernon Walters, then deputy director of the Central Intelligence Agency (CIA), revealed what

amounted to the unpredictability of US policy intentions on Korea: "If a Soviet KGB spy had broken into the Pentagon or the State Department on June 25, 1950, and gained access to our most secret files, he would have found the US had no interest at all in Korea. But the one place he couldn't break into was the mind of Harry Truman, and two days later America went to war over Korea." Truman, unprepared for global leadership, insecure and paranoid, fell under the spell of Winston Churchill, who, borrowing from Lenin, equated anti-imperialism with anti-capitalism. Churchill aimed at using the Cold War as a device to save European imperialism by offering the fruits of neoimperialism to the US in the name of democracy. In taking the United States to war in Korea, Truman, in addition to placing the US firmly on the side of imperialists, made two critical decisions that would shape future US military actions. First, he decided to fight the war under the auspices of the United Nations, a pattern followed by president Lyndon B Johnson in the Vietnam War in 1964, president George H W Bush in the Gulf War in 1991, by president Bill Clinton in Bosnia-Herzegovina in 1999, and by President George W Bush in Afghanistan in 2001 and in Iraq in 2003. Second, for the first time in US military history, Truman decided to take the nation to war without first asking Congress for a declaration of war. Using the UN Security Council resolution as his authority, he said the conflict in Korea was not a war but a "police action". With the Soviet Union then boycotting the Security Council, the United States was able to gain approval of UN resolutions labeling the North Korean invasion a "breach of the peace" and urging all members to aid South Korea, notwithstanding that both North and South Korea had been aiming for unification by force for several years. Another consequence of the Korean War was damage to the image of the UN as a neutral world body. Secretary general Trygve Lie was forced to resign over Soviet complaints of the way he manipulated Security Council procedures to comply with US dictates. Colonel Summers pointed out that, in reality, UN involvement was a facade for unilateral US action to protect its vital interests in northeast Asia. The UN Command was just another name for General Douglas MacArthur's US Far East Command in Tokyo. At its peak strength in July 1953, the UN Command stood at 932,539 ground troops. Republic of Korea (ROK) army and marine forces accounted for 590,911 of that force, and US Army and Marine Corps forces for another 302,483. By comparison, other UN ground forces totaled 39,145 men, 24,085 of whom were provided by British Commonwealth Forces (Britain, Canada, Australia and New Zealand) and 5,455 of whom came from Turkey. The troop composition was similar to that of the "coalition of the willing" in the 2003 Iraq war. While the UN facade was detrimental to the prestige of the UN, Truman's decision not to seek a declaration of war set a dangerous precedent in the erosion of the constitutional power of the US Congress. Claiming that their war-making authority rested in their power as commanders-in-chief, both Johnson and Nixon refused to ask Congress for approval to wage war in Vietnam, a major factor in undermining popular support for that conflict. In the entire history of the United States, only seven wars had been declared by Congress, with World War II the last declared war. Ten other wars were not declared: the Florida Seminole Wars, 1817-58; the Civil War, 1861-65; the Korean War, 1950-53; the Vietnam War, 1964-72; the first Gulf War, 1991; the war on drugs, 1980s to the present; the Kosovo war, 1999; the "war on terror", 2001 to the present; Operation Enduring Freedom (Afghanistan), 2001; and the second Gulf war (Iraq), 2003. Instead of formal war declarations, the US Congress has issued authorizations of force. Such authorizations have included the Gulf of Tonkin Resolution of 1964 that officially initiated US participation in the Vietnam War, and the "use-of-force" resolution that started the 2003 Iraq war. Questions remain as to the legality of these authorizations of force. Ironically, the Federal Republic of Germany, whose own empire had been partitioned out of existence since the end of World War I, was pushed to contribute financially to its own defense against Soviet threat so that its less prosperous but victorious imperialist allies, Britain and France, could spend their hard-pressed resources to defend their crumbling empires outside of Europe in the name of democracy. For West Germany, five years after having lost the most devastating of all wars, this meant forming a new army, a step unthinkable for many Germans who had just gone through de-Nazification and demilitarization indoctrination during Allied occupation. But the worldwide "Korean War boom" of 1950 came at exactly the right moment for an export-addicted Germany eager to capture new overseas

markets. As West Germany prospered from profits garnered from new wars to defend imperialism in Asia, the US was in a position to push Germany into rearmament, despite the fact that German rearmament was anathema not only to German citizens, but also to all their apprehensive neighbors, especially France. As the Korean War continued, however, opposition to rearmament lessened within West Germany, and China's entry into the war caused Gaullist France, which was apprehensive of the liberating impact of Asian communism on its crumbling empire in Southeast Asia, to revise its negative posture toward German rearmament, as long as the new German war machine was oriented toward the east. Instead of the tradition Franco-Russian alliance against a powerful Germany, the French began to see benefits in using the Germans to deter Soviet intentions to march toward Paris. It was a classic balance-of-power move. Germany, deprived of sovereign authority, was at the mercy of superpower global conflict. To contain a newly armed Germany, French officials proposed the creation of the European Defense Community (EDC) under the aegis of North Atlantic Treaty Organization (NATO), but with strengthened European control, with a European Army to run in parallel with the European Steel and Coal Community that France and Germany had formed earlier. Within the EDC context was the need to rearm West Germany to counter the Soviet Union's overwhelming superiority in military manpower. Adenauer quickly agreed to join the EDC because he saw membership as likely to enhance the eventual full restoration of German sovereignty. The treaties establishing the EDC were signed in May 1952 in Bonn by the Western Allies and West Germany. Britain refused to be part of it, seeing its armed forces as being more important to NATO, the Commonwealth and the special relationship with the US than to Europe. Arguments arose over who would have ultimate control over the army - would it be the EDC or would it be the national governments? The whole idea eventually fell apart, although West Germany was welcomed into NATO and the West European Union (WEU) was created. Although the German Bundestag ratified the treaties, the EDC was ultimately blocked by the French National Assembly, because it opposed putting French troops under foreign command. The French veto meant that Adenauer's attempt to regain German sovereignty through disguised militarism had failed and a new formula was needed to allay French fears of a strong Germany. The failed negotiations surrounding the planned rearmament of West Germany through the creation of the EDC nevertheless provoked a Soviet countermeasure. After a second East German proposal for talks on a possible unification of the two German states failed because of West Germany's demands for free elections in the German Democratic Republic (GDR), the Soviet Union put forth a new proposal to its wartime Western Allies in March 1952. The Soviet Union would agree to German unification if the Oder-Neisse border were recognized as final and if a unified Germany were to remain neutral. If the proposal were accepted, Allied troops would leave Germany within one year, and a united neutral Germany would obtain its full sovereignty. The offer, directed to the Western Allies rather than Germany, which, deprived of sovereignty, had no authority to negotiate its own fate, nevertheless aroused lively public discussion in West Germany about the country's political future. Adenauer was afraid that neutrality would mean Germany's exclusion from US-dominated Western Europe and that without US support, he and his conservative Christian Democrats might not stay in power, in view of the traditional strength of the Social Democrats or, worse, the communists. Encouraged by the United States, Adenauer demanded free elections in all of Germany as a precondition for negotiations, a demand he knew was unacceptable to both the Soviets and East Germany, as Western-style elections would be financed by money from the US to ensure the defeat of communist and socialist candidates, repeating the postwar political sham in both West Germany and Japan. The Soviet Union declined and abandoned its proposal. Adenauer was harshly criticized by the opposition for not having seized this opportunity for unification. By allying itself with the US, West Germany sacrificed its unification with East Germany for half a century. A divided Germany provided a balance-of-power arrangement between the two superpowers all through the Cold War. Adenauer's decision to turn down the Soviet proposal left Germany divided for the then foreseeable future. West Germany was then expected to remain firmly anchored in the Western defense community. Yet doubt remained in Washington on whether Germans would kill other Germans to protect US interests in Europe.

After plans for the EDC failed because of the French veto, negotiations were successfully concluded on the Treaties of Paris in May 1954, which ended the Occupation Statute and made West Germany a member of the Western European Union and of NATO. NATO was the vehicle to camouflage US geopolitical interests in Europe with a common goal among the Western Allies against Soviet communism. On May 5, 1955, the Federal Republic of Germany declared its sovereignty as a state and, as a new member of NATO, undertook to contribute to the organization's defense effort by building up its own armed forces, the Bundeswehr. German rearmament was to be camouflaged under the NATO umbrella. West German soldiers could now be counted on to fight East German soldiers to protect Western Europe against communism. Militarism was the price the United States extracted for granting Germany a facade of independent sovereignty, but not yet full independence of foreign or security policy, as NATO continued to be dominated by the US, with its mission framed by US geopolitical interests. The buildup of the Bundeswehr met considerable popular opposition within West Germany. To avoid isolating the army from the country's civilian and political life, as was the case historically up to the fall of the Weimar Republic, laws were passed that guaranteed civilian control over the armed forces and gave the individual soldier a new social status. Members of the conscription army were to be "citizens in uniform" and were encouraged to take an active part in democratic politics, in contrast to the Junker tradition of a warrior class. This was done to inject a measure of consideration of German domestic politics into US-dominated NATO decision-making. By 1955, the Soviet Union had abandoned efforts to secure a neutralized united Germany. After the Four Power Conference in Geneva in July that year, Adenauer accepted an invitation to visit Moscow, seeking to open new lines of communication with the East without compromising West German commitments to the West. On the other side, Moscow wanted to exploit German apprehension of being in the front line of hostility to create a voice of caution within NATO. In Moscow in September, Adenauer arranged for the release of 10,000 German war prisoners in the Soviet Union. In addition, without having recognized the division of Germany or the Oder-Neisse line as permanent, West German negotiators also established diplomatic relations with the Soviet Union. The Soviet Union recognized the German Democratic Republic as a sovereign state in 1954, and the two communist countries established diplomatic relations. The Federal Republic of Germany (FRG) had not, however, recognized the GDR. And to dissuade other countries from recognizing East Germany, Adenauer's foreign policy adviser, Walter Hallstein, proposed that the FRG break diplomatic relations with any country that recognized the GDR. Anti-communism was the convenient decoy from targeting the rise of neo-fascism in a society that had won a permissive reprieve from its US conqueror's de-Nazification program. As the brilliant German filmmaker Rainer Werner Fassbinder showed in many of his films, postwar Germany turned out to be very much what it would have been like if the Nazis had won the war. The Hallstein proposal was based on the West German claim that as a democratic state, it should be accepted as the only legitimate representative of the German people. By contrast, East Germany claimed to be the legitimate state of the German people because it was a dictatorship of the proletariat. Democracy was used as a justification for legitimacy in the West. Israel would learn from the former persecutor of its people to use democracy to bargain for US acceptance of its legitimacy in an Arab region, using anti-communism as currency to secure US support, by purging the left totally from Israeli domestic politics. The Hallstein Doctrine was adopted as a principle of West German foreign policy in September 1955 and remained in effect until the late 1960s when the idea of two German states became a reality, and Germany remained divided until the dissolution of the USSR in 1991. Unfortunately, whereas militarism under market capitalism stimulated economic expansion by providing profit to private enterprise, it operated to drain prosperity under communism, which could not find a vehicle to recycle financial energy consumed by the arms race. Militarism then was co-opted by finance capitalism as an effective weapon against communism, which was an economic system that could only be operative in peace. The reason war has not ended even after the global war on communism has ended with the dissolution of the USSR is because militarism and capitalism have a mutual dependency. The end of the Cold War, while marking the failure of peaceful communism, marked the triumph of capitalistic militarism. Traditionally, European integration and trans-Atlantic relations have been the two key components of

postwar German foreign policy. German trans-Atlantic relations are a euphemism for German acceptance of US dominance. Both components were strategic necessities for the Federal Republic of Germany after World War II, and at the same time paved the way for West Germany to rejoin the European community of nations. Since then, the US had been Germany's protector ally both in and outside Europe. This relationship remained after German unification. Today, while the US and Germany continue to share similar views on a range of global issues such as terrorism, WMD (weapons of mass destruction) proliferation and regional conflicts, there is increasing divergence on what constitute proper policy responses to these new threats and challenges. Germany subscribes to multilateralism as a fundamental component of its foreign policy in a multipolar world. Differences on issues such as Iraq, Iran, the International Criminal Court, the Kyoto Protocol and the Ottawa Convention have surfaced between the US and Germany as the latter regains more of its full sovereignty and as its domestic politics turns centrist as opposed to US unilateralism. Strategically, German relations with China and Russia are evolving along lines more independent from US policies. During the Cold War, trans-Atlantic relations in the West were dominated by the need to defend the US and Western Europe jointly against the Soviet threat. This was also the reason for US forces to remain in Europe via NATO. With the end of the Cold War in 1989, the threat posed by the Warsaw Pact and the Soviet Union disappeared overnight. Since then, trans-Atlantic relations have faced new challenges devoid of a common thread. Having contained domestic terrorism on its own soil, Germany, like many other nations, is being pressured by the United States to join in the "global war on terrorism" as a replacement of the threat from global communism. International terrorism, which also put a new dimension on the problem of WMD proliferation, created a demand from the US for German military projection beyond German borders, along with regional conflicts that allegedly had supra-regional destabilizing effects, eg the Balkans, the Middle East, Congo, Afghanistan, India-Pakistan. This definition of supra-regional stability can involve Germany in distant conflicts around the globe, since no regional conflict can remain isolated in an interconnected global security network. The process of greater European integration has spilled beyond historical European borders into the Crimea and the Balkans, the Middle East, Africa and Asia. Yet domestic threats from international terrorism can be intensified by a country's military involvement beyond its borders, as demonstrated by the terrorist bombing of trains in Spain in response to deployment of Spanish troops in Iraq. As early as 1990, the European Union and the United States agreed in the Transatlantic Declaration to establish a closely meshed network of twice-yearly summit consultations. The terrorist attacks of September 11, 2001, showed that security policy and trans-Atlantic cooperation have not been removed with the end of East-West conflict. Yet the nature of the cooperation has undergone a fundamental change: comprehensive security implies that internal and external security threats are interconnected. There is also a historical legacy that set German relations with Islamic nations apart from the Anglo-US legacy. Competition for the hearts and minds of Islamic peoples had been a focus of the contest between Germany and the Western Allies in the two World Wars. With the US drifting toward a policy of relying on its super-power to impose a global geopolitical, economic and financial architecture to its liking, a critical divergence has emerged between the US and its NATO allies over the need for conflict prevention and the most effective paths of conflict resolution. US responses to terrorism threats, as manifested in its invasion and occupation of Iraq, if not Afghanistan, have created policy rifts between the EU and the US. With the end of the Soviet threat to Western Europe, US planners began to ask whether the United States would always have to deploy troops and equipment to sort out Europe's problems. Consequently, the US was looking to Western Europe to take more responsibility for its own defense and security. It has also become harder for US policymakers to justify spending considerable amounts of money on overseas deployments. Equally, the US remains hesitant over overseas deployments because of experiences and lessons from the Vietnam War. Despite being the main contributor to Operation Desert Storm in the Persian Gulf during 1991, the later debacle of Operation Restore Hope in Somalia only reinforced US objections to its their ground forces in international hotspots. For the United States, modern warfare or military operations have to be conducted with minimum risk to US lives. When the US refused to deploy peacekeepers to UN operations in Croatia and Bosnia-

Herzegovina during 1992-95, or make the ground-force option available during Operation Allied Force in Kosovo in 1999, many Western European governments wondered whether the United States could always be counted on if military intervention were needed in an international crisis. Many were now asking the same questions as the French had asked years before: Why should an economically and politically powerful Western Europe not take more responsibility for its own security, especially as there was no longer the threat from the USSR and the Warsaw Pact? As a result, Western Europe had begun to develop a European Security and Defense Identity (ESDI) since the early 1990s. In 1993, the EU decided to embody parts of the Petersberg Tasks into the Treaty on the European Union. This gave the WEU, Western Europe's own security apparatus within NATO, a clear defined role in humanitarian and conventional operations. The WEU was strengthened. Among other changes, this included the appointment of a secretary general and a planning cell that were responsible for assessing and planning for operations as they arose. The number of troops available to it was also increased. If necessary, the WEU could call on other NATO units such as the UK/Netherlands Landing Force. It also had its own rapid-response unit, EUROFOR, which was made up of troops from France, Italy, Spain and Portugal. It was envisaged that the WEU would act independently or as part of a UN force in humanitarian operations in which the US would not want to become involved. In other operations, it would act as part of NATO. Both the US and Western Europe believed that the proposals would strengthen NATO by providing better cooperation and coordination, a problem NATO had suffered from in multinational operations. In 1999, however, the EU decided to revise the WEU plans. It decided to adopt the crisis-management and conflict-prevention elements itself. The WEU would remain as an organization but would mostly concentrate on being a contribution to NATO during a conventional war. At the European Council's Cologne Summit in June 1999, the EU launched the Common European Security and Defense Policy (CESDP). A later summit at Helsinki built on Cologne and defined new EU structures to undertake the crisis-management role. Both summits also proposed an EU Rapid Reaction Force that would draw mostly on the member states' commitments that had already been made to the WEU after the Petersberg Tasks - the force levels being agreed at the Military Capabilities Conference in November 2000. The EU force is not a European Army in the sense of a standing army. It follows a similar character to NATO's Allied Command Europe (ACE) Rapid Reaction Corps (ARRC) in which certain elements of member states' armed forces are earmarked for rapid deployment if the need arises. Only one part of the force could be considered a standing army. In 1987, France and Germany decided to create a Security and Defense Council (SDC) that would allow for better coordination on joint Franco-German operations as part of the WEU and later NATO. In 1991, both countries decided to back up the SDC with a joint Franco-German brigade directly responsible to the EU and the WEU (and NATO from 1993) - this became known as the Eurocorps. Spain, Belgium and Luxembourg then went on to join, allowing the WEU to call on a sizable force for immediate deployment. With its headquarters in Strasbourg, the Eurocorps has since deployed to Bosnia and Kosovo and is likely to feature in the new EU force. Germany goes its own way The EU created the European Security and Defense Policy (ESDP) to ensure independent control of its security policy. The United States views the ESDP as an attempt to replace NATO by creating a security and defense system free of US dominance if not involvement. Changing its Cold War role of an economic giant and a geopolitical pigmy, drawing on the lesson of Iraq, Germany, the dominant component in the EU, has taken on the task of trying to prevent a military confrontation between the US and Iran. The European initiative, led by Germany, France and an ambiguously European Britain, proposes to give Iran substantial economic benefits in exchange for Iranian commitment to cease efforts to become a nuclear power. This initiative has received little support either from Iranian domestic politics or from the US. Washington views the European initiative with skeptical contempt. US hawks want "regime change" and/or a "surgical strike" against Iranian nuclear facilities. The EU views both options as ineffective, based on what has transpired in Iraq, since Iranian nuclear facilities are both dispersed and hardened, and since the US faces a severe shortage of troops because of its aggressive foreign policy, a problem that NATO is not at all keen to help resolve with its own troops. German officials point out that their country's Iran initiative is a breakthrough, since for the first time in recent memory the leading European powers are united and proactive, as well as independent from

Washington, on a major issue that threatens peace. There is sober concern about Iran playing off the US against Europe. German officials see their role as demonstrating that there are diplomatic alternatives to a repeat of US Iraq policy in Iran. If the EU approach to Iran should break down, the EU, being still economically dependent on the US, would have no choice but to join the United States in economic sanctions against Iran. Diplomatically, the EU would still be in a position to dissuade the Bush administration from pursuing a military option or seeking Security Council action that Russia and China could be expected to oppose. Since the end of World War II, nothing major has happened on the world stage, good or bad, unless the United States has orchestrated it. The only two notable exceptions are chancellor Willy Brandt's efforts more than two decades ago to engage the Soviet Union and East Germany, and British and French diplomatic efforts that helped produce the deal to trade an end of Libyan terrorism for an end to economic and diplomatic sanctions. Washington at first reacted negatively to both of these initiatives. European involvement in world affairs beyond continental borders has been welcomed by Washington only when Europe served as a docile junior partner to US geopolitical designs. On Iraq, most of Europe refused to accept this subservient role. The Iraq war is immensely unpopular in Europe, similarly to other regions around the globe, even in Britain, which has happily accepted the role of geopolitical water boy for US foreign policy since the end of World War II. German domestic politics does not give Chancellor Gerhard Schroeder an option to support the Bush administration's Iraq policy. The blatant ineptitude of recent US foreign policy, particularly in the Persian Gulf and the Middle East, has provided a window of opportunity for European independent activism in world affairs. The re-election of Schroeder as chancellor of Germany with the help of the Green Party in September 2002 symbolized the end of an era in close, albeit unequal, postwar relations between the US and Germany. Schroeder held on to power after his SPD (Sozial-demokratische Partei Deutschlands, or Social Democrat Party), ran an intensely anti-US campaign based upon opposition to US policy on Iraq. The SPD was tied with the conservative, pro-US CDU-CSU (Christian Democrats), each getting 38.5% of the votes in an election in which 80% of eligible voters took part. But with the support of the Green Party's 8.6% vote, Schroeder defeated Edmond Stoiber, the CDU candidate, by fewer than 9,000 votes over the conservative coalition, giving the SPD-Green coalition 306 seats in the 603-seat parliament. The generally conservative German press referred to the winning coalition derogatorily as the Red-Green Coalition. The German Greens are a party of ecology and used to be a pacifist party until their chairman, Joschka Fischer, won a battle between the realists and the fundamentalists and got the party to back German troops going into Kosovo. The re-election of Schroeder has been tremendously damaging to the carefully nurtured five-decadeold US-German alliance. After Schroeder's victory, a curt statement from the White House did not congratulate him, or even mention him by name. It was a marked contrast to a statement congratulating French President Jacques Chirac, with whom Washington also has serious diplomatic problems, on his May re-election. The White House also declined to arrange a personal telephone call between Schroeder and Bush. In the view of the US, Schroeder and key members of his cabinet played to antiUS sentiment in Germany over foreign-policy issues during the final weeks of the campaign beyond election politics to the point of personal attacks on the US president. Politically, the Bush administration at the time leading up to the Iraq invasion wanted Germany to join its international coalition to support its disastrous policy on Iraq, with diplomatic backing at the UN, and to grant the "coalition of the willing" complete access to German airspace and allow the US and Britain full use of their bases on German soil for offensive operations against Iraq. The White House also wanted Germany to support more fully Washington's "war on terrorism", especially with regard to the extradition of terrorist suspects on German soil, even those with German citizenship, and the release of crucial evidence that could be used to help convict them in US courts. It also wanted Germany to increase defense spending, which had fallen to just 1.5% of its GDP, and to pay for costs associated with increased terrorism security at US bases in Germany. The US has warned that if the German government continues to hinder US policy toward Iraq and elsewhere, such as Iran and in the UN, Washington may conclude that Berlin is reneging on its defense-treaty obligations, which would have serious political consequences, beyond being labeled the "old Europe". US support for German membership in the UN Security Council hangs in the balance.

With the creation of NATO in April 1949, the US and Germany formally became military allies. It was a turning point for both. For the first time in its history, the United States had signed on to a permanent alliance that linked it to Europe's defense; and for Germany, as for Italy, membership in NATO signaled a new acceptance internationally, an important political legitimacy for a nation with an embarrassing past. It was an alliance relationship that remained solidly operative throughout the decades of the Cold War, as a succession of German leaders, from Konrad Adenauer to Helmut Kohl, remained determinedly pro-US in their policies. The US views Schroeder as having placed in jeopardy this historically close relationship for shortsighted political gain. Germany, on the other hand, merely sees itself as finally acting as an independent nation with full sovereignty responsive to its social-democratic heritage. The new independent Germany will support US policies that converge with German national interests and values and opposed those that diverge from them. From this point on, no German politician can afford to play the role of collaborator to US occupation on the Adenauer rationalization that it would buy better treatment from the occupier. The Germans have been occupiers and they know from first-hand experience that collaborators enjoy no respect from anyone, least of all from the occupiers. Schroeder has stated unequivocally that Germany would not participate in US-led military action in Iraq. In his first successful election campaign in September 1998, he declared that "this country under my leadership is not available for adventure". In reference to Germany's $9 billion contribution to funding the first Gulf War, Schroeder warned that "the time of checkbook diplomacy is over once and for all". During the Cold War, checkbook diplomacy for West Germany meant to give money in place of sending German troops. It remains unclear if the end of checkbook diplomacy according to Schroeder means acceptance of a revival of German militarism or merely refusal to pay the bill for US militarism, something Saudi Arabia has never dared to do. To buy their precarious security, the Saudis have been forced to pay all sides in complex Mid-East politics. The first months of Schroeder's chancellorship were marked by policy disputes with his more strongly socialist finance minister (and Social Democratic party chairman) Oskar Lafontaine, who was SPD regional chairman in 1977 and premier of the Saar in 1985. A leader of his party's "peace faction" in the early 1980s, Lafontaine denounced chancellor Helmut Schmidt's nuclear policy, calling for German withdrawal from NATO. He was seen as the party's "conceptual pioneer", who would redefine its policies on unemployment and the environment. He opposed the German reunification agreement negotiated by chancellor Helmut Kohl, but lost support within the SPD. Lafontaine was defeated in the December 1990 election, having survived an assassination attempt in April. In 1995, he became national chairman of the SPD. Returned to parliament, Lafontaine became finance minister in the Schroeder government in 1998, but clashes over policy caused him to resign the ministry, his SPD leadership, and his parliamentary seat in March 1999. Schroeder succeeded Lafontaine as party chairman. However, after the Social Democrats' subsequent series of electoral defeats on the state level, Schroeder moved to shore up his standing with the left. But economic problems forced him in 2000 to reduce individual and corporate income taxes and positioned the Social Democrats as a "modernizing force" in German politics. Internationally, Schroeder's pursued a less EU-centered and NATO-dependent foreign policy than his predecessor, establishing good relations with Russia and China. He also supported the US in its "war on terrorism" in Afghanistan, which strained relations with the Green Party, his main coalition partner. The Social Democrats' electoral setbacks in the 2002 elections initially led Schroeder to move forward more modestly with reforms in his second term, despite Germany's weak economy, and late in 2003 he secured passage of supply-side tax cuts and anti-labor laws intended to revive the economy. Rank-andfile unhappiness with his reform program forced Schroeder to resign as party chairman in 2004. Schroeder is a firm believer of a more independent German foreign policy. For the first time since World War II, Germany's leaders are advocating a course based on German national interests. The general secretary of the Social Democratic Party, Franz Muentefering, summarized this position clearly: "Independently of what the UN decides, there must be a German way, that we must decide for ourselves what is to be done. That decision for us means no involvement in any ... conflict or war in Iraq." Reflective of rising anti-US sentiments in Germany, campaign polemic invoked harsh criticism of US

policy on Iraq. The chancellor himself mocked the US president in election rallies, telling crowds that he would not "click his heels" and say "ja" automatically to US foreign-policy demands or commands. Ludwig Stiegler, the Social Democrat parliamentary leader during the election, accused Bush of acting like a Roman dictator, "as if he were Caesar Augustus and Germany were his province Germania". Stiegler also compared the US ambassador to Berlin to Pyotr Abrassimow, the unpopular Soviet ambassador to East Germany prior to the fall of the Berlin Wall. Schroeder's justice minister, Herta Daeubler-Gmelin, compared the Bush administration's policy towards Iraq to that of Hitler's strategy before World War II. She was quoted by the German regional newspaper Schwabisches Tagblatt as stating: "Bush wants to divert attention from his domestic problems. It's a classic tactic. It's one that Hitler also used." Daeubler-Gmelin also remarked that the United States "has a lousy legal system" and that "Bush would be sitting in prison today" if new insider-trading laws had applied when the president had worked as an oil executive. Condoleezza Rice, then the US national security adviser, condemned the remarks as "way beyond the pale", and according to the White House, the president was "very angered" by the comments. Schroeder sent a letter of apology to Bush. Daeubler-Gmelin denied making the comments, but Schroeder announced that she would resign. Then defense minister Rudolf Scharping, a leading figure in the SPD, accused Bush of wishing to remove Saddam Hussein in order to placate "a powerful - perhaps overly powerful - Jewish lobby". Predictably, this raised vocal accusations of anti-Semitism in Washington. Unfortunately for the United States, German opposition to US foreign policy tends to be validated by the march of events. Accordingly, there is little prospect that Berlin is willing to compromise over the Iraq question. Immediately after his re-election, Schroeder declared that "we have nothing to change in what we said before the election and we will change nothing", a view backed by Green Party secretary general Reinhard Buetikofer. Opposition to the Iraq war formed part of a wider German foreign-policy strategy - actively pursued by Foreign Minister Joschka Fischer - of opposing key elements of the Bush administration agenda and thinking. Like Schroeder, Fischer's roots lie in radical left-wing politics. A self-professed Marxist activist in the late 1960s and early 1970s with a record of violent street protest, Fischer leads a party that stands on the extreme left of the political spectrum and that is shunned as a respectable political force even in much of Europe until recent successes at the polls. The Green Party is fundamentally opposed to the US missile defense system and highly critical of US unilateralism on the Kyoto Protocol. With just 11 seats in the 601-seat German parliament, the Green Party holds the balance of power and with it a great deal of influence in the governing Red-Green coalition. Fischer was also outspoken in his criticism of Bush's 2002 State of the Union address, which called for action to be taken against the emerging threat posed by rogue states that were relabeled an "axis of evil". Fischer warned the White House that the fight against terrorism was not "a blank check in and of itself to invade some country - especially not single-handedly". In an interview with Die Welt, he criticized what he perceived to be US unilateralism over a possible war with Iraq: "Without compelling evidence, it will not be a good idea to launch something that will mean going it alone. The international coalition against terror does not provide a basis for doing just anything against anybody - and certainly not by going it alone. This is the view of every European foreign minister. For this reason, talk of the 'axis of evil' does not get us any further. Lumping Iran, North Korea and Iraq all together, what is the point of this? ... For all the differences in size and weight, alliance partnerships between free democracies cannot be reduced to obedience; alliance partners are not satellites." Fischer is fiercely critical of America's policy of using military power to deal with the threat of global terrorism. The solution, according to his view, lies in the reduction of global inequalities between rich and poor: "Chaos, poverty and social instability form the breeding ground on which fundamentalism, hatred and terror thrive. To tackle the new challenges, we need more than police and military missions. We need a long-term political and economic strategy which deals especially with the forgotten conflicts, the failed states, the black holes of lawlessness on our planet." Fischer has opposed most of the foreign-policy initiatives under the Bush administration, with the notable exception of the war against the Taliban in Afghanistan. In defiance of Bush's "axis of evil" speech, Fischer openly courted close ties with Iran and North Korea, and has been a keen supporter of the EU's policy of "constructive engagement" with what the US identifies as rogue regimes. At the same time, he is a staunch defender of the International Criminal Court and has fiercely opposed the concept of individual EU member states signing bilateral immunity agreements with the US. Environmental concerns have also been elevated by Fischer to the top of the Schroeder government's

international agenda, and the foreign minister declared that Bush was making a "fatal error" by refusing to sign the Kyoto Protocol on global warming. Germany is urging the US to remove its 150 or so land-based nuclear weapons still deployed on German soil. "The nuclear weapons still housed in Germany are a relic from the Cold War," said Green Party leader Claudia Roth in the Berliner Zeitung newspaper. "There is no need for them to be there. They should be removed and destroyed." Engaging China The EU is actively expanding beyond trans-Atlantic relations. The annual EU-China summits highlight not only the burgeoning economic ties between the major European powers and China but also moves toward closer political relations. Germany, backed by France, pushed for and achieved an in-principle agreement for the EU to work toward lifting the arms embargo imposed on China after the Tiananmen Square incident in 1989. The arms embargo has been an obstacle to stronger strategic ties. In the leadup to the most recent summit last December, China branded the ban "political discrimination" and "the result of the Cold War". During his recent visit to China, Schroeder expressed the hope that the summit would "give an important signal" for the removal of the ban. Chirac also declared the French government in favor of rescinding the embargo during a visit to China last October. Washington has strongly objected to any lifting of the arms embargo. Behind the US opposition lie broader concerns that a stronger China military, along with closer strategic relations between the EU and China, would undermine the present US hegemony in Northeast Asia. The Bush administration lobbied EU members to oppose the move by France and Germany to get the embargo lifted. The EU members that vocally resisted the change are those most closely aligned to the US, notably the government in British Prime Minister Tony Blair. Japan, a major US ally in East Asia, also urged the EU to retain the ban, with France and Germany asserting a more independent European stance toward China. While yielding to US pressure, the EU has declared that it "confirms its political will to continue to work towards lifting the embargo". For its part, Beijing "welcomed the positive signal, and considered it beneficial to the sound development of the comprehensive strategic partnership between China and the EU". The best the US can do is to slow EU-China convergence, but it cannot stop it. Political and strategic considerations are closely tied to trade opportunities for European corporations in China. In 1980, China ranked 25th among the EU's trading partners. Today, it is the second-largest after the US and growing at a faster pace. Bilateral trade between the EU and China has doubled since 1999 to 142.3 billion euros ($180.1 billion), making the EU China's largest trade partner. A number of bilateral agreements were signed at the seventh EU-China summit at The Hague last December 8 to accelerate economic relations. EU Trade Commissioner Peter Mandelson summed up the mood in European capitals when he called on the EU to "place China firmly and centrally on our radar. We must review and lift our relations with China to a new and higher, more intense level ... Europeans have to sit up and take notice because in absolute and relative terms, China is a huge phenomenon to be reckoned with." Germany's central role in pushing for an end to the arms embargo is related to the fact that German corporations have been major beneficiaries of developing EU-China ties. Germany is by far the largest EU exporter to China, accounting for 44% of the total. Bilateral trade between China and Germany reached $43.6 billion last year - a 31% annual increase - and is expected to double by 2010. Some 2,000 German companies, including major banks, operate in China. China is heavily reliant on imported machinery and technology, especially from Germany and Japan, the world's two largest exporters of machine tools. Nearly two-thirds of EU exports to China are in the category of "machinery and vehicles". According to a research paper issued by Deutsche Bank, 80% of German investors in China are major corporations in the automotive, steel, mechanical and chemical industries. BASF and Bayer, for instance, are the largest chemical firms in China. Volkswagen controls about 30% of the Chinese car market, where sales surged to five million units this year. In 2003, Volkswagen produced more cars in China than in Germany and Chinese sales accounted for one-third of the company's global net profit. The company has unveiled plans to invest another $6.5 billion in China to increase its annual production there to 1.6 million vehicles by 2008. German investment in China since 1995 increased tenfold, from just 800 million euros to 7.9 billion euros, by 2003, making Germany China's seventhlargest foreign investor.

German hopes in China were clearly displayed during Schroeder's three-day visit there on the eve of the Hague summit in December. Accompanied by 44 business leaders from major corporations such as DaimlerChrysler, Siemens and Deutsche Bank, the German chancellor signed 22 agreements with the Chinese government. These included the sale of Airbus commercial jets worth $1.3 billion, as well as $480 million in railway locomotives and $280 million in power-generation equipment. Schroeder declared that China's fast-growing car industry - now dominated by German companies - could be the "engine" of China's economic growth. He laid the cornerstone for a new DaimlerChrysler plant in Beijing and attended the opening ceremony of the second joint-venture factory between Volkswagen and First Auto Works, China's largest vehicle producer, in Changchun, in northeastern China. He told Chinese officials that German corporations were very interested helping to "restructure" China's northeastern heavy industries. The northeastern provinces, or Manchuria, are a key focus of German attention. The region has been the center of China's state-owned heavy industry. Anti-Americanism has prove to be a useful ideology for the definition of a new European identity. It was the attempt to defend European colonialism in the Third World, particularly in Asia and the Middle East, that had forced Europe to accept US dominance. A new definition of European identity will seek strength from anti-Americanism in the form of anti-neo-imperialism in Asia and the Middle East. European anti-Americanism is not just a friendly disagreement with its former senior ally, it is a widening chasm to buttress an independent Europe. Although in the formerly communist states of Eastern Europe, the US anti-communist policies during the Cold War can translate into pro-US sympathies today, a comparable post-Cold War bonus does not appear to apply in the new state of a unified Germany. The social democracies in Europe seem more in tune with the neo-communism in China than the neo-liberal supply-side market fundamentalism promoted by the United States.

Dollar Hegemony By Henry C K Liu (Originally published as [US Dollar Hegemony has to go] in AToL on April 11. 2002)

There is an economics-textbook myth that foreign-exchange rates are determined by supply and demand based on market fundamentals. Economics tends to dismiss socio-political factors that shape market fundamentals that affect supply and demand. The current international finance architecture is based on the US dollar as the dominant reserve

currency, which now accounts for 68 percent of global currency reserves, up from 51 percent a decade ago. Yet in 2000, the US share of global exports (US$781.1 billon out of a world total of $6.2 trillion) was only 12.3 percent and its share of global imports ($1.257 trillion out of a world total of $6.65 trillion) was 18.9 percent. World merchandise exports per capita amounted to $1,094 in 2000, while 30 percent of the world's population lived on less than $1 a day, about one-third of per capita export value. Ever since 1971, when US president Richard Nixon took the dollar off the gold standard (at $35 per ounce) that had been agreed to at the Bretton Woods Conference at the end of World War II, the dollar has been a global monetary instrument that the United States, and only the United States, can produce by fiat. The dollar, now a fiat currency, is at a 16-year trade-weighted high despite record US currentaccount deficits and the status of the US as the leading debtor nation. The US national debt as of April 4 was $6.021 trillion against a gross domestic product (GDP) of $9 trillion. World trade is now a game in which the US produces dollars and the rest of the world produces things that dollars can buy. The world's interlinked economies no longer trade to capture a comparative advantage; they compete in exports to capture needed dollars to service dollar-denominated foreign debts and to accumulate dollar reserves to sustain the exchange value of their domestic currencies. To prevent speculative and manipulative attacks on their currencies, the world's central banks must acquire and hold dollar reserves in corresponding amounts to their currencies in circulation. The higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold. This creates a built-in support for a strong dollar that in turn forces the world's central banks to acquire and hold more dollar reserves, making it stronger. This phenomenon is known as dollar hegemony, which is created by the geopolitically constructed peculiarity that critical commodities, most notably oil, are denominated in dollars. Everyone accepts dollars because dollars can buy oil. The recycling of petro-dollars is the price the US has extracted from oil-producing countries for US tolerance of the oilexporting cartel since 1973. By definition, dollar reserves must be invested in US assets, creating a capital-accounts surplus for the US economy. Even after a year of sharp correction, US stock valuation is still at a 25-year high and trading at a 56 percent premium compared with emerging markets. The Quantity Theory of Money is clearly at work. US assets are not growing at a pace on par with the growth of the quantity of dollars. US companies still respresent 56 percent of global market capitalization despite recent retrenchment in which entire sectors suffered some 80 percent a fall in value. The cumulative return of the Dow Jones Industrial Average (DJIA) from 1990 through 2001 was 281 percent, while the Morgan Stanley Capital International (MSCI) developed-country index posted a return of only 12.4 percent even without counting Japan. The MSCI emerging-market index posted a mere 7.7 percent return. The US capital-account surplus in turn finances the US trade deficit. Moreover, any asset, regardless of location, that is denominated in dollars is a US asset in essence. When oil is denominated in dollars through US state action and the dollar is a fiat currency, the US essentially owns the world's oil for free. And the more the US prints greenbacks, the higher the price of US assets will rise. Thus a strong-dollar policy gives the US a double win. Historically, the processes of globalization has always been the result of state action, as opposed to the mere surrender of state sovereignty to market forces. Currency monopoly of course is the most fundamental trade restraint by one single government. Adam Smith published Wealth of Nations in 1776, the year of US independence. By the time the constitution was framed 11 years later, the US founding fathers were deeply influenced by Smith's ideas, which constituted a reasoned abhorrence of trade monopoly and government policy in restricting trade. What Smith abhorred most was a policy known as mercantilism, which was practiced by all the major powers of the time. It is necessary to bear in mind that Smith's notion of the limitation of government action was exclusively related to mercantilist issues of trade restraint. Smith never advocated government tolerance of trade restraint, whether by big business monopolies or by other governments. A central aim of mercantilism was to ensure that a nation's exports remained higher in value than its imports, the surplus in that era being paid only in specie money (gold-backed as opposed to fiat money). This trade surplus in gold permitted the surplus country, such as England, to invest in more factories to manufacture more for export, thus bringing home more gold. The importing regions, such as the American colonies, not only found the gold reserves backing their currency depleted, causing free-fall devaluation (not unlike that faced today by many emerging-economy currencies), but also

wanting in surplus capital for building factories to produce for export. So despite plentiful iron ore in America, only pig iron was exported to England in return for English finished iron goods. In 1795, when the Americans began finally to wake up to their disadvantaged trade relationship and began to raise European (mostly French and Dutch) capital to start a manufacturing industry, England decreed the Iron Act, forbidding the manufacture of iron goods in America, which caused great dissatisfaction among the prospering colonials. Smith favored an opposite government policy toward promoting domestic economic production and free foreign trade, a policy that came to be known as "laissez faire" (because the English, having nothing to do with such heretical ideas, refuse to give it an English name). Laissez faire, notwithstanding its literal meaning of "leave alone", meant nothing of the sort. It meant an activist government policy to counteract mercantilism. Neo-liberal free-market economists are just bad historians, among their other defective characteristics, when they propagandize "laissez faire" as no government interference in trade affairs. A strong-dollar policy is in the US national interest because it keeps US inflation low through low-cost imports and it makes US assets expensive for foreign investors. This arrangement, which Federal Reserve Board chairman Alan Greenspan proudly calls US financial hegemony in congressional testimony, has kept the US economy booming in the face of recurrent financial crises in the rest of the world. It has distorted globalization into a "race to the bottom" process of exploiting the lowest labor costs and the highest environmental abuse worldwide to produce items and produce for export to US markets in a quest for the almighty dollar, which has not been backed by gold since 1971, nor by economic fundamentals for more than a decade. The adverse effect of this type of globalization on the developing economies are obvious. It robs them of the meager fruits of their exports and keeps their domestic economies starved for capital, as all surplus dollars must be reinvested in US treasuries to prevent the collapse of their own domestic currencies. The adverse effect of this type of globalization on the US economy is also becoming clear. In order to act as consumer of last resort for the whole world, the US economy has been pushed into a debt bubble that thrives on conspicuous consumption and fraudulent accounting. The unsustainable and irrational rise of US equity prices, unsupported by revenue or profit, had merely been a devaluation of the dollar. Ironically, the current fall in US equity prices reflects a trend to an even stronger dollar, as it can buy more deflated shares. The world economy, through technological progress and non-regulated markets, has entered a stage of overcapacity in which the management of aggregate demand is the obvious solution. Yet we have a situation in which the people producing the goods cannot afford to buy them and the people receiving the profit from goods production cannot consume more of these goods. The size of the US market, large as it is, is insufficient to absorb the continuous growth of the world's new productive power. For the world economy to grow, the whole population of the world needs to be allowed to participate with its fair share of consumption. Yet economic and monetary policy makers continue to view full employment and rising fair wages as the direct cause of inflation, which is deemed a threat to sound money. The Keynesian starting point is that full employment is the basis of good economics. It is through full employment at fair wages that all other economic inefficiencies can best be handled, through an accommodating monetary policy. Say's Law (supply creates its own demand) turns this principle upside down with its bias toward supply/production. Monetarists in support of Say's Law thus develop a phobia against inflation, claiming unemployment to be a necessary tool for fighting inflation and that in the long run, sound money produces the highest possible employment level. They call that level a "natural" rate of unemployment, the technical term being NAIRU (non-accelerating inflation rate of unemployment). It is hard to see how sound money can ever lead to full employment when unemployment is necessary to maintain sound money. Within limits and within reason, unemployment hurts people and inflation hurts money. And if money exists to serve people, then the choice becomes obvious. Without global full employment, the theory of comparative advantage in world trade is merely Say's Law internationalized. No single economy can profit for long at the expense of the rest of an interdependent world. There is an urgent need to restructure the global finance architecture to return to exchange rates based on

purchasing-power parity, and to reorient the world trading system toward true comparative advantage based on global full employment with rising wages and living standards. The key starting point is to focus on the hegemony of the dollar. To save the world from the path of impending disaster, we must: # promote an awareness among policy makers globally that excessive dependence on exports merely to service dollar debt is self-destructive to any economy; # promote a new global finance architecture away from a dollar hegemony that forces the world to export not only goods but also dollar earnings from trade to the US; # promote the application of the State Theory of Money (which asserts that the value of money is ultimately backed by a government's authority to levy taxes) to provide needed domestic credit for sound economic development and to free developing economies from the tyranny of dependence on foreign capital; # restructure international economic relations toward aggregate demand management away from the current overemphasis on predatory supply expansion through redundant competition; and restructure world trade toward true comparative advantage in the context of global full employment and global wage and environmental standards. This is easier done than imagained. The starting point is for the major exporting nations each to unilaterally require that all its exports be payable only in its currency, so that the global finance architecture will turn into a multi-currency regime overnight. There would be no need for reserve currencies and exchange rates would reflect market fundamentals of world trade. As for aggregate demand management, Asia leads the world in both overcapacity and underconsumption. It is high time for Asia to realize the potential of its market power. If the people of Asia are to be compensated fairly for their labor, the global economy will see its fastest growth ever.

The BIS vs national banks By Henry C K Liu This article appeared in AToL on May 14, 2002

Banking is an important institution in the economy, but it is not the economy. Banks' traditional role is primarily that of an intermediary for money. Under finance capitalism, banks on the one hand take on new importance in the financial system (apart from their traditional lending role in industrial capitalism) while on the other hand they lose their traditional monopoly, as sole conduits of credit, to

the unregulated global capital and credit markets dominated by non-bank financial entities and overthe-counter (OTC) derivative trades between market participants without intermediaries and outside of exchanges. In these markets, banks are reduced to merely special market participants that both enjoy the protection of and are restrained by national regulatory regimes. The securities exchange commission views the difference between equity and debt as only technical, a distinction only meaningful in the legal accounting of risk. Convertible bonds, for example, blur the distinction by assigning the choice between debt and equity to the terms of credit. Even under market capitalism, banking systems in different economies serve different economic policy goals, which invariably evolve and change over the course of history, reflecting the financial needs of various developmental stages in different economies. In developmental terms, economies in the takeoff stages require different economic policies than those is consolidation stages. Economies that aim toward a hard landing from exuberant growth also require different economic policies than one aiming toward a soft landing. These differing economic policies are most effectively supported by differing banking regulations. The United States did not have a central bank until 1913. President Franklin D Roosevelt's New Deal responded to the Great Depression of 1929 with massive banking reform, adding to the Reconstruction Finance Corp (RFC) already set up by president Herbert Hoover, which lent to distressed corporations and banks. The RFC, designed as an emergency institution to be liquidated within two years, had a capital of US$500 million, and authority to issue government-backed, tax-free debentures of $1.5 billion. A Farm Credit Administration took over problem farm mortgages. A Home Owners' Loan Corp did the same for problem urban mortgages. An abrupt bank "holiday" was declared to make the government the lender of last resort. Export of gold as well as the redemption of currency for gold were forbidden by executive order. The Emergency Banking Act of 1933 endorsed emergency actions already taken by the president and created the Federal Deposit Insurance Corp to protect depositors. The Security Act of 1933 and the Securities and Exchange Act of 1934 created the Securities and Exchange Commission (SEC) to regulate equity markets. The Glass-Steagall Act of 1933 split investment banking from commercial banking to prevent the conflict of interest in pushing new issues of shares of the banks' clients on the banks' own depositors. The New Deal made recent emergency banking measures in Argentina look like a tea party. The difference was that the New Deal did not have an International Monetary Fund (IMF) to insist on conditionalities of austerity on the government. The emergence of junk bonds, providing risky ventures with open access to institutional money, was instrumental in restructuring the US economy, bringing into existence new productive apparatus, such as MCI, Turner Broadcasting, Dell, AOL and Microsoft, which constituted the New Economy. Drexel's Michael Milken created a new use for junk bonds in the 1980s, persuading executives to issue them to restructure and grow their companies and speculators and investors to buy and trade them. Much of the phenomenal increase in indebtedness of US corporations during past decades has been due to junkbond holdings, not bank loans, at least until creative accounting allowed corporation new off-balancesheet access to virtual money. With Drexel's aggressive campaign, the amount of junk bonds in the market swelled to $200 billion, and bonds became an important component in pension plans and mutual-fund investment. Despite Drexel's demise, corporate bonds outstanding in the United States has grown from $366 billion in 1980 to more than $2.5 trillion now. It is $1 trillion larger than municipal debt. It is 70 percent as large as the outstanding Treasury debt. Corporate bond issuance has increased more than fourfold since 1990 and, for high-yield junk bonds, more than 10-fold. A total of $16.4 billion of junk bonds, or 3.1 percent of the $510 billion outstanding, went into default in January and February 2002 alone - led by bankrupt telecommunications company Global Crossing Ltd ($3.4 billion) - on the heels of $43.6 billion of defaults last year. Charles Keating of Lincoln Savings and Loan purchased the since defunct institution in 1983 with $50 million raised by Milken through the sale of junk bonds, which started a daisy chain set of transactions that became a centerpiece of the savings and loan crisis.

From their different historical backgrounds, different banking systems and regulatory regimes have evolved for different national economies. The globalization of finance, accelerated by "big bangs" in major financial markets, has brought about the urgent push for global regulatory standards applicable to banks worldwide, while leaving credit and capital markets largely unregulated, and a foreign exchange regime driven by predatory processes disguised as free markets for currencies. The situation is further complicated by the use of new instruments in structured finance: securitization and derivatives which permit the unbundling of risks that are marketed to bidders willing to take different levels of risks for compensatory returns. Looking to keep such risks from infesting the banking system while not preventing the banks from participating in the highly profitable new markets, national banking systems are suddenly thrown into the rigid arms of the Basel Capital Accord sponsored by the Bank of International Settlement (BIS), or to face the penalty of usurious risk premium in securing international interbank loans. Thus national banking systems are all forced to march to the same tune, designed to serve the needs of highly sophisticated global financial markets, regardless of the developmental needs of their national economies. Banking reform becomes the mantra of neo-liberal globalization while the real systemic risk in the global economy has been socialized globally through structured finance, and the benefits of socializing such risk remains concentrated in the hands of private investors in the rich economies. Many national banking systems came into existence to support mercantilist or national industrial policy goals, such as rapid industrialization, gaining global market share, building an armament sector, rural electrification, regional development, flood management, etc, free from the dictate of private institutional profitability. Both the prewar and postwar German and Japan economic miracles were clear examples. With financial globalization, these banking structures of national policy have been forced to transform themselves into components of a globalized private banking system that puts institutional creditworthiness and profitability as prerequisites, serving the needs of the global financial system to preserve the security and value of global private capital. National policies suddenly are subjected to profit incentives of private financial institutions, all members of a hierarchical system controlled and directed from the money center banks in New York. The result is to force national banking systems to privatize and, in order to compete for interbank funds, to redefine and recognize domestic nonperforming loans (NPLs) under BIS guidelines. BIS regulations serve only the single purpose of strengthening the international private banking system, even at the peril of national economies. The BIS does to national banking systems what the IMF has done to national monetary regimes. National economies under financial globalization no longer serve national interests. They operate to strengthen what US Federal Reserve chairman Alan Greenspan calls US financial hegemony in the name of private profit. The IMF and the international banks regulated by the BIS are a team: the international banks lend recklessly to borrowers in emerging economies to create a foreign currency debt crisis, the IMF arrives as a carrier of monetary virus in the name of sound monetary policy, then the international banks come as vulture investors in the name of financial rescue to acquire national banks deemed capital inadequate and insolvent by the BIS. Profit of financial institutions now depends on increased price volatility more than on interest-rate spreads. Price adjustments in capital markets have been most clearly visible in a re-pricing of risks in a wide range of equity and high-yield bond markets. The high correlation of asset price movements across countries reflects the globalization of finance and the heightened tendency of global investors to invest on the basis of industrial sectors or credit ratings, rather than geographic location. Yet large segments of many national economies have no intrinsic need for foreign direct investment (FDI), or even market capitalization in foreign currencies. Applying the State Theory of Money, any government can fund with its own currency all its domestic developmental needs to maintain full employment without inflation. FDI denominated in foreign currencies, mostly dollars, has condemned many national economies into unbalanced development toward export, merely to make dollar-denominated interest payments to FDI, with little net benefit to the domestic economies. Further, assessment of risks is complicated by recent structural financial developments in the advanced nations' financial systems, including increasing global market power concentration in large, complex banking organizations (LCBOs), the growing reliance on over-the-counter (OTC) derivatives and

structural changes in government securities markets. Despite all the talk of the need for increased transparency, these structural changes have reduced transparency about the distribution of financial risks in the global financial system, rendering market discipline and official oversight impotent. Even blue-chip global giants such as GE, JP Morgan/Chase and CitiGroup have overhanging dark clouds of undisclosed off-balance-sheet risk exposure. Ironically, banks in emerging markets are penalized with disproportionate risk premiums when they fail to meet arbitrary BIS Basel Accord capital requirements, while LCBOs with astronomical risk exposures in derivatives enjoy exemption from commensurate risk premiums. National capital markets around the globe are vulnerable to spillovers and contagion from volatility in US capital markets. Continuous and steady access by emerging markets to global capital has been strongly affected by events in the mature markets. While the emergence of exchange-rate and banking crises in emerging markets and the ensuing contagion led to an abrupt loss of markets access in the past, many emerging markets now lose market access mainly because of developments in distant mature markets, such as the collapse of market capitalization on the Nasdaq, or the collapse of the telecom sector debt market built on the US formula of "air ball" financing - loans based on pro forma future cashflow rather than hard assets or current profits. The BIS is an international organization that aims to foster cooperation among central banks and other agencies in pursuit of global monetary and financial stability in the interest of the rich nations. It was established in the context of the Young Plan (1930), which dealt with the issue of the reparation payments imposed on Germany by the Treaty of Versailles. Thus from its birth, its institutional bias has been genetically in favor of winners/creditors. The reparations issue quickly faded into the background, focusing BIS's activities entirely on cooperation among central banks and, increasingly, other agencies, such as the IMF, in pursuit of monetary and financial stability for the benefit of global private creditors. Incidentally, the US Federal Reserve, the head of the central-bank snake, is privately owned by member private banks, though it presents itself to the world as a government institution, presumably along the same logic as Christ being both God and man. The BIS aimed at defending the Bretton Woods system until 1971, when the US abandoned the gold standard. It aimed at managing capital flows after the two oil crises and the international debt crisis in the 1980s. More recently, its thrust has been to foster financial stability in the wake of economic integration and globalization. Its Basel Committee on Banking Supervision recommended a riskweighted capital ratio for internationally active banks (1988 Basel Capital Accord, currently under revision) that has become international standard, forcing banks in poor nations to observe the same rules as banks in rich nations. The BIS performs traditional banking functions, such as reserve management and gold transactions, for the accounts of central-bank customers and international organizations. The total of currency deposits placed with the BIS amounted to $128 billion as of March 31, 2000, representing about 7 percent of world foreign-exchange reserves. In addition, the BIS has performed trustee and agency functions, acting as agent for the European Payments Union (EPU, 1950-58), helping the Western European currencies restore convertibility after World War II; as the agent for various European exchange-rate arrangements, including the European Monetary System (EMS, 197994), which preceded the move to a single currency. The BIS has also provided or organized emergency financing to support the international monetary system when needed. During the 1931-33 financial crisis, the BIS organized support credits for both the Austrian and the German central banks, resulting in a systemic financial collapse that contributed in no small way to the political success of the Nazis. In the 1960s, the BIS arranged special support credits for the Italian lira (1964) and for the French franc (1968) and two so-called Group Arrangements (1968 and 1969) to support sterling. More recently, the BIS has provided finance in the context of IMF-led stabilization programs (eg for Mexico in 1982, for Brazil in 1998, and for Turkey and Argentina in 2000-present). On January 8, 2001, the BIS decided to restrict, for the future, the right to hold shares in the BIS exclusively to central banks and approved the mandatory repurchase of all BIS shares held by private shareholders, against payment of compensation of 16,000 Swiss francs for each share (equivalent to some $9,950 at the USD/CHF exchange rate on January 8, 2001). Financial affirmative action for weak economies is not part of the BIS lexicon of international finance.

Since 1988, banks that trade internationally have been "invited" to observe the terms of the Basel Capital Accord signed by more than 110 countries. The accord has been made compulsory for all credit institutions in the G10 (Group of 10, comprising Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States) countries. The 1988 accord, with a deadline implementation by the end of 1992, focused on a single risk measure, with a one-size-fits-all, broad-brush approach, setting a minimum capital requirement at 8 percent. While Third World banks that do not meet BIS capital requirements are frozen from the global interbank funds, BIS rules have been eroded by LCBOs in advanced economies through capital arbitrage, which refers to strategies that reduce a bank's regulatory capital requirements without a commensurate reduction in the bank's risk exposures. One example of such arbitrage is the sale, or other shift-off, from the balance sheet of assets with economic capital allocations below regulatory capital requirements, and the retention of those for which regulatory requirements are less than the economic capital burden. Aggregate regulatory capital thus ends up being lower than the economic risks require; and although regulatory capital ratios rise, they are, in effect, merely meaningless statistical artifacts. Risks never disappear; they are always passed on. LCBOs in effect pass their unaccounted-for risks onto the global financial system. Thus the fierce opponents of socialism have become the deft operators in the socialization of risk while retaining profits from such risk socialization in private hands. Set for 2004, implementation of the new Basel Capital Accord II is meant to respond to such regulatory erosion by LCBOs. "Synthetic securitization" refers to structured transactions in which banks use credit derivatives to transfer the credit risk of a specified pool of assets to third parties, such as insurance companies, other banks, and unregulated entities, known as Special Purpose Vehicles (SPV), used widely by the likes of Enron and GE. The transfer may be either funded, for example, by issuing creditlinked securities in tranches with various seniorities (collateralized loan obligations or CLOs) or unfunded, for example, using credit default swaps. Synthetic securitization can replicate the economic risk transfer characteristics of securitization without removing assets from the originating bank's balance sheet or recorded banking book exposures. Synthetic securitization may also be used more flexibly than traditional securitization. For example, to transfer the junior (first and second loss) element of credit risk and retain a senior tranche; to embed extra features such as leverage or foreign currency payouts; and to package for sale the credit risk of a portfolio (or reference portfolio) not originated by the bank. Banks may also exchange the credit risk on parts of their portfolios bilaterally without any issuance of rated notes to the market. Another variant is to use credit derivatives to transfer the risk of a small number of corporate "names" rather than that of a larger portfolio. In this type of synthetic securitization, a SPV acquires the credit risk on a reference portfolio by purchasing credit-linked notes (CLNs) issued by the sponsoring banking organization. The SPV funds the purchase of the CLNs by issuing a series of notes in several tranches to third party investors. The investor notes are in effect collateralized by the CLNs. Each CLN represents one obligor and the bank's credit risk exposure to that obligor, which may take the form of, for example, bonds, commitments, loans, and counterparty exposures. Since the noteholders are exposed to the full amount of credit risk associated with the individual reference obligors, all of the credit risk of the reference portfolio is shifted from the sponsoring bank to the capital markets. The dollar amount of notes issued to investors equals the notional amount of the reference portfolio. Basel II regulation requires banks to build capital that will reflect a certain proportion of their financial activity, which occurs because of market volatility of financial instruments such as bonds, equities and derivatives. This discrepancy between the outcomes of the regulation capital and risk analysis has indeed fueled the development of new categories for financial instruments, such as credit derivatives or asset-backed securities, where regulated financial institutions transfer their low, but regulatorily expensive risks to non-regulated investors in order to extract value. As of December 31, 2001, CitiGroup held derivative exposure of $6.25 trillion, while its combined total asset was only $500 billion, according to the FDIC. The proposed new Basel Accord II is built around three pillars, each of which reinforces the other. The first pillar establishes the way to quantify the minimum capital requirements in the context of the brave new world of structured finance, the second organizes the regulator's supervision and the third establishes the foundations for market discipline through public disclosure of the way that banks implement the accord. Accurate internal risk-based (IRB) inputs are crucial to obtaining reasonably

accurate regulatory measures of capital adequacy. And the market will not believe or use risk disclosures unless it believes that the underlying risk measures, such as ratings and the probabilities of default, have been validated. Thus, supervisors must validate the risk measures to support both capital regulation and market discipline. While international rating agencies have been slow in coming to terms with true risk exposures of giant transnational corporations such as Enron and GE, they are subject of complaint from the government of Japan with regard to their "qualitative" judgment that lacks "objective criteria" of Japanese sovereign creditworthiness despite Japan's undisputed status as the world's leading creditor nation. Japan is singled out among its peers in the advanced industrial world for scrutiny over the basic rating question of threat of default. Yet Japan has the largest savings surplus in the world and the largest foreign exchange reserves. There is increasing evidence that the Japanese bank system crisis is not the cause but merely the symptom of its economic malaise which has resulted from the disadvantaged structural position Japan has allowed itself to fall into in terms of the global financial system. BIS regulations are a big part of that structural disadvantage. This is the reason why Japan has been resistant toward US demands for Japanese bank reform. No doubt Japan needs to reform its banking system, but it is highly debatable that the reform needs to go along the line proposed by US neoliberals or that bank reform alone will lift the Japanese economy out of its decade-long doldrums. The record of US supervisory effectiveness has been gravely tarnished by the shameful performance of the US accounting profession and the unethical behavior of corporate management. The SEC is only now frantically trying to play catch-up after the horses have fled the barn, with dead and wounded corporate bodies strewn around the market landscape. Fed governor Laurence H Meyer has publicly declared that at this moment and with current systems, no bank in the US likely would qualify to use the advanced IRB approach. LCBOs will be under pressure to enhance their risk management practices so that they might be prepared to adopt the advanced IRB approach. Tension exists between setting high standards and the expectation of wide adoption of the advanced IRB approach by LCBOs. There is a possibility that the US banking industry will simply stick with the standardized approach and turn a cold shoulder to advanced IRB. It would be the financial version of US unilateralism and exceptionism. The effective average risk weight for a bank as a whole should decline with the more sophisticated approaches depending on the extent of capital arbitrage already accomplished. Such banks would achieve lower total regulatory capital charges and, consequently, a higher reported risk-weighted capital ratio. Given the different risk profiles at individual banks, capital requirements almost certainly would vary more widely under the new risk-based capital ratios than under current BIS measure. A bank with a relatively low risk portfolio would find that its risk-weighted capital ratio increased because its risk-weighted exposures had declined. It would, as a result, presumably reduce its capital, or increase its leverage, or even increase its risk exposure, defeating the purpose of the new accord. Banks in the emerging economies will definitely be put at a disadvantage due to their lack of sophisticated risk management capabilities and limited access to global capital and credit markets. A look at US credit-market debt as a percentage of gross domestic product (GDP) is revealing. Domestic financial debt jumped from 12.3 percent of GDP in 1971 to 91.8 percent of GDP in 2001. According to Fed data on the flow of funds, banks' share of net credit markets dropped from a peak of over 62 percent in 1975 to 26 percent in 1995 and is still falling rapidly, while security markets' share rose from negligible in 1975 to over 20 percent in 1995 and still rising rapidly, with insurers and pension funds taking the rest. In 1999, US credit market debt amounted to $25.6 trillion, two and a half times GDP, of which commercial banking debt was only $5.0 trillion. Treasuries was $5.2 trillion, agencies were $8.5 trillion and mortgage or asset backed securities was $3 trillion. Commercial papers was $1.4 trillion. Money market instrument was $2.3 trillion. Securitization now stand at over $3 trillion, up from $375 billion in 1985. Insurance companies and banks in the US fell from 75 percent of financial industry assets in the 1950s to less than 35 percent today, while mutual-fund and pension-fund firms increased their share from 6 percent to 43 percent over the same time period. The fundmanagement industry has profited as individuals replaced the majority of their directly held equities with managed funds. Banks have lost assets to the financial markets, as those markets have become more attractive to debtors and investors.

More than 75 percent of the global volumes in securitization originate from the US. Asia, including Japan, which still funds its economies mostly through banks, could not recover quickly from the 1997 financial crisis, primarily because of underdeveloped debt and securitization markets in Asia. And the Basel Accord capital requirements have a more restrictive impact on Asian economies for that reason. Financial market creativity has brought forth an explosion in the number of securitized products which in turn has contributed significantly to the growth of capital and debt markets, which in turn has paralleled the decline of the banks' share of financial industry assets. The importance of banks in the management of credit risk has also declined with the growth in the commercial paper and high-yield bond markets. Banks' loss of market share in the credit card market has been extremely rapid, as their share of credit card receivables fell from 95 percent in 1986 to 25 percent in 1998. During this period, non-bank credit card companies and the securitization of receivables have exploded. Over the same time period, securitized mortgages grew from 10 percent to 41 percent of the US mortgage market. Finally, there was the rise of money market accounts and brokerage firm sponsored cash management accounts. Banks' share of checkable deposits fell from 85 percent to 55 percent from 1980 to 1998, while money markets and alternative checking accounts grew to 45 percent of checkable deposits. These new products have allowed consumers unparalleled declines in funding costs and transactions convenience. Despite these tremendous losses in market share, banks have been able to maintain a position of importance in the modern economy. Banks have experienced an erosion in their core business of borrowing and lending, and net interest income has fallen precipitously. But banks have successfully replaced this income by growing fee-based and value-added services such as brokerage, trusts, annuities, mutual funds, trading, mortgage banking and insurance. In other words, by becoming nonbank financial entities, instead of providing safety to its customers, banks have become brokers of risk rather than cushions against risk. A case study from Brady bond prices (July 2001) applying a reduced-form model to uncover from secondary market's Brady bond prices, together with Libor interest rates, shows how the risk of sovereign default is perceived to depend on time. Thus Walter Wriston of Citibank was essentially correct that countries do not go bankrupt in the long run. What Wriston failed to take into account was that governments can default on their foreign currency loans. Subsuming liquidity risk in default risk may result in a mis-specified model that, while generating the desired negative correlation between credit spreads and default-free interest rates, also generates negative probabilities of default at long horizons. Floating exchange rates, of course, further complicates the situation on foreign currency loans, which every sane government should avoid at all cost. Globalization of markets has put a premium on cooperation between national authorities and institutions as a means of achieving a more harmonized financial environment, while in the foreign exchange arena, violent volatility, erratic spreads, high trading volumes and liquidity crises are commonly expected as natural. In this context, national banks are pushed to fall in line with guidelines developed by the BIS, which demanded simplistic risk management formulae, not to mitigate real risk, but to appease rating agencies, which act as a police force for the BIS and global investors. Rating agencies now exercise powerful arbitration on the cost of sovereign and private sector credit. Reversing the logic that a sound banking system should lead to full employment and developmental growth, BIS regulations demand high unemployment and developmental degradation in national economies as the fair price for a sound global private banking system. Stephen Roach, Morgan Stanley's chief economist, wrote, "In theory, globalization is all about a shared prosperity - bringing the less-advantaged developing world into the tent of the far wealthier industrial world. But, in reality, when there's less prosperity to share, these benefits start to ring hollow. As the world economy now tips into recession, the assault on globalization can only intensify. The intrinsic tensions of globalization: market-driven forces of cross-border economic integration are increasingly at odds with the politics of fragmentation and nationalism. In the end, it probably boils down to jobs, voters and the social contracts that bind politicians to these key constituencies. Disparities in social contracts around the world underscore the inherent contractions of globalization." While banks in the US have successfully shifted bad loans off their books through securitization, banks in Asia, including Japan, are saddled with a NPL crisis created largely by the Basel Accord capital

requirements. Post-Keynesian economist Paul Davidson's distinguishing NPLs into episodic or systemic types is very perceptive, as is his conclusion that "we should never let the score keeping per se retard the game as long as there are real resources available to engage in productive activities". Obviously, the most effective resolution of NPLs is to turn them into performing loans. Yet the approach of the BIS (escalating capital requirement, loan writeoffs and liquidation, and restructuring through selloffs, layoffs, downsizing, cost-cutting and freeze on capital spending), a banking version of the IMF austerity conditionality, creates macroeconomic conditions that would turn more performing loans into NPLs and NPLs into total loss.

Power and the new world order By Henry C K Liu This article appeared in AToL on February 25, 2003

Thomas L Friedman, three-time Pulitzer-winning columnist for the New York Times, is the ordained voice of US neo-liberalism. In his February 17 column, Friedman reported that China was described privately by an aide of US President George W Bush as "not having a dog in this fight" at the UN Security Council debate over Iraq. Friedman offered a tutorial to China on the new international order of World War III, which he saw as having been set off by the events of September 11, 2001.

Friedman wrote: "The new world system is also bipolar, but instead of being divided between East and West (as in the Cold War) it is divided between the World of Order and the World of Disorder. The World of Order is built on four pillars: the United States, European Union-Russia, India and China, along with all the smaller powers around them. The World of Disorder comprises failed states (such as Liberia), rogue states (Iraq and North Korea), messy states - states that are too big to fail but too messy to work (Pakistan, Colombia, Indonesia, many Arab and African states) - and finally the terrorist and mafia networks that feed off the World of Disorder." Friedman asserts that the World of Disorder has been made more dangerous today by globalization, a trend that he has enthusiastically promoted for a decade since the end of the Cold War. "In a networked universe, with widely diffused technologies, open borders and a highly integrated global financial and Internet system, very small groups of people can amass huge amounts of power to disrupt the World of Order. Individuals can become super-empowered. In many ways, September 11 marked the first fullscale battle between a superpower and a small band of super-empowered angry men from the World of Disorder." Yet Friedman leaves his Aristotelian syllogism incomplete, failing to explain how regime changes in Afghanistan and Iraq and war against defenseless nation-states fit into "a battle between a superpower and super-empowered individuals". Friedman asserts that "the job of the four pillars of the World of Order is to work together to help stabilize and lift up the World of Disorder". He observes that some Chinese intellectuals, not to mention French and Russian, "wrongly believe" that they "all have more to fear from US power than from Osama, Kim or Saddam". He warns, "If America has to manage the World of Disorder alone, the American people will quickly tire." And he quotes Michael Mandelbaum, the Johns Hopkins foreignpolicy expert: "'The real threat to world stability is not too much American power. It is too little American power.' Too little American power will only lead to the World of Disorder expanding." Friedman cannot be referring to military or financial power, of which the United States has ample supply. He would be right if he were referring to moral power. The US military is by far the most powerful in the world, with more advanced technology and greater force-projection capability than all other nations combined. And dollar hegemony dominates the global economy. The last Gulf War was largely paid for by Saudi Arabia and other oil-producing Arabic states, with substantial benefit for the defense sector of the US economy. The real threat to world stability is too much military and financial power coupled with too little moral power on the part of any nation, and such a combination is particularly dangerous on the part of a sole superpower. Increasingly, US values, expressed in high-minded terms such as "democracy" and "freedom", are sounding more like empty slogans of tiresome propaganda. "Freedom" rings hollow to people around the world who find themselves unable to pay for privatized water, the basic necessity of life that used to flow clean and free, or to those forced to buy imported packaged food they used to grow free on their own land for themselves. "Democracy" cannot buy medicine for children exposed to new contagious diseases brought in by visitors arriving on jetliners, nor can it keep drug prices from wholesale gouging in the name of intellectual property rights. These are the real freedoms that have been taken away from much of the world by US-imposed globalization. The so-called World of Disorder has been constructed in large measure by half a century of US foreign and economic policies. Much of this World of Disorder lay in the US sphere of influence all through the Cold War. The memory of US support for Osama bin Laden against the Soviets in Afghanistan and for Saddam Hussein's war against Iran is still fresh in the minds of the people of the world. And US policies of sanctions and embargoes have caused millions of deaths and starvation. Now the world is asked to join a new US crusade against this year's list of latest evils in the name of order and stability. A stable world order cannot be constructed out of fear of precision bombs or tactical nuclear weapons, or with economic sanctions. It can only be constructed out of equality, equity and non-exploitative development - elements in short supply in globalization. The world is not just a marketplace; it is an

organism in which disease and poverty in any of its parts adversely affect the health of the whole organism. It I hard to visualize how another war can put things right. The Bush administration's policy toward China had been aggressively antagonistic prior to September 11, fanning public paranoia against the world's most populous nation in the early phases of legitimate self-renewal as a potential competitor against US global hegemony. Friedman now beseeches China to help keep alive "the open society in America" and to help save globalization, "because we Americans will tighten our borders, triple-check every ship that comes into port and restrict civil liberties as never before, and this will slow the whole global economy". He argues: "One more September 11 and your [China's] growth strategy will be in real trouble [unless you plan on only exporting duct tape], which means that the Chinese leadership will be in real trouble." He maintains that China cannot be a "free rider on an Iraq war" or "leave America to carry the burden of North Korea". Yet up until September 11, the United States actively supported separatist terrorism against China. The nuclearization of the Korean Peninsula is mostly a result of US policy. Friedman allows that it is quite legitimate for China to oppose the US waging war on Iraq or North Korea. But he asks in exasperation: "Why isn't China's foreign minister going to Baghdad and Pyongyang, slamming his fist on tables and demanding that their leaders start complying with the United Nations to avoid war?" Notwithstanding that most households in the United States are now looking to return the oversupply of duct tape they bought a few days ago, it would really be a page out of a Wag the Dog screenplay for the Chinese foreign minister to suggest, let alone demand, that Iraq or North Korea, both longtime targets of US sanction and other warlike hostile actions, is morally obligated to save the US from unilaterally dismantling its domestic civil liberty or to save US-imposed globalization that has impoverished much of the world. It would be a more credible scenario if the US secretary of state would go to Taipei to slam his fist on tables to demand that its leaders stop flirting with Taiwan independence to avoid war. Friedman warns: "One more September 11, one bad Iraq war that ties America down alone in the Middle East and saps its strength, well, that may go over well with the Cold Warriors in the People's Liberation Army, but in the real world - in the world where the real threat you face is not American troops crossing your borders but American dollars fleeing from them - you will be out of business." Friedman is right to be concerned about the adverse effects of terrorism and the uncertainty of another Iraqi war on the slowing US economy. And it is likely that one outcome of current US foreign policy of preemptive military attacks on less than clearly imminent threats will be further reversal of globalization trends. Globalization had already stalled since the Asian financial crises of 1997, long before the war on terrorism was launched, because the globalized game of transferring wealth from the poor to the rich is not sustainable. But Friedman must be astute enough to realize that China is at best a reluctant participant in the globalization game and not a zealous advocate. He is well enough informed not to be oblivious to the fact that serious debate is openly being held among Chinese planners about the proper policy response to stalled globalization. Many in China are openly questioning the wisdom of relying on export, within the context of dollar hegemony, as the sole engine of growth, or on market fundamentalism as a development principle, with visible effects of failed markets all over the world. The argument for a shift from export for dollars toward national domestic development is fast gaining acceptance among Chinese policymakers. Earlier, on January 6, Friedman wrote: "I have no problem with a war for oil - provided that it is to fuel the first progressive Arab regime, and not just our SUVs [sport-utility vehicles], and provided we behave in a way that makes clear to the world we are protecting everyone's access to oil at reasonable prices - not simply our right to binge on it." While the path to hell may be paved with good intentions, the path to nirvana is never paved with devious justification. Friedman's idea of a postwar "progressive" Iraq is definitely not a Venezuela of the Middle East, with a democratically elected president that the Bush White House tried to topple with a coup. Or is Kuwait or Saudi Arabia Friedman's idea of a "progressive" regime? He must realize that his "open door" policy on access to

Mideast oil is incompatible with a truly progressive Iraqi regime, and that "reasonable" oil prices are incompatible with conservation. In his book The Lexus and the Olive Tree, Friedman wrote that "the globalization system, unlike the Cold War system, is not static, but a dynamic ongoing process: globalization involves the inexorable integration of markets, nation-states, and technologies to a degree never witnessed before - in a way that is enabling individuals, corporations, and nation-states to reach around the world farther, faster, deeper, and cheaper than ever before, and in a way that is also producing a powerful backlash from those brutalized or left behind by this new system. "The driving idea behind globalization is free-market capitalism - the more you let market forces rule and the more you open your economy to free trade and competition, the more efficient and flourishing your economy will be. Globalization means the spread of free-market capitalism to virtually every country in the world. Globalization also has its own set of economic rules - rules that revolve around opening, deregulating and privatizing your economy. "Unlike the Cold War system, globalization has its own dominant culture, which is why it tends to be homogenizing. Culturally speaking, globalization is largely, though not entirely, the spread of Americanization - from Big Macs to iMacs to Mickey Mouse - on a global scale. "If the defining anxiety of the Cold War was fear of annihilation from an enemy you knew all too well in a world struggle that was fixed and stable, the defining anxiety in globalization is fear of rapid change from an enemy you can't see, touch or feel - a sense that your job, community or workplace can be changed at any moment by anonymous economic and technological forces that are anything but stable. "Last, and most important, globalization has its own defining structure of power, which is much more complex than the Cold War structure. The Cold War system was built exclusively around nation-states, and it was balanced at the center by two superpowers: the United States and the Soviet Union. The globalization system, by contrast, is built around three balances, which overlap and affect one another. The first is the traditional balance between nation-states. In the globalization system, the United States is now the sole and dominant superpower and all other nations are subordinate to it to one degree or another. The balance of power between the United States and the other states still matters for the stability of this system. And it can still explain a lot of the news you read on the front page of the papers, whether it is the containment of Iraq in the Middle East or the expansion of NATO against Russia in Central Europe. "The second balance in the globalization system is between nation-states and global markets. These global markets are made up of millions of investors moving money around the world with the click of a mouse. The United States can destroy you by dropping bombs and the Supermarkets can destroy you by downgrading your bonds. The United States is the dominant player in maintaining the globalization gameboard, but it is not alone in influencing the moves on that gameboard. This globalization gameboard today is a lot like a Ouija board - sometimes pieces are moved around by the obvious hand of the superpower, and sometimes they are moved around by hidden hands of the Supermarkets. "The third balance that you have to pay attention to in the globalization system - the one that is really the newest of all - is the balance between individuals and nation-states. Because globalization has brought down many of the walls that limited the movement and reach of people, and because it has simultaneously wired the world into networks, it gives more power to individuals to influence both markets and nation-states than at any time in history. So you have today not only a superpower, not only Supermarkets, but, as I will also demonstrate later in the book, you have Super-empowered individuals. Some of these Super-empowered individuals are quite angry, some of them quite wonderful - but all of them are now able to act directly on the world stage without the traditional

mediation of governments, corporations or any other public or private institutions." Friedman went on: "Osama bin Laden, a Saudi millionaire with his own global network, declared war on the United States in the late 1990s, and the US Air Force had to launch a cruise-missile attack on him as though he were another nation-state. We fired cruise missiles at an individual!" So, assuming the September 11 attacks were indeed masterminded by Osama bin Laden, the attacks were, by Friedman's account, merely retaliatory strikes. But Friedman's mentality transcends his personal insights. It is a mentality of arrogance of power for which the United States has been criticized by many. US moral imperialism demands not only quiet submissiveness from its victims, but vocal loyal support. Not only is globalization a game of heads I win for the US, and tails you lose for other participants, Friedman has the audacity to dangle globalized trade as a political favor from the United States to be granted only to sycophant partners. If China wants to continue to export goods manufactured by low-paid labor in exchange for dollars that the US can print at will, and in the process keeping US inflation unnaturally low even in the face of fiscal irresponsibility, to earn a trade surplus unspendable in the Chinese domestic economy as it must be held as foreign-exchange reserves in dollar-denominated instruments to finance the US trade deficit, then China had better fall in line to unquestioningly support US political hegemony. It is easy to act humbly when you are rich; the trick offered by Friedman is for the United States is to be arrogant when it is in debt up to its ears. The fact is that the US can no more dispense with low-cost Chinese imports than it can do without Mideast oil, both of which it pays for with paper money it can print without restriction. US Trade Representative Robert Zoellick said on the same day as Friedman's article: "China's ballooning trade surplus with the US is a boon to global growth and therefore desirable at a time when the economies of Japan and Europe are pretty stagnant." So who's kidding whom? US-China trade faces stagnant growth anyway unless the United States abandons its sanction on hightechnology export to China. With the US relocating all manufacturing offshore under globalization, high tech and military systems are the main US exports outside of agriculture and financial services. Thus high-tech sanctions put a damper on US-China trade growth and contribute to the growth of the US trade deficit. Last year, China overtook the United States as the leading exporter to Japan (US$61.7 billion, up 6.1 percent from 2001), accounting for 18.3 percent of Japanese imports, while US export to Japan dropped 9.5 percent to $57.5 billion. The US exported $22 billion to China, imported $125 billion (against import of $121 billion from Japan), chalking up a deficit to China of $103 billion in 2002. In 1985, the US incurred a trade deficit of $6 million with China. Friedman is not just another columnist. He is the celebrated spokesman for US neo-liberalism and, as such, his views are highly influential on, if not in concert with, US policy. In fact, US officials have been making similar noises in recent days about US dissatisfaction on China's posture on Iraq and North Korea. Yet the war on Iraq is not simply about oil. The United States already controls the global oil market and it does not need a war to consolidate its hold further. Despite recent surges, oil prices are still low by historical standards and as long as oil is denominated in dollars, the rise and fall of oil prices do not present insurmountable problems for the US economy. Petro-dollars are in essence captured US assets. If Friedman is really concerned about open access to oil at reasonable prices for everybody, he should support a progressive pricing regime for oil with higher prices for high per-capita consumption markets. The more you waste, the more you pay - the conservation formula of market fundamentalism. The average consumption in the inclusive period of 1983-2001 was 4.47 barrels per person per year for the world. A barrel of oil contains 5.8 million British thermal units (BTU). In 1995, US per capita usage was 327 million BTU per year, which is equivalent to 56.38 barrels of oil, 12.6 times of world average. On a deeper level, the real threat on long-term economic growth for the global economy is not

the price of commodities but the tyranny of mostly Western intellectual property rights. The war on Iraq is part of a US grand strategy to reposition the entire post-Cold War global geopolitical landscape to reflect a new world order with a single superpower. The split in the European Union into Old and New Europe over the Iraq war is part of a US objective of establishing a new US satellite system in Eastern European client states to fill the vacuum left by the collapse of the Soviet satellite system. The North Atlantic Treaty Organization (NATO) is being transformed from a defensive alliance for Europe against the Soviet bloc to an offensive proxy war machine for US policy of moral imperialism. France, Germany, Russia and China are working not as allies, but as nations with common interest in preventing the US in again turning the UN Security Council into a lap dog of US foreign policy, as the International Monetary Fund has been for US financial hegemony in the past two decades.

World Trade Needs a Global Cartel for Labor (OLEC) Part I: Background and Theory By Henry C.K. Liu This series appeared in Asia Times in February-March 2006 The global economy as currently constituted does not operate with a free market by any stretch of imagination, the propaganda of neo-liberal free traders notwithstanding. For this reason, there is a need for a global cartel for labor. Three related facts combine to make the global market not free. The first fact is that global trade is carried out under an international finance architecture based on dollar hegemony, which is a peculiar arrangement in which the dollar, a fiat paper currency backed by nothing of intrinsic value, can be printed at will by the US, and only the US, thus making export for dollars a game of shipping real wealth overseas for paper that is only usable in the dollar economy and useless domestically in all other non-dollar countries. Key commodities, such as oil, are denominated in dollars primarily because of US geopolitical prowess. Most economies need dollars to buy imported oil, but the exporting economies buy much more oil than they otherwise need domestically merely to satisfy the energy needs of their export sectors. The net monetized trade surplus from exports in the form of dollars, after paying for dollar-denominated oil and other imports, remains useless in the domestic markets of the exporting economies. Thus dollar hegemony reduces the non-dollar exporting economies to an absurd position of the more dollars from trade surplus they accumulate, the poorer they become domestically. This absurd

position is further exacerbated if domestic wages are kept low by export policy in order to compete for more global market share to earn dollars. It is a case of starving ones own children to provide free child labor to serve ice cream to outsiders. It is bad enough to exchange valuable goods for fiat paper; it is outright foolhardiness to keep domestic wages low merely to earn fiat paper that cannot even be spent in ones own economy. The second fact that makes the global market not free comes from neoclassical economics flawed definition of labor productivity as the amount of market value a worker can produced with a given unit of capital investment. Since according to monetary economics, market value, which is expressed as price, needs to remain stable to prevent inflation, labor productivity in financial terms can only be increased with declining wages per unit of capital. Further, price competition for market share directly depresses wages. Even if wages can at times rise in monetary terms, the ratio of wages to the market value of production must constantly fall in order for increased labor productivity to be monetized as profit. Thus profits from trade under this flawed definition of productivity ultimately can only be derived from falling wages. The concept of surplus value within the context of the labor theory of value as explained by Marx embodies this structural compulsion. Yet Marx was speaking of the structural effect of fair profits, not the obscene profits that are now the norm from sweatshops in the deregulated global market. Neoclassical economics replaces the labor theory of value with the theory of marginal utility in which price is defined as the intersection of supply and demand in a free market. William Stanley Jevon (Theory of Political Economy 1817), Carl Menger (Principles of Economics 1871), and Leon Walrus (Elements of Pure Economics 1877) promulgated the marginal utility, neoclassical revolution. Yet todays allegedly free market effectively deprives labor of any pricing power over its market value. Since capitalism does not recognize any ceiling for fair profit, always celebrating the tenet of the more the merrier, it must by implication oppose any floor for fair wages, to validate the opposite tenet of the lower the merrier. The terms of global trade then are based on seeking the lowest wages for the highest profit, rather than fair wages for fair profit. This is the linkage between neo-liberal capitalistic globalization and wage arbitrage, both in the domestic labor market and across national borders. Yet in a consumer-based global market economy, low wages lead directly into overcapacity because consumer demand depends on high wages. The adverse effect on consumer demand from the quest for maximum profit is the critical internal contradiction of the deregulated capitalistic market economy. The third fact that makes the global market not free is that while financial globalization facilitates unrestricted cross-border mobility of capital around the globe, obdurate immobility of workers across national borders continues to be maintained through government restrictions on immigration. Free trade advocates, from Adam Smith (1723-1790) to David Ricardo (1772-1823), in considering the relationship between capital and labor, treat the mobility disparity between capital and labor as a nature state, never entertaining that it is a mere political idiosyncrasy. This natural immobility of labor might have been reality in the 18th Century, but it is no longer natural in the jet-age global economy of the 21st Century in which mobility has become a natural characteristic. Labor immobility deprives labor of pricing power in a global market by preventing workers to go to where they are needed most and where market wages are highest, while capital is free to go where it is need most and where return on investment is highest. This econ-political regime against labor mobility, coupled with unrestrained cross-border mobility of capital, maintains a location-bound wage disparity that has created profit opportunities for cross-border wage arbitrage, in a downward spiral for all wages everywhere. Greenspan Supports More Immigration for the US Economy In January 2000, when the US unemployment rate reached 4.1% (4.7% in January 2006), the low end of structural unemployment without wage-pushed inflation, employers found it difficult to fill low-pay agricultural, meat and poultry packing and health services jobs, as well as high-pay high-tech information technology and software design jobs. The problem led the Federal Reserve to become concerned about possible wage-pushed inflation. It forced lawmakers to sponsor legislation which would make it easier for farmers, meat processors, and high-tech industries to import temporary workers through exemptions in immigration restrictions. Fed Chairman Alan Greenspan told Congress that increasing immigrant numbers in areas where workers are difficult to find could relieve stress in the job market and therefore wage-pushed inflation. Consistent with the Feds warped mission of maintaining structural unemployment to contain inflation, Greenspan said: Aggregative demand is putting very significant pressures on an ever-decreasing available supply of unemployed labor. The one obvious means that one can use to offset that is expanding the number of people we allow in.

Reviewing our immigration laws in the context of the type of economy which we will be enjoying in the decade ahead is clearly on the table in my judgment. Congress showed no enthusiasm for Greenspans suggestion of permanent immigration liberalization along with global finance liberalization. Farm growers in the US had hoped to increase the number of immigrant farm workers by attaching a provision in their interest to the highly favored high-technology industry's legislation to increase the number of high-tech immigrant workers. In 2000, high-tech immigration legislation seemed likely to pass Congress until the Clinton administration began attaching legislative riders that would give Latin American refuges legal permanent residency. In addition, the Clinton administration wanted to grant amnesty to a large number of illegal immigrants, most of whom were Hispanics. This political maneuvering stopped the pending high-tech legislation dead in its tracks because Republicans feared that the Democrats were attaching such legislative riders in order to gain support from the large number of Hispanic voters. The shortage of high-tech workers forced the industry to move operations overseas, at first not to save money on wages, but to find available workers. The labor unions reacted to immigration with traditional phobia, viewing it as a development that would keep wages low, rather than a new source for reversing the steady decline in membership. Yet employment data showed that high-tech immigrant workers did not lower wages during the high-tech boom in the US. What eventually lowered high-tech wages in the US was overcapacity resulting from overinvestment caused by excessive debt and inadequate consumer demand resulting from stagnant wages. After its collapse, the US high-tech sector recovered by outsourcing manufacturing jobs to low-wage countries, leaving consumer demand to be sustained by an expanding debt-driven asset bubble. Three years later, Greenspan took up another argument on behalf of immigration: this time in response to the actuary dilemma facing social security. On February 27, 2003, Greenspan, testifying before the Senate Special Committee on Aging, chaired by Sen. Larry Craig (R-ID), described the economic impact of an aging US population, which would lead to slow natural population growth that would result in slow economic growth, diminishing growth in the labor force, and an increase in the ratio of the retired elderly to the working-age population. By 2030, the growth of the US workforce will slow from 1% to %, according to census projections cited by Greenspan. At the same time, the percentage of the population over 65 years old will rise from 13% to 20%. Greenspan described how the aging population would have significant adverse fiscal effects. In particular, it makes our social security and Medicare programs unsustainable in the long run, short of a major increase in immigration rates, a dramatic acceleration in productivity growth well beyond historic experience, a significant increase in the age of eligibility for benefits, or the use of general revenues to fund benefits, Greenspan warned. According to Greenspan, immigration could prove a most potent antidote for slowing growth in the working-age population. As the influx of foreign workers in response to the tight labor markets of the 1990s showed, immigration does respond to labor shortages. An expansion of labor-force participation by immigrants and the healthy elderly offers some offset to an aging population. Fortunately, the US economy is uniquely well suited to make those adjustments said Greenspan. Our open labor markets can adapt to the differing needs and abilities of our older population. Our capital markets can allow for the creation and rapid adoption of new labor-saving technologies, and our open society has been receptive to immigrants. All these factors put us in a good position to adjust to the [impacts] of an aging population. Short of a major increase in immigration, economic growth cannot be safely counted upon to eliminate deficits and the difficult choices that will be required to restore fiscal discipline," said Greenspans semiannual report To Congress on monetary policy , submitted Feb. 11, 2003. Also, immigrants tend to have higher birth rate than native-born citizens. This would moderate the aging population trend. Still, anti-immigration phobia continue to rise in the US, as reflected by CNN personality Lou Dobbs, recipient of the 2004 Man of the Year Award from The Organization for the Rights of American Workers for his tilted coverage of the national debate on jobs, global trade and outsourcing. Dobbs was also a recipient of the Eugene Katz Award for Excellence in the Coverage of Immigration from the Center for Immigration Studies for his ongoing series "Broken Borders," which criticizes US policy on illegal immigration and the Bush Administrations guest worker program and proposals for immigration amnesty, not withstanding that if his crusade should bear fruit, there would be no one to clean his broadcast studio every night. Time is Ripe for a Global Cartel for Labor

In a world operating under the rules of political economy, the idea of a global cartel for labor, to be known as Organization of Labor-intensive Exporting Countries (OLEC), can help to level the playing field between capital and labor. It is a timely political concept with important positive economic implications in this age of deregulated finance globalization. In finance capitalism, both capital and labor are viewed as mere commodities, not unlike other basic commodities, most notably oil. All commodities command a price in the market by their sellers exercising fair pricing power. They do this by withholding supply from the market until the price is right and fair. If OPEC (Organization of Petroleum Exporting Countries) members can form a global cartel for oil to control and raise oil prices in the global market for their collective benefit at the same time claiming benefits for the global economy, low-wage manufacture exporting countries can also form a similar cartel for global labor to control and raise wages worldwide with a long-range strategy that would be good for the global economy. The objectives of OLEC would be to coordinate and unify labor policies among member countries in order to secure fair, uniform and stable prices for labor in the global market and an efficient, economic and regular supply of labor to provide a fair return on capital to maximize growth in the global economy. The ultimate aim is to implement a trade regime in which profitability is tied to rising wages. Towards these objectives, the successful experience of OPEC can be a useful guide. Just as OPEC allows different grades of oil to command different prices tied to a bench mark, OLEC will aim to set a price bench mark for labor around which flexible price ranges will reflect factors that affect productivity. The aim is to stop the downward spiral of wages caused by predatory wage policies. OPEC is a permanent, intergovernmental Organization, created at the Baghdad Conference on September 1014, 1960, by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. The five Founding Members were later joined by eight other Members: Qatar (1961); Indonesia (1962); Socialist Peoples Libyan Arab Jamahiriya (1962); United Arab Emirates (1967); Algeria (1969); Nigeria (1971); Ecuador (19731992) and Gabon (19751994). Headquartered in Geneva in the first five years of its existence, OPEC moved to Vienna on September 1, 1965. Each member country selects representatives who choose a governor for their country. These governors attend two regular OPEC meetings every year and they also choose the OPEC chairman. All decisions are to be unanimous. The OPEC Statutes identify the main objective as setting prices of oil and oil products and keep the price and supply stable with fair returns to the investors by adjusting production rates according to market conditions. OPEC operates as a market-sharing cartel within a framework of non-collusive cooperation with imperfect information. For the first decade of OPEC history, the transnational oil companies, the so-called seven sisters (Esso, BP, Shell, Gulf, Standard Oil of California, Texaco and Mobil) managed to use their overwhelming financial power to ignore it, by continuing their decade-old strategy of keeping oil prices low, with low royalty to the producer governments to subsidize the advance consumer economies while maintaining high corporate profit. In 1947, the price of oil was around $2.20/barrel, while exporter government taxes were less than 50 cents/barrel and production costs were between 10 to 20 cents/barrel. These figures remain relatively constant until the cartel effects of OPEC took form in the 1970s. Up to 1973, oil was selling for less than $3 per barrel just before the OPEC oil embargo, a rise of less than 80 cents in 26 years, way behind inflation. In 1967, during the Six Day War, OPEC member nations, namely Saudi Arabia, Kuwait, Libya, provided financial support to Jordan, Egypt and Syria. OPEC also successfully embargoed oil to Israel and the countries that supported Israel. In 1970, Libyan leader Muhammar Quadaffi used OPECs influence to put pressure on the other independent Middle Eastern states to increase oil prices and raised taxes on oil company incomes and in some cases to nationalize the oil companies dominated by foreign joint venture partners. But it was not until the 1973 that OPEC began to gain real market power. By 1973, US oil production was falling due to rising dependence on low-price oil from the Middle East. The oil crisis of the 1970s was a pricing problem rather than a shortage problem. In 1973, a barrel of Arabian crude sold for $3, and in 1980, the price peaked at $37 a barrel. In 1978, the second oil crisis was triggered by the Iranian revolution, causing its production to drop from 6 MMB/D in September 1978 to 2.4 MMB/D by December 1978. In the 1980s, OPEC learned from experience that the higher oil prices of the 1970s decreased demand, stimulated conservation, encouraged new exploration and production and quest for alternative energy sources, expanding the life span of the oil age. In May 1990, the first Gulf War caused a temporary oil shortage. In response to the crisis, OPEC increased supplies from fields not affected by the Iraq-Kuwait crisis, stabilizing prices. After the 1997 Asian financial crisis, oil fell to below $10. The second Gulf

War caused oil prices to increased more than six folds to reach above $70 per barrel, despite US pressure on OPEC to increase production. Few if any market analysts currently expect oil to fall below $50 in the foreseeable future. The impact of high oil prices, while stimulating conservation, has not been fatal to the global economy. See: The Real Problems With $50 Oil (http://www.atimes.com/atimes/Global_Economy/GE26Dj02.html) OPEC came into existence in 1960, but emerged as an effective cartel only following Arab Oil embargo which began on October 19-20, 1973 and ended on March 18, 1974. During that period the price for benchmark Saudi Light increased from $2.59 in September 1973 to $11.65 in March. OPEC has since been setting bottom benchmark prices for its various crudes. Yet oil price immediately before the current crisis dipped below $10 after the Asian Financial Crisis of 1997 and eventually stabilized around $20. Today, OPEC is the source of slightly more than a third of the worlds oil supply. The margin for turning three barrels of crude oil into two barrels of gasoline and one of heating oil fell to $3.086 a barrel on February 9, 2006, based on futures prices in New York, the lowest since June 2003. The profit for turning a barrel of crude into gasoline fell below $1 a barrel for the first time since September 1994; the margin plunged from $3.17 on Sept. 1, 2005. Oil reached a record $70.85 on Aug. 30, the day after Hurricane Katrina made landfall on the U.S. Gulf Coast, wrecking oil platforms, pipelines and refineries, and cutting production in the world's largest energy market. Oil may rise to a record $96 a barrel in August 2006 when hurricanes typically cut U.S. output, said Mitsui & Co., Japan's second-largest trading company on February 6. China kicked off the trading of fuel oil futures on the Shanghai Futures Exchange on August 25 2005 for the first time in a deca<>de. There is a fundamental relationship between wages and prices. Pricing policies of firms as they are actually practiced in the real world, both by cartels such as OPEC in oil, by other commodity producers, market leaders in pharmaceuticals, software, communication, and in fact the price of money (interest rates), have one thing in common. Pricing policies across all these different economic sectors are predicated on the proposition that price is seldom, if ever, set by the intersection of supply and demand, as neo-classical economics textbooks teach. The bottom line is that price is determined not by supply and demand but by strategies that aim at optimizing the long-term value of assets and political considerations. OPEC pricing is a good example. Because of OPEC, oil prices have become a key factor in the global economy. Throughout the history of oil, price has been set by highly complex considerations and supply has always been adjusted to maintain the set price. In pharmaceuticals, price is set neither by cost nor demand. The pricing model of any new drug aims at achieving maximum lifetime value of the drug that has very little to do with current supply and demand. Microsoft's pricing model for Windows has nothing to do with supply and demand, or marginal costs, which are close to zero. Telephone charges are similarly disconnected from supply and demand, or marginal costs. Even in the auto industry, the dinosaur of the old economy, where cost input is high and discounted return on capital low, pricing is based more on complex considerations than demand. With 80 percent of autos financed or leased, subsidy of financing costs is the name of the game, not sticker price. Farm commodities prices are definitely not set by the intersection of supply and demand. They are set artificially high by political considerations of practically all producer governments; and both supply and demand are artificially distorted to maintain the politically set price. The general consensus of mainstream economists on the global steel overcapacity problem is to reduce capacity, not to let prices fall. Price in fact is the most manipulated component in trade. That is the fundamental flaw of market fundamentalism. Friedrich Hayek's rejection of socialist thinking is based on his view that prices are an instrument of communication and guidance, which embodies more information than each market participant individually processes. Thus Hayek uses the aggregate defect of individual misjudgments as the correct judgment. To Hayek, it is impossible to bring about the same price-based order based on the division of labor by any other means. Similarly, the distribution of incomes based on a vague concept of merit or need is impossible. Prices, including the price of labor, are needed to direct people to go where they can do the most good. The only effective distribution is one derived from market principles. On that basis, Hayek intellectually rejects government regulation of market. The only trouble with this view is that Hayek's notion of price is a romantic illusion and nowhere practiced. That was how the Native Americans sold Manhattan to the Dutch for a handful of beads which under modern commercial law would be categorized as a fraudulent transaction. The Bank of Sweden Prize in Economic Sciences (Nobel Prize) was awarded to Joseph Stiglitz, George Akerlof and A Michael Spence for "their analyses of markets with asymmetric information". In his acceptance press conference, Stiglitz said, "Market

economies are characterized by a high degree of imperfections." Further, and most significantly, Hayeks argument is predicated on labor being able to go where it can do the most good, a precondition that is denied by immigration constraints. The Nature of Cartel A global cartel can take on many variant forms with different characteristics and impacts on the global market. Although every cartel is unique, from oil to diamond, the common attributes of any effective cartel are agreement among members for deliberate restraint on supply to the market to achieve a consistently higher price than that from predatory competition among sellers with no market pricing power. Theoretically, an ideal cartel can act as a monopoly operated by a number of separate but related yet independent entities. The multi-entity monopoly cartel assumes that it is a cartel authority rather than individual cartel members who makes price and supply decisions such that the cartel as a whole obtains the maximum possible monopoly revenue and profits from the market, and cartel members do not compete with each other but share the total profits in a pre-agreed manner. Under these terms, the cartel authority actually acts as a monopolist, but not necessarily a total monopolist. OPEC controls only one third of the worlds oil supply. The marginal cost curve is determined by using up the lowest cost area first, regardless of which member country the supply area belongs to. Given the market demand curve for the cartels supply, the cartel authority calculates the marginal revenue pattern and equates it to the jointly decided marginal cost curve. The equilibrium will set the cartels profitmaximizing supply level and the corresponding monopoly price. The central determination of price and supply by the cartel authority can guarantee maximum profit to the organization as a whole. Under this framework, the producers with high marginal cost might not produce at all if their marginal cost is higher than the cartels marginal revenue. Therefore, a unanimously accepted profit-share arrangement must be pre-agreed and post-enforced. However, such a perfect cartel cannot be sustained in reality by OPEC which is composed of constituent sovereign nations. The large producer (Saudi Arabia) would have to act as the swing producer, absorbing the demand and supply fluctuations in order to maintain the monopoly price. A cartel for labor would have to operate under rules responsive to the unique problems of labor markets, the details of which will have be workout depending of the membership make-up and the negotiated outcome among the members. But the prospect of common benefit will insure that the appropriate operational mechanics can be worked out. For OLEC, China and India can be swing suppliers to absorb labor supply and demand fluctuations to maintain stable and rising global wages for the common benefit of all OLEC members. A market-sharing cartel is one in which the members decide on the share of the market that each is allotted as a cartel member to achieve fair sharing of benefits and costs. In order to achieve this objective the members may then meet regularly to reach consensual measures in light of changing market conditions monitored by a staff of specialists. Since each member country in OPEC retains sovereign power over its own production rate and no individual one (except, possibly, Saudi Arabia as a swing producer) has the power to fix the price favorable to the cartel, it is predictable that member countries would adopt the market-sharing strategy as the way to achieve the cartel objective. The members join together to restrain their production for higher prices to gain optimum profit. Violating the cartel quota would serve no purpose as individual member may sell more oil but total revenue would fall because of lower prices. Theoretically, if cartel members have similar marginal cost curves, the ideal market-sharing strategy can achieve the same goals as the joint profit-maximizing ideal cartel model, outcomes of which are equivalent to those of a monopolist operating a number of plants. Third World economies with surplus labor operate separately from a collective disadvantaged position in global trade because global capital obeys the Law of One Price while global labor is exempt form the Law of One Price. As dollar hegemony forces all foreign investments into the export sectors of nondollar economies to earn dollars from trade, it produces a structural shortage of capital for non-export domestic development in all developing countries. These non-dollar economies then suffer from an imbalance between excess labor and a shortage of capital that prevents them from achieving full employment and to improve overall labor productivity. This imbalance translates into low wages that depress domestic consumer demand that in turn discourages investment in a downward vicious cycle of perpetual domestic underdevelopment. This widespread local underdevelopment in turn prevents the global economy from developing its full growth potential from rising consumer demand. This hurts not only the developing economies, but the advanced economies as well. On the one hand, crossborder wage disparity has given rise to predatory outsourcing that threatens employment and wage levels in the advanced economies. On the other hand, low wages around the world prevents needed

growth of exports from the advanced economies to balance trade. Thus raising wages around the world to reduce or even eliminate cross-border wage disparity is good for all economies. It would be the winwin proposition that neo-liberal free traders promised but never delivered. The current regressive terms of global trade need to be altered by a progressive global labor cartel. An International Labor Cartel is a Positive and Progressive Undertaking Since competition for global capital in a deregulated global financial market tends to depress wages worldwide to the detriment of all, it follows that a cartel to give labor fair pricing power in international trade would be a positive and progressive undertaking. Dollar hegemony has deprived Third World economies the option of using sovereign credit for domestic development, leaving export trade as the only available alternative. Yet economic and monetary policy sovereignty of all Third World nations has been under relentless attack from neo-liberal terms of trade. But creating a cartel for labor along the lines of OPEC, a political organization with an economic agenda, i.e. a cartel for oil, is something that Third World leaders can do while they are still in command of political sovereignty. OPEC of course got its inspiration from the De Beer diamond cartel. The Zaibatsu was a finance cartel in pre-war Japan. When the US occupation broke up the Zaibatsu, the dispersed companies quickly reformed in Keiretsu of horizontally-integrated alliances across industries around a major bank. The Keiretsu has been instrumental to Japans post-war economic recovery. The OPEC leaders achieved pricing power in the global oil market with two preconditions: ownership of oil in the ground (not movable) they occupy and political sovereignty. With that they managed to raise the price of oil, albeit with occasional failures and at the same time reduce the abusive waste of energy in the consuming countries, especial the advanced economies. Now the labor-intensive exporting countries have two similar preconditions: 1) workers that cannot leave because of immigration regimes of all advanced countries and 2) political sovereignty. They can do the same in pricing labor as OPEC did in pricing oil to provide a bench mark global wage platform and to steadily raise wages to alter the current destructive terms of trade in the globalized market. The idea should also get support from the US corporations and labor movement and the likes of Lou Dobbs. The way to do this is to make it impossible for global capital to exploit cross-border wage arbitrage for profit without raising wages to close to wage gap, and if necessary, with countervailing charges or taxes. Conversely, tax preference can be tied to a rising wage policy. Globalization itself is not a bad development. What is destructive is the current terms of trade behind globalization which operates as a beggar thy neighbor process while trumpeting a win-win fallacy. The idea of economic development is not to redistribute wealth by making the rich poor, but to create new wealth by making the poor rich at an accelerated pace to reverse the widening gap between rich and poor. Current terms of globalized trade widens the income and wealth gap by driving wages down and making low wages as the main factor in measuring competitiveness. The neo-liberal financial system provides credit only to firms that profit from driving wages down and withholds credit from firms that raise wages. What the world needs is a credit allocation regime and a profit measuring system to link corporate profitability with raising wage levels rather than lowering them. Lest we should forget, this is a very American idea. Henry Ford did it in the US by voluntarily paying higher wages than the market norm so that his workers could afford to buy the cars they produced. The US experience has proved that the poor can be made richer without the rich getting poorer. This can be done by enlarging the pie while benignly redividing it so that no one gets less than before while the poor get more faster, rather than just redividing a shrinking pie. The US itself provided very good lessons on how it could be done. The US has a superior Gini coefficient, which measures net income equality, than many underdeveloped economies. And the US is a richer nation by far. This shows that if global Gini coefficient improves with more income equality, the global economy can also be richer. Much of the problems currently faced by the US economy have to do with the use of debt to mask a declining Gini coefficient. US Prosperity Built on High Wages<> The US economy emerged after WWII as the strongest, the most productive and the most dynamic in the world, not only because Europe, Britain, Japan and the USSR and were all in war ruins, and the rest of the world was left barren from a century of plundering by Western imperialism, but because the US model was operatively superior. This superiority was based on three factors: 1) high socio-economic mobility, 2) high wages with relatively equality of income and 3) heavy public investment in physical and social infrastructure such as transportation, education and research and public health.

Socio-economic mobility manifested itself in a flowering of creative entrepreneurship and innovation. It was easy to turn new ideas and innovations into new small businesses because of pent-up demand from the war years and a friendly posture of banks that provided easy credit for returning veterans who aspired to be small business owners. Big business applied its war-time management techniques to concentrate on heavy industry, benefiting from technological and management breakthroughs made in war research and systems analysis, leaving small and medium business opportunities to young new entrepreneurs to exploit innovations to fill the needs of a market economy in transition from war production to peace production. Communication and transportation were relatively costly and cumbersome, keeping centralized management from being cost-effective in pervasive control of local markets, thus enabling small local entrepreneurs to compete effectively with big business through nearness to market and sheer nimbleness to change. A new middle class of good and rising income came quickly into existence that was confident, dynamic and independent. This came to be recognized around the world as the American Spirit, the belief that the combination of good ideas and hard work will lead to success in a free and open market, even though only a very small part of the US market was really free and open. China is now at the beginning of this path of development with spectacular success. High wages and full employment in post-war US led to strong consumer demand and a happy working class whose economic interests were effectively promoted by a strong labor movement that had developed productive symbiotic relationships with management from war production. Home ownership was promoted by government subsidies through credit guarantees and interest ceilings. All that was need to realize the American dream was a job, the income from which was closely calibrated to pay for a home, a car, a good life, free education, affordable health care and comfortable retirement, all accomplished with consumer financing. The concept of pay as you go liberated Americans from the slavery of save first, consume later, which would produce overcapacity while consumer needs remained unsatisfied. And jobs were plentiful because consumer demand war strong. There was living democracy in the workplace, with bosses forced to treat workers with equality and with the respect awarded to customers in order to retain them. The income gap between factory workers and professionals (engineers, lawyer, doctors, etc.) were narrow. Many hourly-paid union tradesmen such as plumbers, carpenters, metal workers, electricians, etc. actually enjoyed higher income than professional engineers, at least in the early decades of their careers. Aside from old money, income disparity among the working population was small, giving society de-facto socio-economic-cultural democracy. This happy outcome was because work was fairly and highly compensated. The GI Bill obliterated the elitist tradition of higher education. Children of working class, farming and immigrant background went to college and graduate school for the first time in US history and went on to be titans of industry and academia. This public-funded investment in human capital was the single largest contributor to US prosperity for the post-war decades until this generation reached retirement age in the mid 1970s. Despite the anti-communist ideology behind the Cold War, the US economy benefited greatly from socialistic programs that began in the New Deal while the core of the US economy remained firmly rooted in capitalism. The combination of a capitalistic core and a socialist infrastructure produced one of the greatest prosperities in human history, relatively free of oppressive exploitation. Within limits, the US was undeniably the freest and riches society in the world. With such a wondrously successful system, it was a puzzle why Americans were told by their leaders to fear communism since the whole world was trying to copy the US. Even the USSR was copying the US model with the ideological modification of state capitalism at the core. Where the USSR erred was that it failed to allow a consumer market of small entrepreneurs, a mistake China is now avoiding. Income Disparity Hurts the US Economy The good times in the US did not last forever, but the decay came imperceptibly slowly. Cold War paranoia in the US reversed the populist policies and arrested the economic ascendance of the middle class in the US while it turned the young socialist economies around the world into victims of garrison state politics. The Korea War set the US on a path against all national liberation movements in all former colonies which constituted two thirds of the worlds population that had risen from the post-war ashes of European imperialism. The Vietnam War was a continuation of that misguided geopolitical posture. These counterproductive wars not only did not achieve their misguided geopolitical objectives,

they forced the US to rely on Japan as a convenient and docile ally both militarily and economically, shutting out the rest of Asia, and most importantly, its vast market by self-negating embargos imposed by US foreign policy. In Europe, confrontation with Soviet communism after the Berlin Crisis forced the US to build up defeated Germany as a key military and economic client state. These policies set up the US in a new role of neo-imperialist in a global struggle of the rich against the poor. To support Germany and Japan and to incorporate them economically into a reactionary West led by the US, the US decided to allocate the sunset industries to their economies, such as auto manufacturing, while the US kept the high-tech industries such as aircraft manufacturing, television and computers and most importantly defense industries. Japan and South Korea were later given steel-making and shipbuilding to help support US logistics in Asian wars. The original idea was that subsidized imports to the US from these new allies were to be tolerated only on a temporary basis, that they were expected to supply low-priced goods to the parts of the global market that were too poor to buy US goods produced at high wages. But the Cold War embargos put all such markets off limit to US allies, forcing the US market to stay permanently open to Japan and Germany. In time, the US came to depend on relatively inexpensive imports from Japan and Germany to help contain inflation. Both German and Japan failed to recover to this day as truly sovereign powers to fulfill their full potential as independent states. Meanwhile, domestically the worst aspects of both capitalism and socialism were working hand-inhand to weaken the US economy. The organization man emerged from US corporate bureaucratic culture, robbing the economy of creativity and initiative. The likes of IBM, General Motors and General Electric became ruthless predators that chewed up independent entrepreneurs for breakfast by their market monopoly. A MIT professor of electronics with a new technology would start a successful company by servicing IBM which then would force a fire sale of the new company to IMB by threatening to stop buying from it. Within a year of its success, the new innovative company would become another IBM subsidiary managed by the huge bureaucracy of a gigantic enterprise. And the professor would retire from creative work with the sale proceeds. In this manner, IBM grew into a sluggish giant on a diet of other peoples ingenuity. Unionism turned into a drag on productivity and efficiency and the main resistant against change, rather than the driving force of innovation to protect labors pricing power. Finance and banking evolved in ways that discriminated against small business and those with inadequate capital, and pushed innovative entrepreneurs to seek funding from venture capitalist firm whose main aim to sell the new companies to big business for a quick profit. Risk-taking eventually became too costly for entrepreneurs, but cheap for speculators. The US trade deficit grew along with war-induced fiscal deficits threatening the gold-backed dollar. Keynesian deficit financing, instead of a formula to moderate the business cycle, became a permanent feature even in boom times to support ever higher levels of structural unemployment. Nixon was finally forced by recurring trade deficits and fiscal irresponsibility to take the dollar off gold in 1971; and by 1973, OPEC was allowed to raise oil prices on condition that petroldollars would be recycled backed to the US to limit damage to the US economy. As the US economy continued to stagnate, offering low returns on investment, petrodollars went to so-called newly industrialized countries (NIC). This was the beginning of globalization which at first was called interdependence, as half of the world was still under communist rule. The US was compensating for the slowdown in domestic growth with overseas expansion, by arguing that the US economy was merely growing beyond its borders rather than shrinking domestically, which would only be true if the US accepted a restructuring of its economy: by shifting from domestic manufacturing to global finance. Jimmy Carter presided over this restructuring transition of the US economy and saw a national malaise of spiritual despondency and economic stagflation that was inevitable when the population failed to understand the transition of the US from a strong nation to a hegemonic empire, a fact that US transnational corporations could not level with the US public due to US self-image. The same thing happened to the controversy over Corn Laws during the early days of the British Empire. Silly talks of Japan and Germany overtaking the US were widely circulated in clueless segments of the US, lamenting the disappearance of the good old days from the rearview mirror, unable to see when the rest of the nation was heading without them. Paul Volcker administered a blood-letting cure on US inflation and restored health to the US financial sector by sacrificing US industry which was increasingly forced to go global, leaving the US worker jobless on the roadside.<> Neo-liberal Global Trade with Dollar Hegemony Depress Wages Worldwide<> Bill Clinton was the first neo-liberal president. Just as life-long anti-communist Nixon could strike a deal with communist China without being accused domestically of being soft on communism,

something that a populist JFK could never have done during the Cold War, Clinton was more helpful to US transnational big business by undercutting organized labor than any Republican dared venture. Clinton was able to silent US labor protestation against job outsourcing in globalization because the union vote had no other candidate to vote for. Union wrath was deflected from US management to offshore labor first in Japan, then Southeast Asia and then China, exploiting deep-rooted racial hostility in US labor movements. But it was Robert Rubin, consummate bond trader from Goldman Sachs, who devised dollar hegemony as a way of financing a perpetual trade deficit by forcing US trade partners to recycle their trade surpluses denominated in dollars back into US capital accounts by buying US Treasuries that yield low returns. Thus dollar hegemony allows the US to enjoy a rising current account deficit by a guaranteed capital account surplus and the benefits of a strong dollar and low interest rate all at the same time. The Clinton Administration effectively resisted political pressure from US export manufacturers to devalue the dollar, arguing that devaluation, while helpful to US export, is not good for overall US national interest, which lies in the global dominance of finance. And US global financial dominance depends on a strong dollar made possible by dollar hegemony. Financial dominance is the caviar and the trade deficit is in fact the bait to capture sturgeons in the form of trade partners. By export more to the US for dollars than they import from the US payable in dollars, the trading partners of the US are fooled into thinking that their trade surpluses with the US are a good deal while they are shipping real wealth produced by underpaid labor to the US in exchange for paper money that can only be invested in the US while their own domestic sectors are starved for capital.<> The economic transformation of the industrial base in New England in the US was accomplished in the 1950s by shifting textile manufacturing to the low-wage south. This was repeated by shifting manufacturing from the Midwest to overseas in the 1990s, but unlike New England in the 1950s which transformed into a new economy of finance and high tech, the Midwest remained mostly a rust belt that never recovered. This is because the profit from the economic transition, instead of going to start new, more efficient plants, foes to finance debt that keeps US consumers spending. Robert Rubin, a Wall Street bond trader par excellence who became US Treasury Secretary, is an internationalist whose idea of America does not extend beyond west of the Hudson River. Politically, the Wall Street internationalists, not all of whom are Jewish, appeased the opposition by deregulation of the banking and finance sector, so that non-New-York financial firms could get in on the action. In reality, the New York banks end up turning all banks across the nation as their local branches. Banks in the US, instead of being local financial pillars that prosper only with the local economy of their domicile, now can profit from destroying the local economies. Early financial globalization was pioneered by superWASP Citibank led by Walter Wriston who championed lending petro-dollars to Third World governments who were expected to be bankrupt proved when profitable investment with good returns were getting hard to come by in the US domestic market. The battle between those who sold their labor and those who manipulated finances was won hands down by the financiers in the age of globalization. This is because cross-border wage arbitrage, unlike financial arbitrage that often eliminates market inefficiency by lifting the market value of the coupled instruments, works only to depress wages, never to lift them. Workers are not allowed to go to where wages are high, yet capital is encouraged to go where wages are low. Thus while the aim financial arbitrage is to lift asset value to enhance profit, the aim of wage arbitrage is to lower wage value to enhance profit. To defuse political backlash of falling wages in the advanced economies caused by outsourcing to low-waged economies, an asset bubble, including housing, was allowed to give the masses in the advanced economies capital gain income to compensate of reduced income from work. The formula was to take jobs from high-pay US workers and give them to low-wage oversea workers, and to compensate US workers with rising prices on their homes, low price imports and larger return for their pension fund investments overseas. This formula worked for a while, but it requires an escalating expansion of the money supply to support a debt bubble. The Fed under Greenspan managed to accommodate debt-driven expansion for over a decade, until the problem reached a point when further expansion of the money supply does not leave money in the US, but goes only to the global dollar economy off shore. US corporations are lining up to shed their pension obligation in the name of maintaining global competitiveness. The US housing bubble will burst from insufficient and stagnant income even if mortgage rates should remain low. Thus while it may still be in US imperial interest to expand the dollar economy globally, this expansion is facing domestic political opposition because an expanding global dollar economy leads to imbalances in the US economy with clear winners and losers that will soon translate into political

expressions in future elections. In a democracy, when losers exceed winners in numbers, even if not in aggregate monetary value, the electoral impact can be immediate. The dollar economy, which benefits primarily the financial sectors in the US and other money center locations, continues to expand while the non-financial sectors of the US economy collapse. With domestic political opposition building in the US, it is of critical importance how US policy will deal with the challenge of domestic imbalances created by globalization. The Need to Reduce Global Wage Disparity US policies need be changed to stop the destructive impact of dollar hegemony on both the US economy as well as the global economy. The global dollar economy is shaping up to benefit unfairly only a small number of financial speculators and manipulators, not the worlds population. The key is to eliminate as quickly as possible global income disparity that enable destructive cross-border wage arbitrage. The US should promote, even impose, terms of trade that reduces wage disparity both domestically and globally. This will allow both the US and the global economy to expand faster. Since it is economically painful and politically dangerous to lower wages in the advance economies, the only option is to raise wages at a rapid rate in the currently low-wage regions to reduce global wage disparity. This can be done only if global wage parity is set as a policy objective, rather than letting market forces dictate a downward spiral of falling wages. As global wages reach parity, manufacturing will be redistributed to locations of true overall competitiveness, rather being based on the single dimensional factor of wages. Global trade and exports will be conducted to benefit domestic development rather than to deter domestic development. Global income will rise, creating more consumer demand to reduce or even eliminated current global overcapacity. Without an OLEC cartel to protect the pricing power of labor in a global financial market, the Law of One Price will discriminate against labor by pushing wages down. The Law of One Prices echoes David Ricardos Iron Law of Wages which supplements Thomas Malthus population theory by asserting that wages tend to stabilize at the lowest subsistence level as a result of unregulated market forces. Malthus observed that population growth would mathematically outstrip the means of subsistence, giving economics the label of the dismal science. The theory of marginal utility as espoused by William Stanley Jevons in England, Leon Walrus in France, Eugene Bohm-Bawerk in Austria, Irving Fisher and Alfred Marshall in the US asserts that the market value of a commodity is determined by the demand for it and the relative scarcity at any given time and situation, and not by any intrinsic value. Marginal price is the price above which no buyer will buy. Marginal land is land that will not repay the cost of labor and capital applied to its cultivation or improvement. Marginal wage is the wage above which employment will cease. But while labor is a commodity, humans are not. There are basic human needs that every economy is required to first satisfy before market rules can be applied. For this reason, all civilized societies forbade slavery, child labor and other inhumane labor practices. The Law of One Price for labor decrees that the Iron Law of Wages will depress marginal wage to the lowest possible level if left to market forces. Yet the theory of marginal value of labor operating within a regime of neo-liberal terms of trade only applies impeccable logic to an artificially structure disguised as fundamental truth. The terms of trade in a labor market in which an anti-inflation monetary policy structurally disallows any scarcity of labor to emerge is inherently prejudicial to the fair pricing of labor. Similarly, the theory of marginal value in the flawed terms of trade in the auto market leads Detroit to produce unsafe cars at any speed by calculating that the cost of law suits from injury and death by unsafe cars is less costly than raising auto safety standards when the monetary value of injury and death are set too low by the courts. The current global overcapacity is a direct result of global wages being set too low by global wage arbitrage, depriving the world of the full potential of consumer demand. This overcapacity can be corrected by a global labor cartel. Purchasing Power Parity, the Law of One Price and Exchange Rates Purchasing power parity (PPP) between currencies measures the disconnection between exchange rates and local prices that defy the Law of One Price in a globalized economy. Purchasing power parity is reached when exchange rates between two currencies are adjusted to enable both currencies to buy the same amount of goods and services at local prices. The PPP gap between the US dollar and the Chinese yuan is estimated to be 4, meaning that one Chinese yuan buys four times as much in China than its current exchange rate equivalent in dollars buys in the US. A PPP gap highlights the distortion

exchange rates exert on the Law of One Price in cross-border trade. Purchase power parity contrasts with interest rate parity (IRP), which assumes that the behavior of investors, whose transactions are recorded on the capital account, induces changes in the exchange rate. For a dollar investor to earn the same interest rate on his investment in a foreign economy with a PPP gap of four times, such as the purchasing power disparity between the US dollar and the Chinese yuan, the return would have to buy four time more in China than it does in the US. Thus for every dollars of profit US investors require from investment in China, four dollars equivalent in Chinese goods and services are needed to support the prevailing exchange rate. Accordingly Chinese wages would have to be at least four times lower than US wages unless inflation in China closes the PPP gap, or purchasing power disparity, between the two currencies. But inflation in China will cause the yuan to fall against the dollar, keeping the PPP gap constant even as Chinese prices rise. This shows that pushing China to upward revalue its currency is futile as Chinese wage would fall to compensate for a stronger yuan. What China needs to do is to raise Chinese wages within a stable exchange rate. Applying the Law of One Price to Global Labor The Law of One Price says that identical goods should sell for the same price in two separate markets when there are no transportation costs and no differential taxes or tariffs applied in the two markets. A global trade regime governed by the Law of One Price should have wages in two separate labor markets converging through arbitrage to close the disparity. Since it is economically regressive for the higher wages to fall, the only productive convergence would be for the lower wages to rise. In finance, the Law of One Price is an economic rule which states that in an efficient market, a security must have a single price, no matter how that security is created. For example, if an option can be created using two different sets of underlying securities, then the total price for each would be the same; otherwise an arbitrage opportunity would exist. Because of the Law of One Price, put-call parity requires that the call option and the replicating portfolio must have the same price. Interest rate parity, which plays an important role in the foreign exchange markets, is another example of the Law of One Price. For the Law of One Price to hold between two economies, purchasing price parity, exchange rate parity between the paired currencies and interest rate parity must all exist simultaneously. Any violation of the Law of One Price is an arbitrage opportunity. The same should apply to the disaggregated labor markets in the global economy. The issue of unified wages is not only a matter of morality or social justice, as liberals asserted during the industrial revolution and the age of imperialism and as neoliberals and market fundamentalists reject in the age of globalization and neo-imperialism. It is the law of a truly free global market. While finance arbitrage uses the Law of One Price to raise market value of securities, cross-border wage arbitrage thus far only obstructs the Law of One Price in separate labor markets to keep wages low everywhere. A common mistake traders make is to forget the caveat that arbitragable price discrepancy should be isolated from factors such as tax treatment, liquidity or credit risk. Otherwise, they will put on what they perceive to be an arbitrage when in fact there is no violation of the Law of One Price beyond government intervention. The Law of One Price underlies the important financial engineering definition of arbitrage-free pricing even for disparity of prices created by government policy. To understand the positive potential for cross-border wage arbitrage, beyond the destructive impact of archaic outsourcing, lessons can be learned from how profit is generated by arbitrage plays in financial markets. If risks from oil, weather, environmental impact, credit and interest rates can be arbitraged profitably, there is good reason that risks associated with rising wages can also be arbitraged for profit. Using Wage Arbitrage to Stabilize Rising Wages In finance theory, an arbitrage is a free lunch, a transaction or portfolio that makes a profit without risk. Suppose a futures contract trades on two different exchanges. If, at one point in time, the contract is bid at $40.02 on one exchange and offered at $40.00 on the other, a trader could purchase the contract at one price and sell it at the other to make a risk-free profit of a $0.02. If the market for that security has sufficient broadness and depth, the arbitrageur can make millions. And if an arbitrage opportunity is created by a central bank on two currency, as the Bank of England did in 1992 defending the pound sterling, a arbitrageur like George Soros could make billions in a couple of days at the expense of the British economy. In 1998, an article Soros wrote in the Financial Times on the inevitability of a Russian devaluation of its currency precipitated the fall of the Russian Government, a massive default on its debts, and widespread financial panic that brought down Long Term Capital Management (LTCM), another high-flying hedge fund, requiring involvement of the Federal Reserve in

a $3,5 billion bailout. The IMF plan for Russia assumed that the maturing treasury bills (GKOs) could be rolled over at albeit astronomically high interest rate. But the holders of the GKOs were banks that borrowed dollars to buy the same GKOs which could not repay the dollars without the foreign banks agreeing to lend them more money, which the foreign banks were not. So the Russian banks could not roll over the GKO at any price, leaving a missing link in the financial chain. As the Russian public started withdrawing its savings from the national savings banks, the missing link widened. What started out as a fixable hole of $7 billion, within a week or two became a unfixable abyss. Soros and his partners lost their investment in a Russian telephone company along with countless others. Most arbitrage opportunities normally only reflect minor pricing discrepancies between markets or correlated instruments. Per-transaction profits tend to be small, and they can be negated entirely by retail transaction costs. Accordingly, most arbitrage is performed by institutions that have very low wholesale transaction costs and can make up for small profit margins by doing a large volume of transactions. Formally, theoreticians define an arbitrage as a trading strategy that requires the investment of no net capital, cannot lose money, and has a positive probability of making money. Arbitrage is the quintessential virtual-capital play in capitalism. Wages in different labor markets change for complex reasons. The gap in wages measured by standard productivity units changes which produces arbitrage opportunities. Any company whose revenue is affected by weather has a potential need for weather risk management products that hedge the companys exposure to weather deviating from historical norms. This is true for companies that consume oil, or impacted by changes in interest rates or any kind of uncertainty. In 2003, US Defense Department considered launching a market for terrorism futures to improve the prediction and prevention of terrorist outrages. All companies are affected in their profit by wage/productivity ratios. A labor cartel, like an oil cartel, cannot be expected to keep prices at fixed level for long periods, nor would it be necessary. Thus a wage risk management derivative can be structured to mitigate wage risks and reduce resistance to wage rise caused by fear of unexpected temporary wage decline in competing markets. Like weather and environmental derivatives, hedging can be a defensive use of wage index derivatives. Strategic planning linked to wage uncertainties can also be financially backed by wage index derivatives for pro-active use to sustain wage targets set by the labor cartel. While a market is said to be arbitrage free if prices in that market offer no arbitrage opportunities, there is a second use of the term shunned by theoretical purists but in wide use for several decades to become standard in all markets. According to this usage, an arbitrage is a leveraged speculative transaction or portfolio. During the 1980s, junk bond financing funded an overheated mergers and acquisitions market that produced new corporations, such as CNN, Microsoft and many of the names that are now respected industrial giants. Arbitragers of this period were speculators who took leveraged equity positions either in anticipation of a possible takeover or to put a firm in play. They also engaged in greenmail. Ivan Boesky was a famous arbitrager from this period who was ultimately convicted of insider trading. Michael Milken, the junk bond king also was sent to prison on finance-related charges. But the role of junk bond in financing new companies which otherwise could be secure financing was undeniable. The presence of a labor carter to sustain rising wages that stimulate consumer demand can also be financed by speculative arbitrage. If the conditions should come into existence, the almost inexhaustible creativity of the financial markets will response to the challenge. Neoclassical Economics Arbitrarily Assigns Unequal Pricing Powers between Capital and Labor David Ricardo's interest in economics was sparked by Adam Smiths Wealth of Nations (1776) whose thesis is that the division of labor (specialization) enhances economic growth. Ricardos law of rent was seminally influenced by Malthusian concepts. He propounded his Iron Law of Wages and a labor theory of value. To Ricardo, rent is a result and not a cause of price. The Iron Law of Wages asserts that wages cannot rise above subsistence levels. The theory of value maintains that in exchange, the value, not the price, of goods is measured by the amount of labor expended in their production. Smith also saw advancements in mechanization and international trade as engines of growth through the facilitation of further specialization. Because savings by the rich was seen as what provides investment and hence economic growth, Ricardo saw unequal income distribution as being one of the most important determinants of national economic growth. This is a critical shortcoming in Ricardos proposition, as in the modern economy, capital comes increasingly from the pension funds of workers, not exclusively from the rich. However, Ricardo posited savings to be in part determined by the profits of stock: as the capital stock of a country increased, profit declined - not because of decreasing

marginal productivity, but rather because competition between capitalists for workers would bid wages up to reduce profit. So keeping the living standards of workers low was another way to maintain or accelerate economic growth. This was the critical error Ricardo made in his observation of industrial capitalism. Ricardo did not understand that as industrialization advances, overcapacity will result unless workers are paid enough to consume what they produced. Ricardo did not foresee that free markets must include free labor markets that would enhance worker market power if economic growth were to be maintained. Ricardo reasoned that if labor cost rises with labor productivity, such rise will neutralize any marginal rise in return to capital which requires productivity rising faster than wages. Ricardo thus provided the scientific rationale for the anti-labor mentality of capitalism which is not only unnecessary but also factually incorrect. For Ricardo, capital is deployed to enhance labor productivity to increase return on capital, not to raise the standard of living of workers by raising worker income. The fixation with regressive theory is the rationale for the need of a labor cartel such as OLEC.

The Coming Trade War and Global Depression By Henry C.K. Liu First appeared in Asia Times on Line on June 18 2005 Many historians have suggested that the 1929 stock market crash was not the cause of the Great Depression. If anything, the 1929 crash was the technical reflection of the inevitable fate of an overblown bubble economy. Yet, stock market crashes can recover within a relatively short time with the help of effective government monetary measures, as demonstrated by the crashes of 1987 (23% drop, recovered in 9 months), 1998 (36% drop, recovered in 3 months) and 2000-2 (37% drop, recovered in 2 months). Structurally, the real cause of the Great Depression, which lasted more than a decade, from 1929 till the beginning of the Second World War in 1941, was the 1930 Smoot-Hawley tariffs that put world trade into a tailspin from which it did not recover until World War II began. While the US economy finally recovered from war mobilization after the Japanese attack on Pearl Harbor on December 7, 1940, most of the worlds market economies sunk deeper into war-torn distress and never fully recovered until the Korea War boom in 1951. Barely five years into the 21st century, with a globlaized neo-liberal trade regime firmly in place in a world where market economy has become the norm, trade protectionism appears to be fast re-emerging and developing into a new global trade war of complex dimensions. The irony is that this new trade war is being launched not by the poor economies that have been receiving the short end of the trade stick, but by the US which has been winning more than it has been losing on all counts from globalized neo-liberal trade, with the EU following suit in locked steps. Japan of course has never let up on protectionism and never taken competition policy seriously. The rich nations needs to recognize that in their effort to squeeze every last drop of advantage out of already unfair trade will only plunge the world into deep depression. History has shown that while the poor suffer more in economic depressions, the rich, even as they are fianancially cushioned by their wealth, are hurt by political repercussions in the form of either war or revolution or both. During the Cold War, there was no international free trade. The economies of the two contending

ideology blocks were completely disconnected. Within each block, economies interact through foreign aid and memorandum trade from their respective superpowers. The competition was not for profit but for the hearts and minds of the people in the two opposing blocks as well as those in the non-aligned nations in the Third World. The competition between the two superpowers was to give rather than to take from their separate fraternal economies. The population of the superpowers worked hard to help the poorer people within their separate blocks and convergence toward equality was the policy aim even if not always the practice. The Cold War era of foreign aid and memorandum trade had a better record of poverty reduction in either camps than post-Cold War globalized neo-liberal trade dominated by one single superpower. The aim was not only to raise income and increase wealth, but also to close income and wealth disparity between and within economies. Today, income and wealth disparity is rationalized as a necessity for capital formation. The New York Time reports that from 1980 to 2002, the total income earned by the top 0.1% of earners in the US more than doubled, while the share earned by everyone else in the top 10% rose far less and the share of the bottom 90% declined. For all its ill effects, the Cold War achieved two formidable ends: it prevented nuclear war and it introduced development as a moral imperative into superpower geo-political competition with rising economic equality within each block. In the years since the end of the Cold War, nuclear terrorism has emerged as a serious threat and domestic development is pre-empted by global trade even in the rich economies while income and wealth disparity has widened everywhere. Since the end of the Cold War some fifteen years ago, world economic growth has shifted to rely exclusively on globalized neo-liberal trade engineered and led by the US as the sole remaining superpower, financed with the US dollar as the main reserve currency for trade and anchored by the huge US consumer market made possible by the high wages of US workers. This growth has been sustained by knocking down national tariffs everywhere around the world through supranational institutions such as the World Trade Organization (WTO), and financed by a deregulated foreign exchange market working in concert with a global central banking regime independent of local political pressure, lorded over by the supranational Bank of International Settlement (BIS) and the International Monetary Fund (IMF). Redefining humanist morality, the US asserts that world trade is a moral imperative and as such trade promotes democracy, political freedom and respect for human rights in trade participating nations. Unfortunately, income and wealth equality are not among the benefits promoted by trade. Even if the validity of this twisted ideological assertion is not questioned, it clearly contradicts US practice of trade embargo against countries the US deems undemocratic, lacking in political freedom and deficient in respect for human rights. If trade promotes such desirable conditions, such practice of linking trade to freedom is tantamount to denying medicine to the sick. President George W Bush defended his free trade agenda in moralistic terms. Open trade is not just an economic opportunity, it is a moral imperative, he declared in a May 7, 2001 speech. Trade creates jobs for the unemployed. When we negotiate for open markets, were providing new hope for the worlds poor. And when we promote open trade, we are promoting political freedom. Such claims remain highly controversial when tested by actual data. Phyllis Schlafly, syndicated conservative columnist, responded three weeks later in an article: Free Trade is an Economic Issue, Not a Moral One. In it, she notes while conservatives should be happy to finally have a president who adds a moral dimension to his actions, the Bible does not instruct us on free trade and its not one of the Ten Commandments. Jesus did not tell us to follow Him along the road to free trade. Nor is there anything in the U.S. Constitution that requires us to support free trade and to abhor protectionism. In fact, protectionism was the economic system believed in and practiced by the framers of our Constitution. Protective tariffs were the principal source of revenue for our federal government from its beginning in 1789 until the passage of the 16th Amendment, which created the federal income tax, in 1913. Were all those public officials during those hundred-plus years remiss in not adhering to a moral obligation of free trade? Hardly, argues Schlafly whose views are noteworthy because US politics is currently enmeshed in a struggle between strict-constructionist paleo-conservatives and moral-imperialist neo-conservatives. Despite the ascendance of neoimperialism in US foreign policy, protectionism remains strong in US political culture, particularly among conservatives and in the labor movement.

Bush also said China, which reached a trade agreement with the US at the close of the Clinton administration, and became a member of the WTO in late 2001, would benefit from political changes as a result of liberalized trade policies. This pronouncement gives clear evidence to those in China who see foreign trade as part of an anti-China peaceful evolution strategy first envisioned by John Forster Dulles, US Secretary of State under Eisenhower in the 1950s. It is a strategy of inducing through peaceful trade the Communist Party of China (CPC) to reform itself out of power and to eliminate the dictatorship of the proletariat in favor of bourgeois liberalization. Almost four decades later, Deng Xiaoping criticized CPC Chairman Hu Yaobang and Premier Zhao Ziyang for having failed to contain bourgeois liberalization in their implementation of Chinas modernization policy. Deng warned in November 1989, five months after the Tiananmen incident: The Western imperialist countries are staging a third world war without guns. They want to bring about the peaceful evolution of socialist countries towards capitalism. Dengs handling of the Tiananmen incident prevented China from going the catastrophic route of the USSR which dissolved in 1991. Yet it is clear that political freedom is often the first casualty of a garrison state mentality and such mentality inevitably results from hostile US economic and security policy toward any country the US deems as not free. Whenever the US pronounces a nation to be not free, that nation will become less free as a result of US policy. This has been repeatedly evident in China and elsewhere in the Third World. Whenever US policy toward China turns hostile, as it currently appears to be heading, political and press freedom inevitably face stricter curbs. For trade to mutually and truly benefit the trading economies, three conditions are necessary: 1) the de-linking of trade from ideological/political objectives, 2) equality must be maintained in the terms of trade and 3) recognition that global full employment at rising, living wages is the prerequisite for true comparative advantage in global trade. The developing rupture between the sole superpower and its traditionally deferential allies lies in mounting trade conflicts. The US has benefited from an international financial architecture that gives the US economy a structural monetary advantage over those of the EU and Japan, not to mention the rest of the world. Trade issues range from government subsidies disputes between Airbus and Boeing, banana, sugar, beef, oranges, steel, as well as disputes over fair competition associated with mergers and acquisition and financial services. If either government is found to be in breach of WTO rules when these disputes wind through long processes of judgment, the other will be authorized to retaliate. The US could put tariffs on other European goods if the WTO rules against Airbus and vice versa. So if both governments are found in breach, both could retaliate, leading to a cycle of offensive protectionism. When the US was ruled to have unfairly supported its steel industry, tariffs were slapped by the EU on Florida oranges to make a political point in a politically important state in US politics. Trade competition between the EU and the US is spilling over into security areas, allowing economic interests to conflict with ideological sympathy. Both of these production engines, saddled with serious overcapacity, are desperately seeking new markets, which inevitably leads them to Asia in general and China in particular, with its phenomenal growth rate and its 1.2 billion eager consumers bulging with rapidly rising disposable income. The growth of the Chinese economy will lift all other economies in Asia, including Australia which has only recently begun to understand that its future cannot be separated from its geographic location and that its prosperity is interdependent with those of other Asian economies. Australian iron ores, beef and dairy products are destined for China, not the British Isles. The EU is eager to lift its 15-year-old arms embargo on China, much to the displeasure of the US. Israel faces similar dilemma in its close relations with the US on military sales to China. Even the US defense establishment has largely come around to the view that US arms industry must export, even to China, to remain on top. The Bangkok Post reported on June 7 that Rumsfeld tried to sell to Thailand F-16 warplanes capable of firing advanced medium-range air-to-air missiles (AMRAAMs) two days after he lashed out in Singapore at China for upgrading its own military when no neighboring nations are threatening it. The sales pitch was in competition with Russian-made Sukhoi SU-30s and Swedish JAS-39s. The open competition in arms export had been spelled out for Congress years earlier by Donald Hicks, a leading Pentagon technologist in the Reagan administration. Globalization is not a policy option, but a fact to which policymakers must adapt, he said. The emerging reality is that all nations militaries are sharing essentially the same global commercial-defense industrial base. The boots and uniforms worn by US soldiers in Afghanistan and Iraq were made in China. The WTO is the only global international organization dealing with the rules of trade between its 148 member nations. At its heart are the WTO agreements, known as the multilateral trading system, negotiated and signed by the majority of the worlds trading nations and ratified in their parliaments.

The stated goal is to help producers of goods and services, exporters, and importers conduct their business, with the dubious assumption that trade automatically brings equal benefits to all participants. The welfare of the people is viewed only as a collateral aim based on the doctrinal fantasy that balanced trade inevitably brings prosperity equally to all, a claim that has been contradicted by facts produced by the very terms of trade promoted by the WTO itself. Two decades of neo-liberal globalized trade have widened income and wealth disparity within and between nations. Free trade has turned out not to be the win-win game promised by neo-liberals. It is very much a win-lose game, with heads, the rich economies win, and tails, the poor economies lose. Domestic development has been marginalized as a hapless victim of foreign trade, dependent on trade surplus for capital. Foreign trade and foreign investment have become the prerequisite engines for domestic development. This trade model condemns those economies with trade deficits to perpetual underdevelopment. Because of dollar hegemony, all foreign investment goes only to the export sector where dollars can be earned. Even the economies with trade surpluses cannot use their dollar trade earnings for domestic development, as they are forced to hold huge dollar reserves to support the exchange rate of their currencies. In the fifth WTO Ministerial Conference held in Cancun in September 2003, the richer countries rejected the demands of poorer nations for radical reform of agricultural subsidies that have decimated Third World agriculture. Failure to get the Doha round back on track after the collapse of Cancun runs the danger of a global resurgence of protectionism, with the US leading the way. Larry Elliott reported on October 13, 2003 in The Guardian on the failed 2003 Cancun Ministerial meeting: The language of globalization is all about democracy, free trade and sharing the benefits of technological advance. The reality is about rule by elites, mercantilism and selfishness. Elliot noted that the process is full of paradoxes: why is it that in a world where human capital is supposed to be the new wealth of nations, labor is treated with such contempt? Sam Mpasu, Malawis commerce and industry minister, asked at Cancun for his comments about the benefits of trade liberalization, replied dryly: We have opened our economy. Thats why we are flat on our back. Mpasus comments summarize the wide chasm that divides the perspectives of those who write the rules of globalization and those who are powerless to resist them. Exports of manufactures by low-wage developing countries have increased rapidly over the last 3 decades due in part to falling tariffs and declining transport costs that enable outsourcing based on wage arbitrage. It grew from 25% in 1965 to nearly 75% over three decades, while agricultures share of developing country exports has fallen from 50% to under 10%. Many developing countries have gained relatively little from increased manufactures trade, with most of the profit going to foreign capital. Market access for their most competitive manufactured export, such as textile and apparel, remains highly restricted and recent trade disputes threaten further restrictions. Still, the key cause of unemployment in all developing economies is the trade-related collapse of agriculture, exacerbated by the massive government subsidies provided to farmers in rich economies. Many poor economies are predominantly agriculturally based and a collapse of agriculture means a general collapse of the whole economy. The Doha Development Agenda (DDA) negotiations, sponsored by the WTO, collapsed in Cancun, Mexico over the question of government support for agriculture in rich economies and its potential impacts on causing more poverty in developing countries. The Doha negotiations since Cancun are focused on the need to better understand the linkages between trade policies, particularly those of the rich economies, and poverty in the developing world. While poverty reduction is now more widely accepted by establishment economists as a necessary central focus for development efforts and has become the main mission of the World Bank and other development institutions, very little effective measures have been forthcoming. The UN Millennium Development Goals (UNMDG) commits the international community to halve world poverty by 2015, a decade from now. With current trends, that goal is likely to be achievable only through death of half of the poor by starvation, disease and local conflicts. The UN Development Program warns that 3 million children will die in sub-Saharan Africa alone by 2015 if the world continues on its current path of failing to meet the UNMDG agreed to in 2000. Several key venues to this goal are located in international trade where the record of poverty reduction has been exceedingly poor, if not outright negative. The fundamental question whether trade can replace or even augment socio-economic development remains unasked, let alone answered. Until such issues are earnestly addressed, protectionism will re-emerge in the poor countries. Under such

conditions, if democracy expresses the will of the people, democracy will demand protectionism more than government by elite. While tariffs in the past decade have been coming down like leaves in autumn, flexible exchange rates have become a form of virtual countervailing tariff. In the current globalized neo-liberal trade regime operating in a deregulated global foreign exchange market, the exchanged value of a currency is regularly used to balance trade through government intervention in currency market fluctuations against the worlds main reserve currency the dollar, as the head of the international monetary snake. Purchasing power parity (PPP) measures the disconnection between exchange rates and local prices. PPP contrasts with the interest rate parity (IRP) theory which assumes that the actions of investors, whose transactions are recorded on the capital account, induces changes in the exchange rate. For a dollar investor to earn the same interest rate in a foreign economy with a PPP of four times, such as the purchasing power parity between the US dollar and the Chinese yuan, local wages would have to be at least 4 time lower than US wages. <>PPP theory is based on an extension and variation of the "law of one price" as applied to the aggregate economy. The law of one price says that identical goods should sell for the same price in two separate markets when there are no transportation costs and no differential taxes applied in the two markets. But the law of one price does not apply to the price of labor. Price arbitrage is the opposite of wage arbitrage in that producers seek to make their goods in the lowest wage locations and to sell their goods in the highest price markets. This is the incentive for outsourcing which never seeks to sell products locally at prices that reflect PPP differentials. What is not generally noticed is that price deflation in an economy increases its PPP, in that the same local currency buys more. But the cross-border one price phenomenon applies only to certain products, such as oil, thus for a PPP of 4 times, a rise in oil prices will cost the Chinese economy 4 times the equivalent in other goods, or wages than in the US. The larger the purchasing power parity between a local currency and the dollar, the more severe is the tyranny of dollar hegemony on forcing down wage differentials. Ever since 1971, when US president Richard Nixon, under pressure from persistent fiscal and trade deficits that drained US gold reserves, took the dollar off the gold standard (at $35 per ounce), the dollar has been a fiat currency of a country of little fiscal or monetary discipline. The Bretton Woods Conference at the end of World War II established the dollar, a solid currency backed by gold, as a benchmark currency for financing international trade, with all other currencies pegged to it at fixed rates that changed only infrequently. The fixed exchange rate regime was designed to keep trading nations honest and prevent them from running perpetual trade deficits. It was not expected to dictate the living standards of trading economies, which were measured by many other factors besides exchange rates. Bretton Woods was conceived when conventional wisdom in international economics did not consider cross-border flow of funds necessary or desirable for financing world trade precise for this reason. Since 1971, the dollar has changed from a gold-back currency to a global reserve monetary instrument that the US, and only the US, can produce by fiat. At the same time, the US continued to incur both current account and fiscal deficits. That was the beginning of dollar hegemony. With deregulation of foreign exchange and financial markets, many currencies began to free float against the dollar not in response to market forces but to maintain export competitiveness. Government interventions in foreign exchange markets became a regular last resort option for many trading economies for their preserving export competitiveness and for resisting the effect of dollar hegemony on domestic living standards. World trade under dollar hegemony is a game in which the US produces paper dollars and the rest of the world produce real things that paper dollars can buy. The worlds interlinked economies no longer trade to capture comparative advantage; they compete in exports to capture needed dollars to service dollar-denominated foreign debts and to accumulate dollar reserves to sustain the exchange value of their domestic currencies in foreign exchange markets. To prevent speculative and manipulative attacks on their currencies in deregulated markets, the worlds central banks must acquire and hold dollar reserves in corresponding amounts to market pressure on their currencies in circulation. The higher the

market pressure to devalue a particular currency, the more dollar reserves its central bank must hold. This creates a built-in support for a strong dollar that in turn forces all central banks to acquire and hold more dollar reserves, making it stronger. This anomalous phenomenon is known as dollar hegemony, which is created by the geopolitically constructed peculiarity that critical commodities, most notably oil, are denominated in dollars. Everyone accepts dollars because dollars can buy oil. The denomination of oil in dollars and the recycling of petro-dollars is the price the US has extracted from oil-producing countries for US tolerance of the oil-exporting cartel since 1973. By definition, dollar reserves must be invested in dollar-denominated assets, creating a capital-accounts surplus for the US economy. A strong-dollar policy is in the US national interest because it keeps US inflation low through low-cost imports and it makes US assets denominated in dollars expensive for foreign investors. This arrangement, which Federal Reserve Board chairman Alan Greenspan proudly calls US financial hegemony in congressional testimony, has kept the US economy booming in the face of recurrent financial crises in the rest of the world. It has distorted globalization into a race to the bottom process of exploiting the lowest labor costs and the highest environmental abuse worldwide to produce items and produce for export to US markets in a quest for the almighty dollar, which has not been backed by gold since 1971, nor by economic fundamentals for more than a decade. The adverse effects of this type of globalization on the developing economies are obvious. It robs them of the meager fruits of their exports and keeps their domestic economies starved for capital, as all surplus dollars must be reinvested in US treasuries to prevent the collapse of their own domestic currencies. The adverse effect of this type of globalization on the US economy is also becoming clear. In order to act as consumer of last resort for the whole world, the US economy has been pushed into a debt bubble that thrives on conspicuous consumption and fraudulent accounting. The unsustainable and irrational rise of US equity and real estate prices, unsupported by revenue or profit, had merely been a de facto devaluation of the dollar. Ironically, the recent fall in US equity prices from its 2004 peak and the anticipated fall in real estate prices reflect a trend to an even stronger dollar, as it can buy more deflated shares and properties for the same amount of dollars. The rise in the purchasing power of the dollar inside the US impacts its purchasing power disparity with other currencies unevenly, causing sharp price instability in the economies with freely exchangeable currencies and fixed exchange rates, such as Hong Kong and until recently Argentina. For the US, falling exchange rate of the dollar actually causes asset prices to rise. Thus with a debt bubble in the US economy, a strong dollar is not in the US national interest. Debt has turned US policy on the dollar on its head. The setting of exchange values of currencies is practiced not only by sovereign governments on their own currencies as a sovereign right. The US, exploiting dollar hegemony, usurps the privilege of dictating the exchange value of all foreign currencies to support its own economic nationalism in the name of global free trade. And US position on exchange rates has not been consistent. When the dollar was rising, as it did in the 1980s, the US, to protect its export trade, hailed the stabilizing wisdom of fixed exchange rates. When the dollar falls as it has been in recent years, the US, to deflect the blame of its trade deficit, attacks fixed exchange rates as currency manipulation, as it targets Chinas currency now which has been pegged to the dollar for over a decade, since the dollar was lower. How can a nation manipulate the exchange value of its currency when it is pegged to the dollar at the same rate over long periods? Any manipulation came from the dollar, not the yuan. The recent rise of the euro against the dollar, the first appreciation wave since its introduction on January 1, 2002, is the result of an EU version of the 1985 Plaza Accord on the Japanese yen, albeit without a formal accord. The strategic purpose is more than merely moderating the US trade deficit. The record shows that even with the 30% drop of the dollar against the euro, the US trade deficit has continued to climb. The strategic purpose of driving up the euro is to reduce the euro to the status of the yen, as a subordinated currency to dollar hegemony. The real effect of the Plaza Accord was to shift the cost of support for the dollar-denominated US trade deficit, and the socio-economic pain associated with that support, from the US to Japan. What is happening to the euro now is far from being the beginning of the demise of the dollar. Rather, it is the beginning of the reduction of the euro into a subservient currency to the dollar to support the US debt bubble. Six and a half years since the launch of European Monetary Union, the eurozone is trapped in an environment in which monetary policy of sound money has in effect become destructive and supply-side fiscal policy unsustainable. National economies are beginning to refuse to bear the pain needed for adjustment to globalization or the EUs ambitious enlargement. The European nations are

beginning to resist the US strategy to make the euro economy a captive supporter of a rising or falling dollar as such movements fit the shifting needs of US economic nationalism. It is the modern-day monetary equivalent of the brilliant Roman strategy of making a dissident Jew a Christian god, to pre-empt Judaisms rising cultural domination over Roman civilization. Roman law, the foundation of the Roman Empire, gained in sophistication from being influenced by if not directly derived from Jewish Talmudic law, particularly on the concept of equity - an eye for an eye. The Jews had devised a legal system based on the dignity of the individual and equality before the law four century before Christ. There was no written Roman law until two centuries B.C. The Roman law of obligatio was not conducive to finance as it held that all indebtedness was personal, without institutional status. A creditor could not sell a note of indebtedness to another party and a debtor did not have to pay anyone except the original creditor. Talmudic law, on the other hand, recognized impersonal credit and a debt had to be paid to whoever presented the demand note. This was a key development of modern finance. With the Talmud, the Jews under the Diaspora had an international law that spans three continents and many cultures.<> The Romans were faced with a dilemma. Secular Jewish ideas and values were permeating Roman society, but Judaism was an exclusive religion that the Romans were not permitted to join. The Romans could not assimilate the Jews as they did the more civilized Greeks. Early Christianity also kept its exclusionary trait until Paul who opened Christianity to all. Historian Edward Gibbon (173794) noted that the Rome recognized the Jews as a nation and as such were entitled to religious peculiarities. The Christians on the other hand were a sect, and being without a nation, subverted other nations. The Roman Jews were active in government and when not resisting Rome against social injustice, fought side by side with Roman legionnaires to preserve the empire. Roman Jews were good Roman citizens. By contrast, the early Christians were social dropouts, refused responsibility in government and civic affairs and were conscientious objectors and pacifists in a militant culture. Gibbon noted that Rome felt that the crime of a Christian was not in what he did, but in being who he was. Christianity gained control of Roman culture and society long before Constantine who in 324 A.D. sanctioned it with political legitimacy and power after recognizing its power in helping to win wars against pagans, the way Pope Urban II in 1095 used the crusade to keep Papal temporal power longer. When early Christianity, a secular Jewish dissident sect, began to move up from the lower strata of Roman society and began to find converts in the upper echelons, the Roman polity adopted Christianity, the least objectionable of all Jewish sects, as a state religion. Gibbons estimated that Christians killed more of their own members over religious disputes in the three centuries after coming to secular power than did the Romans in three previous centuries. Persecution of the Jews began in Christianized Rome. The disdain held by early Christianity on centralized government gave rise to monasticism and contributed to the fall of the Roman Empire. By allowing a trade surplus denominated in dollars to be accumulated by non-dollar economies, such as yen, euro, or now the Chinese yuan, the cost of supporting the appropriate value of the dollar to sustain perpetual economic growth in the dollar economy is then shifted to these non-dollar economies, which manifests themselves in perpetual relative low wages and weak domestic consumption. For already high-wage EU and Japan, the penalty is the reduction of social welfare benefits and job security traditional to these economies. For China, now the worlds second largest creditor nation, it is reduced to having to ask the US, the worlds largest debtor nation, for capital denominated in dollars the US can print at will to finance its export trade to a US running recurring trade deficits.<> The IMF, which has been ferocious in imposing draconian fiscal and monetary conditionalities on all debtor nations everywhere in the decade after the Cold War, is nowhere to be seen on the scene in the worlds most fragrantly irresponsible debtor nation. This is because the US can print dollars at will and with immunity. The dollar is a fiat currency not backed by gold, not backed by US productivity, not back by US export prowess, but by US military power. The US military budget request for Fiscal Year 2005 is $420.7 billion. For Fiscal Year 2004, it was $399.1 billion; for 2003, $396.1 billion; for 2002, $343.2 billion and for 2001, $310 billion. In the first term of the Bush presidency, the US spent $1.5 trillion on its military. That is bigger than the entire GDP of China in 2004. The US trade deficit is around 6% of its GDP while it military budget is around 4%. In other words, the trading partners of the US are paying for one and a half times of the cost of a military that can someday be used against any one of them for any number of reasons, including trade disputes. The anti-dollar crowd has nothing to celebrate about the recurring US trade deficit.

It is pathetic that US Secretary of Defense Donald H Rumsfeld tries to persuade the world that Chinas military budget, which is less that one tenth of that of the US, is a threat to Asia, even when he is forced to acknowledge that Chinese military modernization is mostly focused on defending its coastal territories, not on force projection for distant conflicts, as is US military doctrine. While Rumsfeld urges more political freedom in China, his militant posture toward China is directly counterproductive towards that goal. Ironically, Rumsfeld chose to make his case about political freedom in Singapore, the bastion of Confucian authoritarianism. Normally, according to free trade theory, trade can only stay unbalanced temporarily before equilibrium is re-established or free trade would simply stop. When bilateral trade is temporarily unbalanced, it is generally because one trade partner has become temporarily uncompetitive, inefficient or unproductive. The partner with the trade deficit receives more goods and services from the partner with the trade surplus than it can offer in return and thus pays the difference with its currency that someday can buy foods produced by the deficit trade partner to re-established balance of payments. This temporary trade imbalance is due to a number of socio-economic factors, such as terms of trade, wage levels, return on investment, regulatory regimes, shortages in labor or material or energy, trade-supporting infrastructure adequacy, purchasing power disparity, etc. A trading partner that runs a recurring trade deficit earns the reputation of being what banks call a habitual borrower, i.e. a bad credit risk, one who habitually lives beyond his/her means. If the trade deficit is paid with its currency, a downward pressure results in the exchange rate. A flexible exchange rate seeks to remove or moderate a temporary trade imbalance while the productivity disparities between trading partners are being addressed fundamentally. Dollar hegemony prevents US trade imbalance from returning to equilibrium through market forces. It allows a US trade deficit to persist based on monetary prowess. This translates over time into a falling exchange rate for the dollar even as dollar hegemony keeps the fall at a slow pace. But a below-par exchange rate over a long period can run the risk of turning the temporary imbalance in productivity into a permanent one. A continuously weakening currency condemns the issuing economy into a downward economic spiral. This has happened to the US in the last decade. To make matters worse, with globalization of deregulated markets, the recurring US trade deficit is accompanied by an escalating loss of jobs in sectors sensitive to cross-border wage arbitrage, with the job-loss escalation climbing up the skill ladder. Discriminatory US immigration policies also prevent the retention of lowpaying jobs within the US and exacerbate the illegal immigration problem. Regional wage arbitrage within the US in past decades kept the US economy lean and productive internationally. Labor-intensive US industries relocated to the low-wage South through regional wage arbitrage and despite temporary adjustment pains from the loss of textile mills, the Northern economies managed to upgrade their productivity, technology level, financial sophistication and output quality. The Southern economies in the US also managed to upgrade these factors of production and in time managed to narrow the wage disparity within the national economy. This happened because the jobs stay within the nation. With globalization, it is another story. Jobs are leaving the nation mercilessly. According to free trade theory, the US trade deficit is supposed to cause the dollar to fall temporarily against the currencies of its trading partners, causing export competitiveness to rebalance to remove or reduce the US trade deficit or face the collapse of its currency. Either case, jobs that have been lost temporarily are then supposed to return to the US. But the persistent US trade deficit defies trade theory because of dollar hegemony. The current international finance architecture is based on dollar hegemony which is the peculiar arrangement in which the US dollar, a fiat currency, remains as the dominant reserve currency for international trade. The broad trade-weighted dollar index stays in an upward trend, despite selective appreciation of some strong currencies, as highly-indebted emerging market economies attempt to extricate themselves from dollar-denominated debt through the devaluation of their currencies. While the aim is to subsidize exports, it ironically makes dollar debts more expensive in local currency terms. The moderating impact on US price inflation also amplifies the upward trend of the trade-weighted dollar index despite persistent US expansion of monetary aggregates, also known as monetary easing or money printing. Adjusting for this debt-driven increase in the exchange value of dollars, the import volume into the US can be estimated in relationship to expanding monetary aggregates. The annual growth of the volume of goods shipped to the US has remained around 15% for most of the 1990s, more than 5 times the average annual GDP growth. The US enjoyed a booming economy when the dollar was gaining ground, and this occurred at a time when interest rates in the US were higher than those in its creditor

nations. This led to the odd effect that raising US interest rates actually prolonged the boom in the US rather than threatened it, because it caused massive inflows of liquidity into the US financial system, lowered import price inflation, increased apparent productivity and prompted further spending by US consumers enriched by the wealth effect despite a slowing of wage increases. Returns on dollar assets stayed high in foreign currency terms. This was precisely what Federal Reserve Board chairman Alan Greenspan did in the 1990s in the name of pre-emptive measures against inflation. Dollar hegemony enabled the US to print money to fight inflation, causing a debt bubble of asset appreciation. This data substantiated the view of the US as Rome in a New Roman Empire with an unending stream of imports as the free tribune from conquered lands. This was what Greenspan meant by US financial hegemony. The Fed Funds rate (ffr) target has been lifted eight times in steps of 25 basis points from 1% in mid 2004 to 3% on May 3, 2005. If the same pattern of measured pace continues, the ffr target would be at 4.25% by the end of 2005. Despite Fed rhetoric, the lifting of dollar interest rate has more to do with preventing foreign central banks from selling dollar-denominated assets, such as US Treasuries, than with fighting inflation. In a debt-driven economy, high interest rates are themselves inflationary. Rising interest rate to fight inflation could become the monetary dog chasing its own interest rate tail, with rising rate adding to rising inflation which then requires more interest rate hikes. Still, interest rate policy is a double edged sword: it keeps funds from leaving the debt bubble, but it can also puncture the debt bubble by making the servicing of debt prohibitively expensive. To prevent this last adverse effect, the Fed adds to the money supply, creating an unnatural condition of abundant liquidity with rising short-term interest rate, resulting in a narrowing of interest spread between short-term and long-term debts, a leading indication for inevitable recession down the road. The problem of adding to the money supply is what Keynes called the liquidity trap, that is, an absolute preference for liquidity even at near zero interest-rate levels. Keynes argued that either a liquidity trap or interest-insensitive investment draught could render monetary expansion ineffective in a recession. It is what is popularly called pushing on a credit string, where ample money cannot find credit-worthy willing borrowers. Much of the new low cost money tends to go to refinancing of existing debt take out at previously higher interest rates. Rising short-term interest rates, particularly at a measured pace, would not remove the liquidity trap when long term rates stay flat because of excess liguidity. The debt bubble in the US is clearly having problems, as evident in the bond market. With just 14 deals worth $2.9 billion, May 2005 was the slowest month for high-yield bond issuance since October 2002. The late-April downgrades of the debt of General Motors and Ford Motor to junk status roiled the bond markets. The number of high-yield, or junk bond deals fell 55% in the March-to-May 2005 period, compared with the same three months in 2004. They were also down 45% from the December-throughFebruary period. In dollar value, junk bond deals totaled $17.6 billion in the March-to-May 2005 period, compared with $39.5 billion during the same three months in 2004 and $36 billion from December through February 2005. There were 407 deals of investment-grade bond underwriting during the March-to-May 2005 period, compared with 522 in the same period 2004 - a decline of 22%. In dollar volume, some $153.9 billion of high-grade bonds were underwritten from March to May 2005, compared with $165.5 billion in the same period in 2004 - a 7% decline. Oil at $50, along with astronomical asset price appreciation, particularly in real estate, is giving the debt bubble additional borrowed time. But this game cannot go on forever and the end will likely be triggered by a new trade wars effect on reduced trade volume. The price of a reduced US trade deficit is the bursting of the US debt bubble which can plunge the world economy into a new depression. Given such options, the US has no choice except to ride the trade deficit train for as long as the traffic will bear, which may not be too long, particularly if protectionism begins to gather force. The transition to offshore outsourced production has been the source of the productivity boom of the New Economy in the US in the last decade. The productivity increase not attributable to the importing of other nations productivity is much less impressive. While published government figures of the productivity index show a rise of nearly 70% since 1974, the actual rise is between zero and 10% in many sectors if the effect of imports is removed from the equation. The lower productivity values are consistent with the real-life experience of members of the blue-collar working class and the white collar middle class who have been spending the equity cash-outs from the appreciated market value of their homes. World trade has become a network of cross-border arbitrage on differentials in labor availability, wages, interest rates, exchange rates, prices, saving rates, productive capacities, liquidity

conditions and debt levels. In some of these areas, the US is becoming an underdeveloped economy. The Bush Administration continues to assure the public that the state of the economy is sound while in reality the US has been losing entire sectors of its economy, such as manufacturing and information technology, to foreign producers, while at the same time selling off the part of the nation to finance its rising and unending trade deficit. Usually, when unjustified confidence crosses over to fantasized hubris on the part of policymakers, disaster is not far ahead. To be fair, the problems of the US economy started before the second Bush Administration. The Clinton Administrations annual economic report for 2000 claimed that the longest economic expansion in US history could continue indefinitely as long as we stick to sound policy, according to Chairman Martin Baily of the Council of Economic Advisors (CEA) as reported in the Wall Street Journal. The New York Times report differed somewhat by quoting Baily as saying: stick to fiscal policy. Putting the two newspaper reports together, one got the sense that the Clinton Administration thought that its fiscal policy was the sound policy needed to put an end to the business cycle. Economics high priests in government, unlike the rest of us mortals who are unfortunate enough to have to float in the daily turbulence of the market, can afford to aloofly focus on long-term trends and their structural congruence to macro-economic theories. Yet, outside of macro-economics, long-term is increasingly being re-defined in the real world. In the technology and communication sectors, longterm evokes periods lasting less than 5 years. For hedge funds and quant shops, long-term can mean a matter of weeks. Two factors were identified by the Clinton CEA Year 2000 economic report as contributing to the good news: technology-driven productivity and neo-liberal trade globalization. Even with somewhat slower productivity and spending growth, the CEA believed the economy could continue to expand perpetually. As for the huge and growing trade deficit, the CEA expected global recovery to boost demand for US exports, not withstanding the fact that most US exports are increasingly composed of imported parts. Yet the US has long officially pursued a strong dollar policy which weakens world demand for US exports. The high expectation on e-commerce was a big part of optimism, which had yet to be substantiated by data. In 2000, the CEA expected the business to business (B2B) portion of ecommerce to rise to $1.3 trillion by 2003 from $43 billion in 1998. Goldman Sachs claimed in 1999 that B2B e-commerce would reach $1.5 trillion by 2004, twice the size of the combined 1998 revenues of the US auto industry and the US telecom sector. Others were more cautious. Jupiter Research projected that companies around the globe would increase their spending on B2B e-marketplaces from US$2.6 billion in 2000 to only $137.2 billion by 2005 and spending in North America alone would grow from $2.1 billion to only $80.9 billion. North American companies accounted for 81% of the total spending in 1998, but by 2005, that figure was expected to drop to 60% of the total. The fact of the matter is that Asia and Europe are now faster growth market for communication and technology. Reality proved disappointing. A 2004 UN Conference on Trade and Development (UNCTAD) report said: In the United States, e-commerce between enterprises (B2B), which in 2002 represented almost 93% of all e-commerce, accounted for 16.28% of all commercial transactions between enterprises. While overall transactions between enterprises (e-commerce and non e-commerce) fell in 2002, ecommerce B2B grew at an annual rate of 6.1%. As for business-to-consumer (B2C) e-commerce, UNCTAD reported that sales in the first quarter of 2004 amounted to 1.9 per cent of total retail sales, a proportion that is nearly twice as large as that recorded in 2001. The annual rate of growth of retail ecommerce in the US in the year to the end of the first quarter of 2004 was 28.1%, while the growth of total retail in the same period was only 8.8%. Dow Jones reported on May 20, 2005 that first-quarter retail e-commerce sales in the U.S. rose 23.8% compared with the year-ago period to $19.8 billion from $16 billion, according to preliminary numbers released by the Department of Commerce. Ecommerce sales during the first quarter rose 6.4% from the fourth quarter, when they were $18.6 billion. Sales for all periods are on an adjusted basis, meaning the Commerce Department adjusts them for seasonal variations and holiday and trading-day differences but not for price changes. E-commerce sales accounted for 2.2% of total retail sales in the first quarter of 2005, when those sales were an estimated $916.9 billion, according to the Commerce Department. Walmart, the low-priced retailer that imports outsourced goods from overseas, grew only 2%, indicating spending fatigue on the part of low-income US consumers, while Target Stores, the upscale retailer that also imports outsourced goods, continues to grow at 7%, indicating the effects of rising income disparity.

The CEA 2000 report did not address the question whether e-commerce was merely a shift of commerce or a real growth. The possibility exists for the new technology to generate negative growth. It happened to IBM the increased efficiency (lower unit cost of calculation power) of IBM big frames actually reduced overall IBM sales, and most of the profit and growth in personal computers went to Microsoft, the software company that grew on business that IBM, a self-professed hardware manufacturer, did not consider worthy of keeping for itself. The same thing happened to Intel where Moores Law declared in 1965 an exponential growth in the number of transistors per integrated circuit and predicted that this trend would continue the doubling of transistors every couple of years. But what Moores Law did not predict was that this growth of computing power per dollar would cut into company profitability. As the market price of computer power continues to fall, the cost to producers to achieve Moores Law has followed the opposite trend: R&D, manufacturing, and test costs have increased steadily with each new generation of chips. As the fixed cost of semiconductor production continues to increase, manufacturers must sell larger and larger quantities of chips to remain profitable. In recent years, analysts have observed a decline in the number of design starts at advanced process nodes. While these observations were made in the period after the year 2000 economic downturn, the decline may be evidence that the long-term global market cannot economically sustain Moores Law. Is the Google Bubble a replay of the AOL fiasco? Schumpeters creative destruction theory, while revitalizing the macro-economy with technological obsolescence in the long run, leaves real corporate bodies in its path, not just obsolete theoretical concepts. Financial intermediaries and stock exchanges face challenges from Electronic Communication Networks (ECNs) which may well turn the likes of NYSE into sunset industries. ECNs are electronic marketplaces which bring buy/sell orders together and match them in virtual space. Today, ECNs handle roughly 25% of the volume in NASDAQ stocks. The NYSE and the Archipelago Exchange (ArcaEx) announced on April 20, 2005 that they have entered a definitive merger agreement that will lead to a combined entity, NYSE Group, Inc., becoming a publicly-held company. If approved by regulators, NYSE members and Archipelago shareholders, the merger will represent the largest-ever among securities exchanges and combine the worlds leading equities market with the most successful totally open, fully electronic exchange. Through Archipelago, the NYSE will compete for the first time in the trading of NASDAQ-listed stocks; it will be able to indirectly capture listings business that otherwise would not qualify to list on the NYSE. Archipelago lists stocks of companies that do not meet the NYSEs listing standards. On fiscal policy, US government spending, including social programs and defense, declined as a share of the economy during the eight years of the Clinton watch. This in no small way contributed to a polarization of both income and wealth, with visible distortions in both the demand and supply sides of the economy. This was the opposite of the FDR record of increasing income and wealth equality by policy. The wealth effect tied to bloated equity and real estate markets could reverse suddenly and did in 2000, bailed out only by the Bush tax cut and the deficit spending on the War on Terrorism after 2001. Private debt kept making all time highs throughout the 1990s and was celebrated by neo-liberal economists as a positive factor. Household spending was heavily based on expected rising future earnings or paper profits, both of which might and did vanished on short notice. By election time in November 1999, the Clinton economic miracle was fizzling. The business cycle had not ended after all, and certainly not by self-aggrandizing government policies. It merely got postponed for a more severe crash later. The idea of ending the business cycle in a market economy was as much a fantasy as Vice President Cheneys assertion in a speech before the Veterans of Foreign Wars in August 26, 2002 that the Middle East expert Professor Fouad Ajami predicts that after liberation, the streets in Basra and Baghdad are sure to erupt in joy . In their 1991 populist campaign for the White House, Bill Clinton and Al Gore repeatedly pointed out the obscenity of the top 1% of Americans owning 40% of the countrys wealth. They also said that if you eliminated home ownership and only counted businesses, factories and offices, then the top 1% owned 90% of all commercial wealth. And the top 10%, they said, owned 99%. It was a situation they pledged to change if elected. But once in office, Clinton and Gore did nothing to redistribute wealth more equally - despite the fact that their two terms in office spanned the economic joyride of the 1990s that would eventually hurt the poor much more severely than the rich. On the contrary, economic inequality only continued to grow under the Democrats. Reagan spread the national debt equally among the people while Clinton gave all the wealth to the rich. Geopolitically, trade globalization was beginning to face complex resistance worldwide by the second

term of the Clinton presidency. The momentum of resistance after Clinton would either slow further globalization or force the terms of trade to be revised. The Asian financial crises of 1997 revived economic nationalism around the world against US-led neo-liberal globalization, while the North Atlantic Treaty Organization (NATO) attack on Yugoslavia in 1999 revived militarism in the EU. Market fundamentalism as espoused by the US, far from being a valid science universally, was increasingly viewed by the rest of the world as merely US national ideology, unsupported even by US historical conditions. Just as anti-Napoleonic internationalism was essentially anti-French, antiglobalization and anti-moral-imperialism are essentially anti-US. US unilateralism and exceptionism became the midwife for a new revival of political and economic nationalism everywhere. The Bush Doctrine of monopolistic nuclear posture, pre-emptive wars, either with us or against us extremism, and no compromise with states that allegedly support terrorism, pours gasoline on the smoldering fire of defensive nationalism everywhere. Alan Greenspan in his October 29, 1997 Congressional testimony on Turbulence in World Financial Markets before the Joint Economic Committee said that it is quite conceivable that a few years hence we will look back at this episode [Asian financial crisis of 1997]. as a salutary event in terms of its implications for the macro-economy. When one is focused only on the big picture, details do not make much of a difference: the earth always appears more or less round from space, despite that some people on it spend their whole lives starving and cities get destroyed by war or natural disasters. That is the problem with macroeconomics. As Greenspan spoke, many around the world were waking up to the realization that the turbulence in their own financial markets was viewed by the US central banker as having a salutary effect on the US macro-economy. Greenspan gave anti-US sentiments and monetary trade protectionism held by participants in these financial markets a solid basis and they were no longer accused of being mere paranoia. Ironically, after the end of the Cold War, market capitalism has emerged as the most fervent force for revolutionary change. Finance capitalism became inherently democratic once the bulk of capital began to come from the pension assets of workers, despite widening income and wealth disparity. The monetary value of US pension funds is over $15 trillion, the bulk of which belong to average workers. A new form of social capitalism has emerged which would gladly eliminate the workers job in order to give him/her a higher return on his/her pension account. The capitalist in the individual is exploiting the worker in same individual. A conflict of interest arises between a workers savings and his/her earnings. As Pogo used to say: The enemy: they are us. This social capitalism, by favoring return on capital over compensation for labor, produces overinvestment, resulting in overcapacity. But the problem of overcapacity can only be solved by high income consumers. Unemployment and underemployment in an economy of overcapacity decrease demand, leading to financial collapse. The world economy needs low wages the way the cattle business need foot and mouth disease. The nomenclature of neo-classical economics reflects, and in turn dictates, the warped logic of the economic system it produces. Terms such as money, capital, labor, debt, interest, profits, employment, market, etc, have been conceptualized to describe synthetic components of an artificial material system created by the power politics of greed. It is the capitalist greed in the worker that causes the loss of his/her job to lower wage earners overseas. The concept of the economic man who presumably always acts in his self-interest is a gross abstraction based on the flawed assumption of market participants acting with perfect and equal information and clear understanding of the implication of his actions. The pervasive use of these terms over time disguises the artificial system as the logical product of natural laws, rather than the conceptual components of the power politics of greed. Just as monarchism first emerged as a progressive force against feudalism by rationalizing itself as a natural law of politics and eventually brought about its own demise by betraying its progressive mandate, social capitalism today places return on capital above not only the worker but also the welfare of the owner of capital. The class struggle has been internalized within each worker. As people facing the hard choice of survival in the present versus wellbeing in the future, they will always choose survival, social capitalism will inevitably go the way of absolute monarchism, and make way for humanist socialism.

Critique of Central Banking By Henry C K Liu Part I: Monetary theology This article first appeared in Asia Times on Line on November 6, 2002 Central bankers are like librarians who consider a well-run library to be one in which all the books are safely stacked on the shelves and properly catalogued. To reduce incidents of late returns or loss, they would proposed more strict lending rules, ignoring that the measure of a good library lies in full circulation. Librarians take pride in the size of their collections rather than the velocity of their circulation. Central bankers take the same attitude toward money. Central bankers view their job as preserving the value of money through the restriction of its circulation, rather than maximizing the beneficial effect of money on the economy through its circulation. Many central bankers boast about the size of their foreign reserves the way librarians boast about the size of their collections, while their governments pile up budget deficits. Paul Volcker, the US central banker widely credited with ending inflation in the early 1980s by administering wholesale financial blood letting on the US economy, quipped lightheartedly at a Washington party that "central bankers are brought up pulling legs off of ants". Central banking insulates monetary policy from national economic policy by prioritizing the preservation of the value of money over the monetary needs of a sound national economy. A global finance architecture based on universal central banking allows an often volatile foreign exchange market to operate to facilitate the instant cross-border ebb and flow of capital and debt instruments. The workings of an unregulated global financial market of both capital and debt forced central banking to prevent the application of the State Theory of Money (STM) in individual countries to use sovereign credit to finance domestic development by penalizing, with low exchange rates for their currencies, governments that run budget deficits. STM asserts that the acceptance of government-issued legal tender, commonly known as money, is based on government's authority to levy taxes payable in money. Thus the government can and should issue as much money in the form of credit as the economy needs for sustainable growth without fear of hyperinflation. What monetary economists call the money supply is essentially the sum total of credit aggregates in the economy, structured around government credit as bellwether. Sovereign credit is the anchor of a vibrant domestic credit market so necessary for a dynamic economy. By making STM inoperative through the tyranny of exchange rates, central banking in a globalized financial market robs individual governments of their sovereign credit prerogative and forces sovereign nations to depend on external capital and debt to finance domestic development. The deteriorating exchange value of a nation's currency then would lead to a corresponding drop in foreign direct or indirect investment (capital inflow), and a rise in interest cost for sovereign and private debts, since central banking essentially relies on interest policy to maintain the value of money. Central banking

thus relies on domestic economic austerity caused by high interest rates to achieve its institutional mandate of maintaining price stability. Such domestic economic austerity comes in the form of systemic credit crunches that cause high unemployment, bankruptcies, recessions and even total economic collapse, as in the case of Britain in 1992, the Asian financial crisis in 1997 and subsequent crises in Russia, Turkey, Brazil and Argentina. It is the economic equivalent of a blood-letting cure. A national bank does not seek independence from the government. The independence of central banks is a euphemism for a shift from institutional loyalty to national economic well-being toward institutional loyalty to the smooth functioning of a global financial architecture. The international finance architecture at this moment in history is dominated by US dollar hegemony, which can be simply defined by the dollar's unjustified status as a global reserve currency. The operation of the current international finance architecture requires the sacrifice of local economies in a financial food chain that feeds the issuer of US dollars. It is the monetary aspect of the predatory effects of globalization. Historically, the term "central bank" has been interchangeable with the term "national bank". In fact, the enabling act to establish the first national bank, the Bank of the United States, referred to the bank interchangeably as a central and a national bank. However, with the globalization of financial markets in recent decades, a central bank has become fundamentally different from a national bank. The mandate of a national bank is to finance the sustainable development of the national economy, and its function aims to adjust the value of a nation's currency at a level best suited for achieving that purpose within an international regime of exchange control. On the other hand, the mandate of a modern-day central bank is to safeguard the value of a nation's currency in a globalized financial market of no or minimal exchange control, by adjusting the national economy to sustain that narrow objective, through economic recession and negative growth if necessary. Central banking tends to define monetary policy within the narrow limits of price stability. In other words, the best monetary policy in the context of central banking is a non-discretionary money-supply target set by universal rules of price stability, unaffected by the economic needs or political considerations of individual nations. The theology of monetary economics Inflation, the all-consuming target of central banking, is popularly thought of as too much money chasing too few goods, which economists refer to as the Quantity Theory of Money (QTM). QTM is one of the oldest surviving economic doctrines. Simply stated, it asserts that changes in the general level of commodity prices are determined primarily by changes in the quantity of money in circulation. But the theology of monetary economics has a long and complex history, an understanding of which is necessary for forming any informed opinion on the validity and purpose of central banking. Below is a brief summary of the stuff dinner conversation is made of among the gods of monetary theory. Jean Bodin (1530-96), a French social/political philosopher, attributed the price inflation then raging in Western Europe to the abundance of monetary metals imported from the newly opened gold and silver mines in the Spanish colonies in South America. Though he held many aspects of mercantilist views, Bodin asserted that the rise of prices was a function not merely of the debasement of the coinage, but also of the amount of currency in circulation. Bodin's religious tolerance in a period of fanatical religious wars drew upon him the accusation of being a "freethinker", a label as damaging as being called a communist sympathizer in the United States in modern times. In his Les Six Livrers de la republic (1576), Bodin replaced the concept of a past golden age with the concept of progress. He foreshadowed Thomas Hobbes (1588-1679: The Leviathan, 1651) by stating the political necessity of absolute sovereignty, subject only to the laws of God (morality) and nature (reality). Bodin also anticipated Baron Montesquieu (1689-1755: De l'esprit des lois, 1748) by highlighting environment as a determinant of laws, customs, beliefs and the interpretation of events, a view that influenced the US constitution, a view since rejected by current US moral imperialism. John Locke (1632-1704) and David Hume (1711-76) provided considerable refinement, elaboration and extension to the QTM, allowing it to be integrated into the mainstream of orthodox monetarist

tradition. Locke developed the right of private property based on the labor theory of value and the mechanics of political checks and balances that were incorporated in the US constitution. Locke, in 1661, asserted the proportionality postulate: that a doubling of the quantity of money (M) will double the level of prices (P) and half the value of the monetary unit. Hume, in 1752, introduced the notion of causation by stating that variation in M (money quantity) will cause proportionate changes in P (price level). Concurrently with Irish banker Richard Cantillon (16801734), Hume applied to the QTM two crucial distinctions: 1) between static (long-run stationary equilibrium) and dynamic (short-run movement toward equilibrium); and 2) between the long-run neutrality and the short-run non-neutrality of money. Hume and Cantillon provided the first dynamic process analysis of how the impact of a monetary change spread from one sector of the economy to another, altering relative price and quantity in the process. They pointed out that most monetary injection would involve non-neutral distribution effects. New money would not be distributed among individuals in proportion to their pre-existing share of money holdings. Those who receive more will benefit at the expense of those receiving less than their proportionate share, and they will exert more influence in determining the composition of new output. Initial distribution effects temporarily alter the pattern of expenditure and thus the structure of production and the allocation of resources. Thus it is understandable that conservatives would be sympathetic to the QTM to maintain the wealth distribution status quo, or if the QTM is skirted, to ensure that the maldistribution tilts toward those who are more likely to engage in capital formation, namely the rich. Thus developing economies in need of capital formation would find logic in first enriching the financial elite while advanced economies with production overcapacity would need to increase aggregate demand by restricting income disparity. Hume describes how different degrees of money illusion among income recipients, coupled with time delays in the adjustment process, could cause costs to lag behind prices, thus creating abnormal profits and stimulating optimistic profit expectations that would spur business expansion and employment during the transition period. These non-neutral effects are not denied by the adherents of QTM, who nevertheless assert that they are bound to dissipate in the long run, often with great damage if the optimism was unjustified. The latest evidence of the non-neutral effects of money is observable in expansion of the so-called New Economy from easy money in the past decade and the recent collapse of its bubble. The QTM formed the central core of 19th-century classical monetary analysis, provided the dominant conceptual framework for interpreting contemporary financial events and formed the intellectual foundation of orthodox policy prescription designed to preserve the gold standard. The economic structure in 19th-century Europe led analysts to acknowledge additional non-neutral effects, such as the lag of money wages behind prices, which temporarily reduces real wages; the stimulus to output occasioned by inflation-induced reduction in real debt burdens, which shifts real income from unproductive creditor-rentiers to productive debtor-entrepreneurs; the so-called "forced saving" effect occasioned by price-induced redistribution of income among socio-economic classes having structurally different propensity to save and invest; and the stimulus to investment imparted by a temporary reduction in the rate of interest below the anticipated rate of return on new capital. Yet classical quantity theorists tended persistently to minimize the importance of non-neutral effects as merely transitional. Whereas Hume tended to stress lengthy dynamic disequilibrium periods in which money matters much, classical analysts focused on long-run equilibrium in which money is merely a veil. David Ricardo (1772-1823), the most influential of the classical economists, thought such disequilibrium effects ephemeral and unimportant in long-run equilibrium analysis. Gods, of course, enjoy longer perspectives than most mortals, as do the rich over the poor. As John Maynard Keynes famously said: "In the long run, we will all be dead." As leader of the Bullionists, Ricardo charged that inflation in Britain was solely the result of the Bank of England's irresponsible overissue of money, when in 1797, under the stress of the Napoleonic Wars, Britain left the gold standard for inconvertible paper. At that time, the Bank of England was still operating as a national bank, not a central bank in the modern sense of the term. In other words, it operated to improve the English economy rather than to strengthen the sanctity of international finance. Ricardo, by focusing on long term-equilibrium, discouraged discussions on the possible beneficial output and employment effects of monetary injection on the national level. Like modern-day monetarists, Bullionists laid the source of inflation, a decidedly evil force in international finance,

squarely at the door of the national bank. As Milton Friedman declared some two centuries after Richardo: inflation is everywhere a monetary phenomenon. Friedman's concept of "money matters" is the diametrical opposite of Hume's. The historical evolution in 18th-century Europe from a predominantly full-metal money to a mixed metal-paper money forced advances in the understanding of the monetary transmission mechanism. After gold coins had given way to banknotes, Hume's direct mechanism of price adjustment was found lacking in explaining how banknotes are injected into the system. Henry Thornton (1760-1815), in his classic The Paper Credit of Great Britain (1802), provided the first description of the indirect mechanism by observing that new money created by banks enters the financial markets initially via an expansion of bank loans, through increasing the supply of lendable funds, temporarily reducing the loan rate of interest below the rate of return on new capital, thus stimulating additional investment and loan demand. This in turn pushes prices up, including capital good prices, drives up loan demands and eventually interest rates, bringing the system back into equilibrium indirectly. The central issue of the doctrines of the British classical school that dominated the first half of the 19th century was focused around the application of the QTM to government policy, which manifested itself in the maintenance of external equilibrium and the restoration and defense of the gold standard. Consequently, the QTM tended to be directed toward the analysis of international price levels, gold flow, exchange-rate fluctuations and trade deficits. It formed the foundation of mercantilism, which underpinned the economic structure of the British Empire via colonialism, which reached institutional maturity in the same period. Bullionists developed the idea that the stock of money, or its currency component, could be effectively regulated by controlling a narrowly defined monetary base, that the control of "high-power money" (bank reserves) in a fractional reserve banking regime implies virtual control of the money supply. High-power money is the totality of bank reserves that would be multiplied many times through the money-creation power of commercial bank lending, depending on the velocity of circulation. In the 1987 crash when the Dow Jones Industrial Average (DJIA) dropped 22.6 percent in one day (October 19) on volume of 608 million shares, six times the normal volume then (current normal daily volume is about 1.6 billion shares), the US Federal Reserve under its newly installed chairman, Alan Greenspan, created US$12 billion of new bank reserves by buying up government securities. The $12 billion injection of high-power money in one day caused the Fed Funds rate to fall by three-quarters of a point and halted the financial panic. If the government had been running a balanced budget and there were no government securities to be bought, the economy would have seized up. This shows that government deficits and debt are part and parcel of the modern financial architecture. In the three decades after Britain returned to the gold standard in 1821, the policy objective focused on the maintenance of fixed exchange rates and the automatic gold convertibility of the pound. But the Currency School (CS) versus Banking School (BS) controversy broke out over whether the "Currency Principle" of making existing mixed gold-paper currency expand and contract in direct proportion to gold reserves was sufficient to safeguard against note overissuance, or whether additional regulation was necessary. This controversy grew out of the expansion pressure put on the supply of pound sterling by the rapid expansion of the British empire. Members of the CS argued that even a fully, legally convertible currency could be issued in excess with undesirable consequences, such as rising domestic prices relative to foreign prices, balance-of-payment deficits, falling foreign-exchange rates, gold outflow resulting in depletion of gold reserves and ultimately forced suspension of convertibility. The rate of reserves drain often accelerated when the external gold drain coincided with internal domestic-panic conversion of paper into gold in fear of pending depreciation. Thus the CS promoted full convertibility plus strict regulation of the volume of banknotes to prevent the recurrence of gold drains, exchange depreciation and domestic liquidity crises. The apprehension of the CS was fully justified by past actions of the Bank of England, which had been perverse and destabilizing by international finance standards. The destabilizing argument stressed the time lag on the Bank's policy response to gold outflow and to exchange-rate movements. The inevitably too little, too late measures taken by the national bank, instead of protecting gold reserves,

merely exacerbated financial panics and liquidity crises that inevitably followed periods of currencycredit excess. The famous Bank Charter Act of 1844, in modern parlance, imposed a 100 percent reserve requirement, with an unabashed bias toward wealth preservation over wealth creation. The CS also asserts that money substitutes cannot impair the effectiveness of monetary regulation. Thus if banknotes could be controlled, there would be no need to control deposits explicitly, on the ground that money substitutes have low velocity and are of declining substitutional value in times of crisis. Keynesians argue that the QTM is invalid because it assumes an automatic tendency to full employment. If resource under-ultilization and excess capacity exist, a monetary expansion may produce a rise in output rather than a rise in prices, as in the case of the 1930s Depression. Money is not a mere veil. Monetary changes may have a permanent effect on output, interest rates, and other real variables, contrary to the neutrality postulate of the QTM. Post-Keynesians also contend that the QTM erroneously assumes the stability of velocity and its counterpart, the demand for money. Velocity is a volatile, unpredictable variable (technically known as exogenous - due to external causes), influenced by meta-rationality and by changes in the volume of money substitutes, not to mention hedges in the form of derivatives. The erratic behavior of velocity makes it impossible to predict the effect of a given monetary change on prices. John Law (1671-1729), a contemporary of Bodin, elaborated in 1705 on the distinction drawn by Bernardo Davanzati (1529-1606) between "value in exchange" and "value in use", which led Law to introduce his famous "water-diamond" paradox: that water, which has great use-value, has no exchange-value, while diamonds, which have great exchange-value, have no use-value. Contrary to Adam Smith, who used the same example but explained it on the basis of water and diamonds having different labor costs of production, Law regarded the relative scarcity of goods in demand as the generator of exchange value. Davanzati showed how "barter is a necessary complement of division of labor amongst men and amongst nations"; and how there is easily a "want of coincidence in barter", which calls for a "medium of exchange"; and this medium must be capable of "subdivision" and be a "store of value". He remarked "that one single egg was more worth to Count Ugolino in his tower [prison] than all the gold of the world", but that on the other hand, "ten thousand grains of corn are only worth one of gold in the market", and that "water, however necessary for life, is worth nothing, because superabundant". That was of course before International Monetary Fund (IMF) conditionality requiring the poor in the indebted Third World to pay for water through privatization of basic utilities to service foreign debt. Davanzati observed that in the siege of Casilino, "a rat was sold for 200 florins, and the price could not be called exaggerated, because next day the man who sold it was starved and the man who bought it was still alive". Of course, modern economists would call that a market failure. Davanzati viewed all the money in a country as worth all the goods, because the one exchanges for the other and nobody wants money for its own sake. Davanzati did not know anything about the velocity of money, and only recognized that every country needs a different quantity of money, as different human frames need different quantities of blood. The mint ought to coin money gratuitously for everybody; and the fear that, if the coins are too good, they should be exported is simply illusory, because they must have been paid for by the exporter. Law's "Real Bills Doctrine" of money applied the "reflux principle" to the money supply. Money, Law argued, was credit and credit was determined by the "needs of trade". Consequently, the amount of money in existence is determined not by the imports of gold or trade balances (as the Mercantilists argued), but rather on the supply of credit in the economy. And money supply (in opposition to the Quantity Theory) is endogenous (growing from within), determined by the "needs of trade". Post-Keynesians have drawn on the Real Bills Doctrine, which asserts that the money supply is an endogenous variable that responds passively to shifts in the demand for it. Thus monetary changes cannot affect prices. Being demand-determined, the stock of money cannot exceed or fall short of the quantity of money demanded. In short, there is no transmission mechanism running from money to prices. Analysts should look instead for the source of economic dislocations in real rather than monetary causes. Inflation creates a corresponding increase in the money supply, not the other way around. Yet QTM theorists exposed the Achilles' heel of the Real Bills Doctrine by demonstrating that as long as the loan rate of interest is below the expected yield on new capital projects, the demand for loans will be insatiable. Thus the "real bills" criterion as an automatic regulator of the money supply is

inoperative unless central banks intervene to raise interest rates in concert with expected return on capital. The attack on the QTM from the Banking School (BS) also supported modern Keynesian views, by pointing out that new money may simply be absorbed into idle balances (gold hoards, a liquidity trap) without entering the spending stream, while the supply of money is determined by the need of trade and thus can never exceed demand (in modern parlance: pushing on the credit string). The BS went farther than the "Real Bills" argument that even if the real-bills criterion of restriction of loans to selfliquidating paper were violated, the law of reflux would prevent overissue. Holders of excess papers would simply redeposit them in banks rather than spending them. The BS asserts that prices are determined by income and not by the quantity of money. For national economies, factor incomes earned from overseas investment, rather than money, are the sources of expenditure that act on prices, unless neutralized by imports. This income-expenditure approach was later developed by Keynes and became a characteristic feature of Keynesian macro-economic models. The BS also disputed the quantity-theory view of money as an exogenous or external independent variable by arguing that the stock of money and credit is a passive, endogenous demand-determined variable. The stock of money and credit is the effect, not the cause, of price changes. The channel of causation runs from prices to money, not the opposite direction as contended by the CS. What determines the volume of currency in circulation is the active initiation of the non-bank public (borrowers) with the banks playing only a passive accommodating role. Implicit in the BS view of massive money are three anti-quantity theory propositions: 1) changes in economic activities precede and cause changes in the money supply (the reverse causation argument); 2) the supply of circulating media is not independent of the demand for it and 3) the central bank does not actively control the money supply, but instead accommodates or responds to prior changes in the demand for money. Against the CS emphasis on a narrowly defined money supply, the BS emphasized the overall structure of credit. The BS advocates more free banking against regulated banking, favoring the discretion of bankers over regulation by government or fixed rules, and, most important, the BS regards attempts to regulate prices via monetary control as futile, since the money supply, especially notes, is an endogenous variable independent of exogenous control. BS views fighting inflation via the supply of money and credit as putting the cart before the horse, since it is prices that determine the quantity of money and credit, and not vice versa. Despite the BS's criticism, the QTM emerged victorious from the mid-19th century Currency-Banking Debate to command wide acceptance until the 1930s. The CS policy of fixed exchange rate, gold standard, convertibility and strict control of banknotes became British monetary orthodoxy in the second half of the 19th century within the context of the triumph of British imperialism. But the rigorous mathematical restatement of the QTM by neo-classical economists around the dawn of the 20th century was the crowning factor to QTM's success in intellectual circles. Irving Fisher (1876-1947) in his classic The Purchasing Power of Money (1911) spelled out his famous equation of exchange: MV=PT, where M is the stock of money, V is the velocity of circulation, P is the price level and T is the physical volume of market transaction. This and other equations, such as the Cambridge cash balance equation, which corresponds with the emerging use of mathematics in neoclassical economic analysis, define precisely the conditions under which the proportional postulate is valid. Yet these conditions include constancy of the velocity of money and of real output. Neoclassical economics assumed that velocity was a near constant determined by individuals' cash-holding decisions in conjunction with technological and institutional factors associated with the aggregate payment mechanism. Today, with interest-bearing cash accounts, electronic payment regimes and cashless credit-card transactions, such assumptions are less valid. Money velocity, like wind velocity in a weather pattern, fluctuates widely and suddenly, caused by complex factors feeding back on each other. Fisher and other neo-classical economists, such as Arthur Cecil Pigou (1877-1959) of Cambridge, demonstrated that monetary control could be achieved in a fractional reserve banking regime via control of an exogenously determined stock of high-power money. Underlying their argument that the total stock of money and bank deposits would be a constant multiple of the monetary base is the claim

that the stock of money is governed by three proximate determinants: 1) the high-power monetary base, 2) the banks' desired reserve to deposit ratio and 3) the public's desired cash-to-deposit ratio, and with the the monetary base dominating determinants 2) and 3). Again the financial reality today is very different. Banks routinely borrow through the repos window to bypass reserve requirements. Banks, to reduce the capital requirement based on their balance sheets, also sell their loans regularly as securitized financial products in the credit markets. Yet QTM continues to exercise a strong hold on monetary theory. Neo-classical quantity theorists stress the long-run non-neutrality of money, a topic not well developed in classical analysis. They integrate the QTM into their analysis of business cycles, identifying the quantity of money as a major cause of booms and busts and monetary effects on price as a prerequisite to the stabilization of economic activity. It was not until the 1930s that the QTM encountered serious criticism and was discredited, replaced by the Keynesian income-expenditure model. Notwithstanding Keynes' earlier support for QTM in A Tract on Monetary Reform (1923), Keynes' General Theory (1936) launched a frontal attack on QTM by observing that if the economy were operating at less than full employment, with idle resources to draw from, changes in spending would affect output and employment rather than prices. Keynes reversed the QTM assumption by treating prices as rigid and output flexible, a situation any businessman could recognize. Keynes criticized the QTM equations as tautological and that QTM erroneously treated the circulatory velocity of money as a near constant. Keynes pointed out that the velocity variable in Fisher's equation was in reality extremely unstable by showing that any change in M (money stock) might be absorbed by an offsetting change in V (circulation velocity) and therefore would not be transmitted to P (price level). Likewise, any change in income or the volume of market transaction might be accommodated by a change in velocity without requiring any change in the money supply. Keynes revived the BS conclusion that economic disturbances arise from exogenous shocks originating in the real economy rather than from erratic behavior of the money supply, and the futility of using monetary policy to regulate economic activity to cure unemployment and recession. The conclusion was based on Keynes' theory of an absolute preference for liquidity at low interest-rate levels - the case for the liquidity trap. Keynes argued that either a liquidity trap or interest-insensitive investment draught could render a monetary expansion ineffective in a depression. Keynes stressed a new nonmonetary adjustment mechanism - the income multiplier. The chief policy implication of the Keynesian income-expenditure analysis was that fiscal policy would have a more powerful impact on income and employment than would monetary policy. Post-Keynesian economists added to Keynes' contra-QTM arguments by pointing out that inflation is predominantly a cost-pushed phenomenon associated with non-monetary institutional forces, such as union wage inelasticity, monopoly pricing, etc. Cheap money, Post-Keynesian advocates assert, from expansionary monetary policy could be used to keep interest rates at low levels, minimizing the burden of both private and public debt, helping to keep unemployment at permanently low levels. These positions depart from the neutrality proposition. The Radcliffe Committee on British monetary reform in 1959 declared that 1) money is an indistinguishable component of a continuous spectrum of financial assets; 2) the velocity of money is devoid of economic content; and 3) attempts to regulate spending via monetary control are futile in a financial system that can produce a limitless array of money substitutes. The Radcliffe Committee declaration is in fact an update of the Banking School. Then came Milton Friedman, who remodeled the QTM into a theory of the demand for money. It was based on the wealth effect, or the theory of real balance effect, which argues that prices would fall in a depression, thereby raising the purchasing power of wealth held in money from. The price-induced rise in the real value of cash balances would then stimulate spending directly until full capacity utilization had been attained. As the wealth effect operates independently of changes in interest rates, closure of the indirect channel could not prevent the restoration of full employment. It follows that a rise in the real balances and hence spending could be accomplished just as easily via a monetary expansion, validating the potency of monetary policy even in a depression. This argument offered an escape from the Keynesian liquidity trap and a way of thwarting the interest inelasticity of the investment-spending draught, thus contradicting the Keynesian doctrine of

underemployment equilibrium. Friedman suggested that the Keynesian view of the monetary transmission mechanism was seriously incomplete. In denying that the quantity theory was a theory of income determination, Friedman freed it from the Keynesian criticism that it assumes full employment. In their A Monetary History of the United States, 1867-1960, Friedman and Anna Schwartz showed that a rapid and large reduction in the money supply played the dominant causal role in the Great Depression of the 1930s. Their observation led to criticism of the Keynesian attribution of the Depression to a collapse of demand. Monetarists argue that the quantity of money, rather than the level and channels of interest rates, is the appropriate variable for the monetary authority to regulate. Greenspan in essence applied this theory to prolong economic expansion in the United States after 1997 and produced the biggest bubble since the 1920s. Monetarists regard monetary policy as having a powerful long-run impact on nominal income as contrasted with fiscal policy. They regard income policy as having a perverse long-term impact on economic activity. Despite lip service paid to the notion of the direct effect of monetary changes on commodity expenditure, modern monetarists acknowledge that the transmission mechanism operates primarily through a complex portfolio or balance-sheet adjustment process involving various interestrate channels and affecting a wide range of assets and expenditures, generating shifts in the composition of asset portfolios, thereby inducing prices and yields of existing financial and nonfinancial assets relative to prices of current services and new assets, albeit that the portfolio approach is not of monetary origin, having been first developed by Keynes and J R Hicks in the mid-1930s and subsequently elaborated by James Tobin and others. These asset price and yield changes, in turn, generate changes in the demands for service flows and new asset stocks and hence in the prices and output of latter items. The question of the appropriate range of assets and interest rates to be considered in the analysis of the transmission mechanism is a key point in the monetarist-Keynesian controversy over the spending impact of monetary changes. Keynesian models tended to concentrate on a narrower range of assets and interest rates, forcing the transmission process through a narrow channel, thus choking off some of the spending impact of a monetary change. Of course, in Keynes' days, the financial architecture was primarily a two-asset world: cash and bonds, fundamentally different from today's infinite range of financial assets in the brave new world of structured finance. Modern monetarists generally favor flexible exchange rates without exchange control, whereas the Currency School advocated fixed rates with exchange control.

The economics of a global empire By Henry C K Liu This article appeared in AToL on August 14, 2002

The productivity boom in the US was as much a mirage as the money that drove the apparent boom. There was no productivity boom in the US in the last two decades of the 20th century; there was an import boom. What's more, this boom was driven not by the spectacular growth of the American economy; it was driven by debt borrowed from the low-wage countries producing this wealth. Or, to put it a tad less technically, the economic boom that made possible the current US political hegemony was fueled by payments of tribute from vassal states kept perpetually at the level of subsistence poverty by their own addiction to exports. Call it the New Rome theory of US economic performance. True, exports can be beneficial to an economy if they enable that economy to import needed goods and services in return. Under mercantilism and a gold standard, for example, an economy that incurred recurring trade surpluses was essentially accumulating gold which could reliably be used for paying for imports in the future. In the current international trade system, however, trade surpluses accumulate dollars, a fiat currency of uncertain value in the future. Furthermore, these dollar-denominated trade surpluses cannot be converted into the exporter's own currency because they are needed to ward off speculative attacks on the exporter's currency in global financial markets. Aside from distorting domestic policy, the export sector of the Chinese economy has been exerting disproportionate influence on Chinese foreign policy for more than a decade. China has been making political concessions on all fronts to the US for fear of losing the US market from whence it earns most of its foreign reserves, which it is compelled to invest in US government debt. This is ironic because according to trade theory, a perpetual trade surplus accompanied with a perpetual capital account deficit is not in the economic interest of the exporting nation. China is not unique in this dilemma. Most of the world's export economies face similar problems. This is the economic basis of US unilateralism in foreign affairs. When Chinese exporters invest China's current account surplus in dollar financial assets, the Chinese economy will see no benefit from exports as more goods leave China than come in to offset the trade imbalance. True wealth is given away by Chinese exporters for paper, at least until a future trade deficit allows China to import an equivalent amount of goods in the future. But China cannot afford a balanced trade, let alone a trade deficit, because trade surpluses are necessary to keep the export sector growing and for maintaining the long-term value of its currency in relation to the dollar. The bulk of China's trade surpluses, then, must be invested in US securities. This is the economic reality of USChina trade. The gap between the perceived value of the accumulated fiat currency (US) of the importing economy (US) and the value of that currency when dollar-denonimated investments are finally cashed in at market price represents the ultimate difference in the quantity of goods and services eventually received between the trading economies. Since the drivers of trade imbalances are overvalued currencies of the importer or undervalued currencies of exporters, obviously the one-sided trade can only end when the exporter has wasted away all its expandable wealth, or the importer has run deficits

to levels that exceed the willingness of the exporter to accept more of the importer's debt. Interest rate policies of central banks are usually the culprit in this matter as they drive investment flows in the direction of a high interest economy, making necessary the perpetual trade imbalance. Other forms of waste of wealth, such as pollution, low wages and worker benefits, neglect of domestic development and rising poverty in both export and non-export sectors, are penalties assumed by the exporter. China exported 4.07 billion pairs of shoes in 2001, up 2.55 percent from the previous year. But the value of those exports, US$10.1 billion, was an increase of only 2.48 percent over 2000. Actual value growth per unit, then, was a negative. Guangdong province is China's largest shoe-making region, with annual production at around three billion pairs, accounting for almost a third of the world's total. Assuming the number of Chinese workers making shoes to be constant, Chinese productivity dropped in the shoe industry in 2001. The only way productivity could have remained the same or improved would have been if the Chinese shoe industry had cut workers, thus contributing to China's growing unemployment problem. Imports from China are resold in the US at a greater profit margin for US importers than that enjoyed by Chinese exporters in production for export. In part, this has to do with the inflated distribution costs in the importing country (US) because of overvaluation of its currency, and the higher standard of living in the US made possible partly by Chinese exporter credit. Thus a $2 toy leaving a Chinese factory is a $3 part of a shipment arriving at San Diego. By the time a US consumer buys it for $10, the US economy registers $10 in final sales, less $3 in imports, for a $7 addition to gross domestic product (GDP). The GDP gain to import ratio is greater than two, in this case two-and-a-third. The GDP gain to export ratio is zero if the $2 export price becomes part of the importer's capital account surplus. If 50 percent of the $2 export price is used for paying return to foreign capital, then the ratio is in fact negative. The numbers for other product types vary greatly, but the pattern is similar. The $1.25 trillion of imports to the US in 2000 are directly responsible for some $2.5 trillion of US GDP, almost 28 percent of its $9 trillion economy. The $400 billion of Chinese exports are directly responsible for a loss of $800 billion in Chinese GDP of $1 trillion as compared to a GDP if that export were consumed domestically. In other words, if it were to not export at all, China would almost double its GDP by redirecting the equivalent productivity toward domestic development. On a purchasing power parity basis (PPP), the GDP loss to exports would be four times greater. The higher the trade surplus in China's favor, meaning more goods and services leaving China than entering, the more serious its adverse impact on China's GDP. Viewing the greater margins available in the importing country as a result of a currency valuation imbalance and understanding that retailing and distribution are operationally less efficient relative to manufacturing, it can be observed that imports raise apparent productivity because sales per employee increase as one goes from the factory floor towards the final consumer. Also, the closer in function the factory floor is to the retail space, the higher its apparent productivity. Through marketing and proximity to customer, a seller can gain advantage in the assembly of imported major parts to order. Thus a US assembler who out-sources its content parts can win final sales away from the offshore integrated manufacturer who makes the same parts and assembles them abroad. In the high technology arena, time to market of design innovation is key. By hiding costs through the use of employee stock options for compensation (an issue of current debate in US corporate governance), a local in the importing country can use the high valuation of his stock, driven by creative accounting and artificially low production costs and interest rates at the exporter country, to raise funds to further subsidize the production costs of the final product, be it software or hardware. The content of the product will increasingly come from low wage, low margin exporting nations, and the out-sourcing assembler's manufacturing involvement may be little beyond snapping out-sourced parts in place, advertised ad nauseum as a US brand. Dell is a classic example, as is Disney's licensing empire. To quantify the order of magnitude of the effect of imports on apparent US aggregate productivity, a direct relationship to the trade deficit can be observed. The productivity gain observed is not as strong as presented by aggregate data. The 4 percent productivity rise cited in US government statistics can be primarily attributable to sharp import increases. The gain in net productivity is much smaller, on the

order of 1.8 percent, since the technology revolution began affecting the economy a whole decade earlier. Much of the rest of the improvement has to do with normal cyclical behavior of productivity, the result of normal rise in capacity utilization during boom times from a bubble economy. There is another measure of increases in trade flow volume that stems from the appreciation of the trade-weighted dollar. The trade-weighted dollar measure shows improvement consistently because of the attempts of European, OPEC and Japanese holders of US debt to retain value in the dollar by creating dollar-denominated debt in emerging economies that actually produce something, as opposed to the US which gains foreign income primarily through the use of international protections for intellectual property. For the purpose of this discussion, one need focus only on the broad trade-weighted dollar index being put in an upward trend, as highly indebted emerging market economies attempt to extricate themselves from dollar-denominated debt through the devaluation of their currencies. The purpose is to subsidize exports, ironically making dollar debts more expensive in local currency terms. The moderating impact on US price inflation also amplifies the upward trend of the trade-weighted dollar index despite persistent US expansion of monetary aggregates, also known as monetary easing or money printing. Adjusting for this debt-driven increase in the value of dollars, the import volume into the US can be estimated in relationship to these monetary aggregates. The annual growth of the volume of goods shipped to the US has remained around 15 percent for most of the 1990s. The US enjoyed a booming economy when the dollar was gaining ground, and this occurred at a time when interest rates in the US were higher than those in its creditor nations. This led to the odd effect that raising US interest rates actually prolonged the boom in the US rather than threatened it, because it caused massive inflows of liquidity into the US financial system, lowered import price inflation, increased apparent productivity and prompted further spending by US consumers enriched by the wealth effect despite a slowing of wage increases. This was precisely what Federal Reserve Board chairman Alan Greenspan did in the 1990s in the name of pre-emptive measures against inflation. Dollar hegemony enabled the US to print money to fight inflation, causing a debt bubble. For those who view the US as the New Roman Empire with an unending stream of imports as the spoils of war, this data should come as no surprise. This was what Greenspan meant by US "financial hegemony". The transition to offshore production is the source of the productivity boom of the "New Economy" in the US. The productivity increase not attributable to the importing of other nation's productivity is much less impressive. While published government figures of the productivity index show a rise of nearly 70 percent since 1974, the actual rise is between zero and 10 percent in many sectors if the effect of imports is removed from the equation. The lower values are consistent with the real-life experience of members of the blue collar working class and the white collar middle class. This era of declining reward for manual effort coincides with the Reagan shift to having workers pay for their social benefits, while promoting heavy subsidies of corporations, particularly in the earlier stages of corporate growth, through pro-business tax policies and regulatory indulgence. Historical timelines for the actual levels of productivity in the US may be traced back to the introduction of computer-assisted accounting by IBM and later EDS in the late 1960s. This cleared the labor-intensive accounting pools of the large corporations and mammoth government agencies. Automation of scientific work began even earlier and entered mainstream engineering by the mid 1970s. By 1980, the ordering-inventory and inter-corporate billing systems were computerized to a great extent, as had occurred in banking and finance in the 1970s. By the 1990s, computerized trading and market modeling actually transformed market efficiency into systemic risk of unprecedented dimensions. The current process is one of standardization and inclusion, as well as reintroduction of regulatory restraint. Inventory management in the current "just in time" manner was not attractive until high US real interest rates made the holding of inventory unattractive. Prior to this, during periods of real inflation, inventory was a profit center, not a cost problem, thanks to FIFO (first in, first out) accounting where inflation would produce an annual statement of higher ending inventory value, a lower cost of goods sold and a higher gross profit. Now that the world has organized away the

inventory that cushions supply disruptions and price inflation, we are quite defenseless against them. Never before has Murphy's Law (if something can go wrong, it will) a better chance to demonstrate itself with a cruel spate of price inflation. The result of this distortion driven by the monetary system is a decline in real living standards of producers in all of the exporting and indebted world, and in the US. Indeed, reward has been divorced from real effort and reassigned to manipulators. There have been enormous strides in productivity around the globe, but few of them came in the US. It has been the seigniorage of the dollar reserve system granted to the US without economic discipline that allowed the import of productivity from abroad and the superficial appearance of prosperity in the US economy. World trade has been shrinking. The conventional wisdom of market fundamentalism is that the global economy is slowing to work off excess debt, causing global trade to shrink temporarily. The world is waiting for a rebound in the US economy so that other countries can again export themselves out of recession. Yet a case can be made that global trade is shrinking because it transfers wealth from the have-nots to the have-too-muches, and after two decades, the unsustainable rate of wealth transfer has slowed, leading to slower economic growth worldwide. Those economies that have been dependent on exports for growth will do well to understand that the recent drop in exports in more than a cyclical phenomenon. It is a downward spiral unless balanced trade is restored so that trade is a supplement to domestic development rather than a deterrent. Regions like Asia and Latin America should restructure their export policies to focus on intra-regional trade that aim at development instead of those that transfer wealth out of the region. Places like Shanghai, Hong Kong, Singapore and Tokyo should stop looking for predatory competitive advantage and move toward symbiotic trade policies to enhance regional development. The purpose of the $30 billion IMF loan of Brazil - an unprecedented figure - is not so much to help the Brazilian economy escape its debt trap as it is to bail out US transnational banks holding Brazilian debt. The net result is to force the Brazilian economy to export more wealth to the tune of $30 billion plus interest on top of the mountains of debt it already has and could not service. Brazil would be better off defaulting as Russia did. Economist Paul Krugman lamented in his New York Times column that he mistakenly bought into the Washington consensus and now his confidence that market fundamentalists had been "giving good advice is way down". The line between honest mistakes in pushing the regulatory envelope and fraud is now debated regarding corporate finance and governance in the US, and many executives and their financial advisors are being charged with criminal liability. Are economists who knowingly pushed the ideological envelope beyond the limits of reality above the laws of conscience?

National Planning and the American Myth By Henry C K Liu This article appeared in AToL on June 13. 2002 Adam Smith published The Wealth of Nations in 1776, the year the United States declared independence. By the time the constitution was framed 11 years later, the founding fathers were deeply influenced by Smith's ideas, which constituted a reasoned abhorrence of trade monopoly and government policy in restricting trade. What Smith abhorred most was a policy known as mercantilism, which was practiced by all major powers at the time. It is necessary to bear in mind that Smith's notion of the limitation of government action was exclusively related to mercantilist issues of trade restraint. Smith never advocated government tolerance of trade restraint, whether by other governments or by big business monopolies. In fact, Smith advocated an activist government against market failures. A truly free market cannot tolerate monopolistic practices. Yet unregulated markets naturally drift towards monopolies. In other words, markets fail when deregulated. After a decade of deregulation, the evidence of market failure is everywhere. A central aim of mercantilism was to ensure that a nation's exports remained higher in value than its imports, the surplus in that era being paid only in specie money (gold-backed as opposed to fiat money). This trade surplus in gold permitted the surplus country, such as England, to invest in more factories to manufacture more for export, thus bringing home more gold. The importing regions, such as the American colonies, not only found the gold reserves backing their currency depleted, causing free-fall devaluation (not unlike that faced by current Asian currencies), but also wanting in surplus capital for building factories for export. So despite plentiful iron ore in America, only pig iron was exported to England in return for English finished iron goods. In 1795, when the Americans began finally to wake up to their disadvantaged trade relationship and began to raise European (mostly French and Dutch) capital to start a manufacturing industry, England decreed the Iron Act, forbidding the manufacture of iron goods in America, which caused great dissatisfaction among the prospering colonials. Smith favored an opposite government policy toward economic production and trade, a policy that came to be known as "laissez faire" (because the English, having nothing to do with such heretical ideas, refuse to give it an English name). Laissez faire, notwithstanding its literal meaning of "leave alone", meant nothing of the sort. It meant an activist government policy to counteract mercantilism. Neo-liberal economists are just bad historians, among their other defective characteristics, when they propagandize "laissez faire" as no government in trade affairs. At this juncture in history, when the failures of neo-liberal market fundamentalism is pervasively discernible, the myth of the American system as anti-statist and anti-planning needs to be re-examined. Another interesting item about Adam Smith was that he advocated, in 1776, a graduated income tax, "the time of payment, the manner of payment, and the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person". Reaganites should put that in their hats and eat it. After the ratification of the constitution, among the first acts of Congress was to adopt, on September 2, 1789, a motion by James Madison to establish a Treasury Department, and to instruct the future secretary to "digest and prepare plans for the improvement of the revenue and for the support of the public credit". This instruction led Alexander Hamilton, the first secretary of the treasury, to establish the first Bank of the United States in 1791, which after many transformations ended up as the Federal Reserve system of today.

Hamilton also engineered the first government bailout of private investors in US history by making the government buy from investors/speculators, at face value, all the market-discounted debt instruments and paper money various state governments as well as that the federal government had issued during the War of Independence. Since one of the causes for independence had been the right to manufacture, Hamilton launched a national plan to develop manufacturing that included government subsidies (called bounties). He also instituted protective tariffs on imports, and committed massive public investment in infrastructure. It was the first industrial policy in US history, a classic national planning measure. Thomas Jefferson was directly involved in land planning for political purposes in contrast to economic efficiency. He believed that his notion of democratic government could be safeguarded by the widespread ownership of land by small farmers. He would fail in this aim, as 28 percent of the land in the United States today is still in government hands, and most non-residential land is owned by big corporations. Jefferson was influenced by the economic doctrines of the French Physiocrats, who claimed that the ultimate source of wealth was land. Jefferson, as president, bought from Napoleon Bonaparte the Louisiana Purchase in 1803, doubling the land area (and the intrinsic wealth) of the nation. It was an act of national planning of heroic dimension. John Quincy Adams, in 1807, as senator, shepherded through Congress a resolution to direct the treasury secretary to draw up a plan for internal transportation. The ensuing Gallatin Plan, named after secretary Albert Gallatin, aimed to connect the states on a north-south axis and to provide for transport from the west to the eastern seaboard. The railroads in the US did not have the benefit of central planning, except in land policy. But that did not mean the government was not involved. In encouraging its development for advancing the national interest, the government granted large tracts of public land to railroad companies to connect the Midwest and the Pacific. Twenty square miles of public land (alternative quarter-sections along the entire rail line) was granted to private railroad companies for every mile of track, and the feasibility norm for return on capital in the new industry was 200 percent annually, excessive by any measure. The lack of government supervision and regulation led to widespread political corruption and fraud against investors, and the rate fixing and price gouging resulted in reduced economic efficiency that eventually destroyed the industry, except during periods of war planning. It was only when such abuses ran up against another powerful special interest, the shipping industry, that an Interstate Commerce Commission was formed to control the railroads, but still to little avail. The monopolistic pricing practices of the railroad were a key factor in the unethical formation of John D Rockefeller's oil empire. Between the Civil War and World War I, there were three major economic recessions: 1873, 1883, and 1907. In contrast to Adam Smith's doctrines, during that period, "trusts" were organized to eliminate competition at the expense of small businesses, farmers, consumers and especially labor. As late as 1920, 12-hour days and seven-day work weeks were common practice in the steel industry, while industrial companies enjoyed protective tariffs from government and generous tax benefits such as accelerated depreciation for tax purposes, all government pro-business intervention measures. The Sherman Anti-Trust Act was adopted in 1890 to prohibit restraint of trade, a true classic Adam Smith measure. But the act has had a history of difficult enforcement due to conservative regulatory and constitutional interpretation and circumventing devices, such as holding companies and interlocking directorates, that even the later Clayton Act of 1914 failed to achieve an effective curb. Whether anti-trust measures belong to the category of national planning depends on who is being busted and the attitude of the categorizer toward planning. Conceptually, they are planning measures pure and simple. Social Darwinism, resurrected as a miracle diet for national prosperity in the 1990s, went briefly out of fashion in the US in the 1920s. But in its place, conservatives peddled new arguments that economic planning for the collective good was beyond human capacity (the futility/unintended consequence argument), and as being alien to traditional American values, in denial of historical fact. World War I forced the US into war planning. The War Industries Board, the Food Administration, with a government-owned Grain Corp, injected purposeful priority in resource allocation to maximize production efficiency, with guaranteed markets and price-stabilizing measures. Labor standards were

instituted, along with recognition of unions and the right to collective bargaining. Women joined the labor force with the beginning of the principle of equal pay for equal work. The government-run Railroad Administration in 1918 handled 10 million ton-miles more than the private companies did under a free market in 1917. After the war, national economic planning advocates sought to continue planning under Theodore Roosevelt's prewar campaign theme of New Nationalism, the so-called "Square Deal". An influential book by Herbert Croly, The Promise of American Life, argued for a Hamiltonian government interventionist approach toward Jeffersonian populist ends. War and revolution being half-brothers, the postwar vision of an ideal economic order came from socialists, syndicalists, guild socialists, and promoters of consumer cooperatives. Even the Catholics opposed the "servile state" and offered a program of "distributivism". Of course, the Church has more than 2,000 years of experience in institutional planning. Little if any of the liberal vision touched isolationist America, which was eager for a "return to normalcy", with wholesale abandonment of the progressive social regime that won the war. Labor standards suffered serious slippage, with minimum wage/maximum hours requirements and collective bargaining discarded as wartime anachronisms, if not outright evils. A speculation/inflation spiral developed with the sudden end of wartime price control, fueled by easy credit for speculation. As much as one-third of asset value was based on inflation anticipation. The collapse came quickly, in 1920-21, the sharpest recession in recent memory, with severe deflation, causing high unemployment (4.75 million), farm failures (453,000) and business bankruptcies (100,000). Yet the 1920-21 recession, though severe, was short. Prosperity returned, subject only to a slight dip in 1924 and again in 1927. Corporate profit rose at an annual rate of 9 percent. Stock prices rose at an annual rate of 14 percent by 1927, even before the start of the final bull market run that ended in the crash two years later. Workers and farmers, who fared well under wartime planning, did not share in this postwar boom, the so-called Coolidge prosperity, also know in history as the New Era. Between 1919 and 1930, mergers and acquisitions eliminated 8,000 manufacturing and mining companies, and 5,000 public utilities. Ultimately 10 holding companies controlled 72 percent of all electricity sales. By 1929, fewer than 200 companies owned half of the corporate assets and 20 percent of the national wealth. The concentration of ownership enabled the business owners to increase their income three times as fast as their employees', which was not at all what Adam Smith had in mind. The 1929 crash eventually forced president Herbert Hoover, the engineer-turned-free-enterprisebusinessman, to resort to planning by carrying out a campaign promise to aid farmers in the Agricultural Marketing Act, which called for self-regulating producers cooperatives for each crop, with price control and government guaranteed markets. While the stock-market crash was not the cause of the Depression, it was one of the factors that intensified it. Every schoolboy was told that Hoover did not have a plan to counteract the Depression, except to wait idly for a return to prosperity around the corner. But in fact that was Hoover's plan, with full support from the business community, based on the assumption that the fundamentals of the economy were sound, and the only trouble was a speculative collapse of the stock market, and the plan was to insulate business against loss of confidence. Hoover also mistakenly believed that private enterprise was the principle element of stability, instead of being a weak point of the economic structure and a destabilizing agent by nature of booms and busts. Hoover's plan called for an active collective denial, but unfortunately, events were unforgiving. Sounds very familiar to what is going on in the linked economies of the world today. The Smoot-Hawley Tariff Act was signed into law by Hoover in June 1930, despite a plea from 1,028 members of the American Economic Association to veto it. Import duties were raised to 59 percent, the highest since 1830. Instead of saving the US from the Depression, it plunged the world into a downward spiral that eventually led to World War II. Meanwhile, early reports of successes in Soviet planning renewed calls from government, business organizations, academe, and labor unions in the US for a more orderly development than the free-forall ways that had led to the collapse of the New Era. It was a coalition between progressive ideology, which was grudgingly accepted by business, and scientific management, which business

enthusiastically endorsed. In 1928, the Soviet Union, under a new state planning commission called "Gosplan", worked out the First Five-year Plan, putting an end to Lenin's New Economic Policy (NEP). This plan succeeded in rapidly developing capital industries but failed in reorganizing agriculture. Many US management engineers were recruited by the Soviet First Five-year Plan. Returning to the US in the depth of the Depression, they brought with them a fresh enthusiasm for national planning within the capitalistic system that excited public interest. In 1931, a book about Russian planning, New Russia's Primer, even made the Book-of-the-Month Club. Franklin D Roosevelt became president of the United States on March 4, 1933. Neither an economist nor a central planner, not even a businessman by virtue of being independently rich from birth, FDR was dedicated to public service. He was assisted by his "brain trust", a group of progressives such as R G Tugwell and Raymond Moley of Columbia, Henry Wallace, an agricultural reformer, Herbert Fei, Adolf Berle and Donald Richberg, experts in law an economics. FDR's administration marked the entrance of academics into government in the ancient Chinese tradition. But FDR, likening himself to a quarterback, called all the shots, some fundamentally contradictory with others. FDR faced urgent problems: a systemic banking crisis, farm bankruptcies and high unemployment. His first term was consumed with rescuing the capitalistic order from its structural faults, and not the establishment of a new system of central economic planning. Two days after he became president, FDR forbade the export of gold and directed banks not to pay out gold in exchange for currency. The Emergency Banking Act (March 9, five days after inauguration) authorized the Reconstruction Finance Corp to buy bank preferred stocks, a back-door nationalization measure. Of the three new agencies created in quick succession by first New Dealers - the Agricultural Adjustment Administration (AAA - May 12, 1933), the Tennessee Valley Authority (TVA - May 18, 1933), and the National Industrial Recovery Act (NIRA - June 16, 1933) which authorized industrial planning - only the TVA survived in its original form. The Supreme Court demolished most of NIRA in 1935 and parts of the AAA in 1936. The flurries of socio-economic legislation passed in the "first 100 days" were all interventionist. Despite the Economy Act (March 20, 1933), which pledged to hold down government expenditure and cutting federal salaries by 10 percent, FDR proposed with congressional sanction, huge unemployment relief and other social projects such as the highly successful Civilian Conservation Corps, the first public environmental protection effort; the Federal Emergency Relief Administration; the Civil Works Administration; the Work Progress Administration; the Emergency Farm Mortgage Act; and the Home-Owners' Loan Act. The most far-reaching was the Glass-Steagall Act (June 16, 1933), which separated commercial banks from investment banks on the ground of conflict of interest, which was repealed in 1999. The Railroad Coordination Act was passed on the same day as Glass-Steagall. On January 31, 1934, FDR by permission of Congress devalued the dollar, reducing its gold content by 40 percent. It was a "beggar thy neighbor" devaluation policy opposed by Adam Smith. The first New Deal promoted economic planning in industry and agriculture in the Soviet style (some say the Italian Fascist style), and ran up against a reactionary Supreme Court. The second New Dealers, including Justice Brandeis, whose fear of the stifling of free competition by big business was greater than his embrace of laissez faire, needed a respectable economic theory to support their spending program in an era of declining government revenue. They found him in John Maynard Keynes, through Felix Frankfurter, who introduced Keynes to FDR. World War II planning was well recognized as the most important contribution to victory. The Cold War gave planning a bad name, as it did anything else that had the slightest leftist association. Grants in support of planning stopped abruptly in academe. But corporate planning that strengthened the corporate system institutionally and theoretically flourished as management science. Just as the church commandeered all talents in the Middle Ages in the name of God, and the monarchies established royal academies to capture all talents in the service of the king, postwar America monopolized all talents, including the whole discipline of planning, in the service of corporate market capitalism, leaving statism starved for talent. Corporate planning flowered in shiny computerized corporate headquarters, while national central planning withered in a neglected garden. But it does not follow that the latter is genetically inferior.

Iraq Geopolitics Part I: Geopolitics in Iraq an old game By Henry C K Liu First appear in Asia Times Online on August 18, 2004

The Arabs, a people generally defined by a common Arabic language, having been awakened with the new faith of Islam by Mohammed, gained control of Syria, Mesopotamia, Persia and Egypt in AD 640, took Roman Africa in AD 700 and reached Spain in AD 711, when they overthrew the Germanic kingdom set up by the West Goths. The Arab realm then stood as the more advanced third component of a triangulated non-Asian world culture consisting of Arab, Byzantine and collapsed West Roman roots. Mesopotamia, a Greek word that means the land between the rivers, the Tigris and Euphrates, meeting at the cradle of Western civilization, known today as Iraq, was and is inhabited predominantly by these Arab tribes. Iraq is an Arabic word that appears in the Koran and has been a geographical term for the Mesopotamia area throughout the Muslim era. Iraq became a target of rivalry between the Persian and Ottoman empires, both Islamic, for almost five centuries beginning around 1500. Shah Ismail, the Safavid ruler of Persia, put Iraq under Persian occupation in 1508. The Ottoman Sultan Selim I regained control of Iraq in 1514, after the battle of Jaldiran. In 1529, Iraq was reoccupied by Persia, but was retaken by the Ottoman Sultan Suleyman the Magnificent in 1543. This recurring tug-of-war over Mesopotamia reflected the precarious and changing military balance between the two Islamic empires on the one hand, and the administrative difficulty in occupying alien lands on the other. Neither could decisively defeat the other and achieve permanent military control over Iraq; nor could either establish effective, lasting administrative control over the local Arabic population when in possession of it. Since the rivalry could not be resolved through military means, a political solution was attempted in the first treaty between the two empires through the Amassia Treaty of 1555. The treaty endured for 20 years with the region remaining an Ottoman province until 1623, when it was again occupied by Persia. However, in 1638, the Ottoman Sultan Murad IV drove the Persians out of Iraq by capturing Baghdad. In 1639, the Treaty of Zuhab was signed establishing a peace and defining the border between the two empires. With this background, conflict between the two Islamic empires was contained in a frontier zone and manifested in shifting tribal allegiances, inter-tribal conflicts and avenging raids. In the Treaty of Zuhab, the frontier zone was over 100 miles wide, between the Zagros Mountains in the east and the Tigris and Shatt al-Arab rivers in the west. While its role in containing armed conflict was short-lived, the Treaty of Zuhab was significant because it became the basis for future treaties and established the framework for future disputes over legitimate borders. By 1730, the two empires were again engaged in full-scale war, with the possession of Iraq a key focus of conflict. A treaty in 1746 between the two empires re-established the century-old 1639 Zuhab boundaries, affirming them as points of reference of future negotiations and foci of future conflicts. A common Islamic culture did not unit the nations of the Middle East any more than a common Christian culture prevented war among the nations of Europe, a historical fact that refutes the current doctrine of a clash of religion-based civilizations that threatens world order. Geopolitics beyond religious bounds was and remains the controlling factor in world armed conflicts. Enter the West By the 19th century, British imperialist expansion in the region had transformed the Ottoman/Persian power balance and changed the geopolitical nature of the conflict. During the 17th and 18th centuries,

British imperialist interests had pushed back in succession Portuguese, Dutch and French commercial and political penetration of the Middle East. By 1820, Britain had turned the Persian Gulf into a British lake and had begun to focus its attention on Ottoman Iraq and Persia in its efforts to protect British India against threats from European imperialist rivalry, particularly expansionist Czarist Russia, to develop a secure line of communication and commerce between British India and the Britain Isles via the Middle East, and to expand commercial markets for British trade in the region. This all came to a head as war erupted in Europe. In the course of World War I, British forces invaded what is now southern Iraq in late 1914 as part of Britain's offensive against the Ottoman Empire (which later collapsed after having suffered the misfortune of being on the losing side of the war). By mid 1914, a stalemate had developed on the Western Front between Allied forces and those of the Central Powers. Following the initial free-flowing operations, the opposing sides found themselves facing each other along a line of defensive trenches that stretched from Switzerland to the Belgian coast. The effective defense of positional warfare forced policymakers in both opposing camps to find new ways to prosecute a war that threatened to drag on without end. Under these circumstances, the need for an alternative approach was becoming pressing before continuing heavy casualties without the promise of victory would begin to threaten the internal security of the opponent governments. Forcing the Dardanelles On the Central Powers side, Germany, the ultra-conservative lead member, was pushed to help Lenin, the detested Bolshevik, to return from exile in Switzerland through Germany in a sealed train to Russia to lead a communist revolution that, if successful, would withdraw Russia, a member of the Allied Nations, from the war between capitalist powers. On the Allied side, the search for a strategic alternative was encouraged by the pride of the British in their invincible sea power. With the German High Seas Fleet contained in the North Sea, the possibility of launching naval attacks on the enemy was particularly appealing to the British First Lord of the Admiralty, through the hawkish imperialist persona of Winston Churchill. Eager to use unmatched British naval resources to maximum advantage against land powers, Churchill advanced a series of provocative proposals, among them a sea assault on the Dardanelles, the nearly 50-kilometer-long strait separating the Aegean Sea from the Sea of Marmara, which at the Narrows was less than two kilometers wide. The object was to drive an overwhelming naval force into the Sea of Marmara and capture Constantinople, the capital of the Ottoman Empire, which on October 29, 1914, had the foolish audacity to ally itself with Germany and the Central Powers against Britain and the Allied Nations. For the Ottomans, the alliance with the Central Powers was a geopolitical natural, since Britain, France and Czarist Russia had been the Western powers that, in the Crimean War, had most recently taken less-than-honorable actions to dismember the Ottoman Empire. The Crimean War (1854-56), like so many of the later Ottoman conflicts with Europe, was instigated not by the Ottomans but by inter-European rivalry. Czarist Russia, Westernized by Peter the Great (1682-1725), was primarily interested in territory as part of a quest for warm-water ports to the Mediterranean Sea. Throughout the 17th and 18th centuries, Russia had been gradually annexing Muslim states in Central Asia. By 1854, Russia found itself edging toward the shores of the Black Sea. Anxious to annex territories in Eastern Europe, particularly the Ottoman provinces of Moldavia and Walachia (now in modern Moldova and Romania), the Russians forced a war on the Ottoman Empire on the pretext that the Ottomans had granted Catholic France, rather than Greek Orthodox Russia, the right to protect Christian sites in the Holy Land, which the Ottomans then controlled. The Crimean War was unique in Ottoman history in that the conflict was not motivated, managed or even influenced by Ottoman policy or interests. The war was a European conflict fought on Ottoman territory, with Britain and France allying with the Ottomans in order to protect their own lucrative economic concessions in the region from Russian infringement. The war ended badly for the Russians, with unfavorable terms in the Paris Peace of 1856, but the Ottomans as victors fared even worse. From that point onward, the Ottoman Dominion fell under direct European domination and earned the derisive label as "the sick man of Europe". The Crimean War marked the decline in Ottoman morale and self-respect. In 1914, 58 years later, the former European rivals of Britain and Russia were united in a world war to once again threaten the Ottoman Empire. Europeans, for their part, no longer saw, as they had three centuries earlier, the Ottoman state as an equal force that could manipulate intra-European rivalry to enhance Ottoman geopolitical advantage,

but as a pliant victim that could be manipulated for larger European geopolitical purposes. This Eurocentric geopolitics permeated beyond Ottoman territories, throughout the whole world, especially in the final decades of dynastic China, and in most of Asia and Africa. Constantinople (now known as Istanbul), which stands guard on the Bosphorus, a narrow waterway into the Black Sea, was viewed by Churchill as being vulnerable to attack by sea. Such naval actions had precedents. In 1807 a small British naval squadron had forced the Narrows only to be marooned and eventually had to retreat before it could attack Constantinople. As recently as the Italian-Turkish War of 1911-12, an Italian force had attacked the Dardanelles and penetrated as far as the defenses of the Narrows. Now, an invincible British navy would bring these promising naval operations to successful conclusion. Even before the Ottoman Empire entered the war on October 13, 1914, the possibility of a joint Greek-Russian assault on the Dardanelles had been canvassed. Once hostilities began, Churchill wasted no time ordering a naval bombardment of the forts guarding the Narrows. This operation, carried out before Britain formally declared war on the Ottoman Empire, reminded the Ottoman Turks of the threat to the Dardanelles, and impelled them to seek German help to improve its defenses, especially by the laying of sea mines in the Narrows. Churchill first urged a naval attack on the Dardanelles at the meeting of the British War Council in London on November, 1914, but his brash naval war plan was rejected. Pre-war studies had indicated that such an operation would be too risky and for no strategic purpose, since Ottoman forces were no threat to British interests in the region. The issue was soon brought back to the fore by the military stalemate on the Western Front. The Ottoman Turks' advance northwards in the Caucasus caused panicky Czarist Russia to urgently appeal to her Western allies for counter action to relieve the pressure. The need turned out to be fleeting since Russian forces were able to drive the Turkish advances back without help. But these events provided impetus for Churchill's precarious plan of a naval attack on Ottoman Turkey. The tempting idea of inducing, with a spectacular British naval victory, the Balkan states newly separated from Ottoman rule to join the Allies and attack AustriaHungary from the southeast, never more than a wishful illusion, was also part of Churchills grand strategy of naval glory. A successful naval campaign in the Eastern Mediterranean with minimum casualties might, moreover, encourage opportunistic Italy to enter the war on the Allied side. Still, no serious thoughts had been given to any possible use of tribal Arabs against the Ottoman Turks, for rule over the disunited Arabs was a war prize to be won from the Ottomans. Britain was not about to jeopardize her coveted post-war rule of the Middle East by fanning the ugly spark of Arab nationalism. Britain's reckless strategic calculations for Arabic territories in the Ottoman Empire, to be accomplished without Arab participation, were reinforced by the promise of the limited nature of Churchill's proposed naval action on the Dardanelles, requiring no need for a sizable land force. Despite the strong reservations of the commander of the Royal Navy's Eastern Mediterranean Squadron, Churchill proposed a naval attack in force on the forts guarding the Narrows, a maneuver supposedly well within the ample range of the world's unmatched naval superpower up to that time in history. His plan, expressed with Churchillean grandiloquence, had the irresistible attraction of not requiring any substantial land forces for its implementation at a time when military manpower was emerging as the decisive factor on the western front. Nor would it diminish Britain's position of naval strength in the vital North Sea against the German fleet, since only surplus older battleships on the verge of obsolescence would be used against the second-rate Ottoman military devoid of a navy. The British War Council approved Churchill's proposal on January 15, 1915. Just as President George W Bush, in 2003, trapped by overzealous, hawkish neo-conservative advisors who subscribed to the fantasy that Iraqis would welcome US liberators with flowers and hugs, sold Congress on the illadvised invasion of Iraq by claiming not to need any sizable force to occupy Iraq for long periods, Churchill in 1915 was trapped by his blind faith in the myth of naval power replacing the need for land troops for imperialist conquest. Churchill forgot that while the Battle of Trafalgar won by Lord Nelson at sea might have saved Britain from French invasion, it was the Battle of Waterloo won by Duke Wellington on land that finally defeated Napoleon. In 1915, in the sea campaign against the Ottoman Empire as planned by Churchill, the Royal Navy, supplemented with ships of her French ally, with a total of 247 floating cannons, was supposed to destroy the Ottoman defense of 150 land guns positioned over 40 bases along the Narrows, blast its way through the Dardanelles, the Sea of Marmara and then the Narrows with Nelsonian daring, reducing the defending forts to rubble as it went. Then, anchoring in the shadow of Constantinople, its sheer invincible presence and threat of destructive navy cannons trained on Topkapi Palace would

induce panic in the Ottoman court and cow the Ottoman government into surrender. The flanks of Germany and Austria-Hungary would then be exposed and with the sea lanes to the Black Sea opened, Czarist Russia could be supplied with much-needed munitions, and the Czar's rejuvenated massive armies would steamroller westward into Berlin, breaking the stalemate on the Western Front. A similar strategy had worked in China in 1840, when, faced with stiff Chinese resistance in the southern coast, the British fleet steamed north to threaten Peking and forced the Qing court to negotiate an unequal treaty that yielded, among other war prizes, the British colony of Hong Kong. The navy campaign on the Dardanelles was to be Churchill's Trafalgar. When, with Churchill's urging, the British War Council reversed its earlier plan to send even the 29th Division to the East Mediterranean campaign; it was decided to deploy to Mudros on the Aegean island of Lemnos untested Dominion troops from Australia and New Zealand. The French government, meanwhile, had also decided to deploy to Mudros a specially composed division of new recruits. All these troops were intended as garrison forces which might occupy the forts (and later Constantinople) after the "shock and awe" naval bombardments had been successfully completed in short order. Since an amphibian assault on Gallipoli was not envisaged in the war plans of the naval campaign through the Dardanelles, this Allied Mediterranean Expeditionary Force, to be commanded by General Sir Ian Hamilton, was not adequately manned, nor its troops trained for heavy combat. By the time Hamilton arrived in the Eastern Mediterranean on March 17, 1915, the slow progress of the naval operations had raised doubts about Churchill's plan of easy victory by naval means alone. The Ottoman land bases with 150 guns dispersed over 40 well-protected forts were largely immune from naval bombardment. In addition to land bases, the strait was protected by some 610 mines set into deep water in the Narrows. And two underwater nets against submarines had been set. Pushed by an impatient Churchill who demanded quick action from London, a heroic attempt to subdue the forts and incapacitate their guns guarding the intermediate defenses was made on March 18 by the British fleet with French support, before the sea mines were cleared by minesweepers whose operation had been hampered and delayed by effective Ottoman gun fire. The sea assault proved disastrous when six of the16 capital ships taking part struck mines, and three sank, carrying 700 sailors to their death. The sea mines remained insurmountable for the British naval force. The Disastrous Assault on Gallipoli Within four days, Hamilton, the supreme commander on the spot, had to shift the emphasis from a predominantly naval to a land operation, to launch an amphibious assault on Gallipoli, a 50-mile long peninsula in the European part of Ottoman Turkey, extending southwestward between the Aegean Sea and the Dardanelles, to use British troops to disarm the Ottoman guns to let the British fleet through. The result was the infamous Gallipoli campaign. It was a change of war plan approved by a desperate Churchill who refused to admit the failure of his foolhardy faith in naval power and rationalized that Ottoman resistance to an amphibious landing had nevertheless been greatly weakened by earlier British naval bombardment. British prestige had to be preserved with bulldog tenacity. The Gallipoli campaign turned out to be a military failure costly in human lives. But the damage to British prestige was decidedly greater. Just like US President George W Bush's disastrous occupation plans of Iraq, the disastrous outcome of Gallipoli was predetermined by the strategic error of not having enough troops available for the task at hand. Hamilton launched the amphibian invasion campaign with five divisions against a roughly comparable Ottoman force that enjoyed the advantage of operating on interior lines. The rough parity was sustained as the campaign progressed with 13 divisions of the Triple Entente (Britain, France and Russia) eventually facing 14 Ottoman divisions. The half-hearted British approach was dictated by Churchill's faulty premise that the objective could be attained by the navy with only a small land force, and with London viewing the Ottoman front as a crazy idea of an overzealous but politically astute hawk, and as an insignificant side show hardly worth any significant sacrifice in manpower and resources even after July 1915. This attitude ensured that the Entente build-up was always too little, too late to secure more than a foothold on the landing on the narrow peninsula. Hamilton, saddled with undeserved blame, was replaced by Sir Charles Munro, who withdrew from the area on January 9, 1916. Just like the desperate British retreat from Dunkirk in World War II, the evacuation from Gallipoli was hailed by British propaganda as having been brilliantly executed, albeit the campaign that should have prevented the need to retreat itself was not. Wrongheaded leadership on the part of Churchill played a key part in the Entente failure, and many men, inadequately trained and poorly led,

who nevertheless fought bravely, mostly Dominion troops from Australia and New Zealand, were sacrificed in futile attacks on strong Ottoman positions. The Gallipoli campaign had no significant effect on the outcome of the war, which could only be resolved where the main forces of the opponents confronted each other on the western front and finally not until the United States entered the war on the side of the Allied Nations on April 6, 1917. And the prospect of a Balkan coalition forming to lead a mighty offensive from the southeast was illusory, if only because of the pitiful state of the Balkan militias. Moreover, there was no certainty that the Ottoman Turks would necessarily have capitulated had their capital come under threat from Allied naval forces. In pursuit of Churchill's hawkish chimera, 120,000 British and 27,000 French troops became casualties in the first months of landing. For the Ottomans, whose casualties probably numbered as many as 250,000, including 87,000 dead, it was the beginning of a process of national revival. The Ottoman hero at Gallipoli, Mustafa Kemal, would eventually become the founding president of the Republic of Turkey, and would later be bestowed the name Ataturk (meaning Father of the Turks). The Beginnings of the Jewish State It was the disaster at Gallipoli that forced the British to accept the idea that an Arab revolt would be useful against the Ottoman Turks. The British then disingenuously began promoting Arab nationalism as a device against the Ottoman Empire, posing as progressive friends who had come to liberate the Arabs from Ottoman oppression. It was the forerunner of a US policy three decades later after the Second World War to promote fundamentalist separatism and bogus democracy as devices against global communism. In late 1915 in the Anglo-Hejaz treaty, Britain promised that the Middle East would become an Arab state. In 1916, T E Lawrence, the famous Lawrence of Arabia, joined Arab forces under Faisal al-Hussein, third son of Hussein ibn Ali, the Sharif of Mecca, in their revolt against the Ottoman Empire. Faisal would later become Faisal I of Iraq. In the same year, the secret SykesPicot treaty between Britain and France divided post-war Middle East between the two imperialist powers. Britain would protect Egypt and the newly created state of Saudi Arabia, France would protect the Syrian-Lebanon state. Palestine would be international, with a new Jewish state earmarked there in the future. Geopolitically, to prevent an alliance between the 56,000 Jews in Palestine and the well-established and influential Jewish population in Germany, the British, with the Balfour Declaration in 1917 agreed to advocate a Jewish homeland in Palestine. Insulating infiltration of German influence into the Middle East through the more liberal German Jews was a factor in British policy towards Palestine, which quietly favored immigration of Russian and Slavic Jews into the region. In addition, the possibilities of a pro-British Jewish state in Palestine to help counter Arab nationalism in the Middle East were not idle thoughts at No 10, Downing Street. The British never seriously contemplated effective resistance from Arabs to a Jewish state in Palestine. Arab nationalism was not a significant consideration in the initial geopolitics behind the Balfour Declaration. A Jewish state in Palestine under British Mandate did not conflict with British plans because the British never intended to give back the Ottoman Arab provinces ,to the Arabs. Still, it took another world war and a horrifying Holocaust which essentially destroyed the liberal influence of the German Jews, to finally bring the new Jewish state into reality. The Sykes-Picot Agreement In the late stage of the multi-front, four-year-long First World War, Britain and France had secretly reached the Sykes-Picot Agreement of 1916, with the acquiescence of Czarist Russia, to partition the Arab provinces of the Ottoman Dominion between the two Western powers. The secret agreement spelled out the division of Ottoman Syria, Iraq, Lebanon and Palestine into various French and Britishadministered areas. The agreement conflicted directly with pledges already given by the British to the Hashemite leader Hussein ibn Ali, the Sharif of Mecca, who had been persuaded to lead an Arab revolt in the Hejaz against the Ottoman rulers on the understanding that the Arabs would eventually receive much of the territory won. The Sykes-Picot Agreement, the Paris Peace Conference and the Cairo Conference were examples of the political hegemony of the European imperialist powers, which shifted borders and annexed territories, inventing dependency through mandates and protectorates. The British had persuaded the Arabs to rise up against the Ottoman rulers. The British high commissioner in Egypt, Sir Henry McMahon, corresponded with the Sharif of Mecca, promising an independent Arab state in return for fighting the Ottoman Turks. Unaware of the secret Sykes-Picot agreement, the Sharif

of Mecca initiated a revolt against Ottoman rule in 1916 with the help of British advisers, training and munitions, and proclaimed himself king of the Hejaz until Mecca fell in 1924 to ibn Saud of Nejd, descendant of the puritanical Wahhabi rulers, who laid the basis of the present Saudi Arabia kingdom. Wahhabis are a puritanical Saudi Islamic sect founded by Mohammed ibn-Abd-al-Wahhab (1699? 1792), which regards all other sects as heretical. His life gave birth to the term "Wahhabi". Mohammed Ibn Abdul Wahhab Najdi was supported by the British who were looking for dissidents to weaken the Islamic Caliphate from within itself. The Wahhabis took Mecca with the help of the British in 1924 and bombarded the Shrine of the Holy Prophet in Medina which they took in 1931. And in 1932, the Wahhabis founded the state of Saudi Arabia. By the mid-20th century, Wahhabism had spread throughout the Arabian Peninsula, and it is the official religion of the Saudi Arabian kingdom. Oil was struck in Saudi Arabia in 1936 and commercial production began during the Second World War, in which Saudi Arabia remained neutral until the end when it became a member of the Allies against the Axis powers. Oil changed the geopolitical importance of Saudi Arabia and the Middle East. The disclosure of the secret Sykes-Picot agreement provided indisputable evidence of British diplomatic duplicity. The Arabs learned about the agreement only in 1917, the year of the Balfour Declaration, when the new Soviet Union published diplomatic documents from the Czarist archives. The secret agreement deprived the Arabs of the right to rule their own territories, newly won with blood. Most of the Middle East came under British and French control. The vision of a free and united Arab realm had been a manipulated illusion perpetrated by Western imperialism. The Sykes-Picot Agreement set the scene for a century of border conflicts that continue today. The Paris Peace Conference in 1919 legitimized the imperialist partitions. Britain was entrusted with mandate powers for Iraq and Palestine, while Syria and Lebanon came under the French mandate. Under Article 22, the League of Nations stated: "Territories inhabited by peoples unable to stand themselves would be entrusted to advanced nations until such time as the local population can handle matters." Peoples unable to stand themselves were apparently quite able to die for the advanced nations in a war of imperialist rivalry, the prize for which was the right to dominate these same people. Britain Occupies Iraq By 1917, British occupation of Iraq began. In the aftermath of the war and the subsequent dismantling of the Ottoman Empire, the Fertile Crescent of ancient Mesopotamia was divided between France and Britain in accordance with the secret Sykes-Picot Treaty. After the war, Britain was given formal control of a territory of 171,600 square miles known as Iraq under a League of Nations mandate, despite widespread popular resentment from the then local population of 7 million, which has since grown to 25 million. Iraq inherited 1,472 kilometers of the old Ottoman-Persian border, 700 kilometers of which passes through Kurdistan, a border resulting from diplomatic intrigue that dated back to the Zuhab settlement in 1639. The mandate encompasses three former Ottoman wilayas, or administrative districts: Mosul, Baghdad and Basra, which historically included Kuwait. The British, being ever conscious of the need for naval bases, carved out Kuwait as a separate nation, whose legitimacy has never been accepted by Iraq. Since 1779, the British East India Company, backed by British naval power, had exercised de facto control over Kuwait. As World War I ended, Britain and France both sent troops to enforce their claims and peace conferences subsequently confirmed this wartime division. Palestine was the exception, becoming part of the British zone and not, as was originally planned, an international zone. Britain merged the Ottoman provinces Baghdad, Basra and Mosul into a new state of Iraq, inhabited by three different groups of people: Shi'ites, Sunnis and Kurds. Under British rule, the new Iraqis were subjected to more taxes than under Ottoman rule and pilfering of Iraqi national wealth occurred on a scale that the Ottoman Empire never contemplated. Arabs in southern Iraq, having helped the British against the Ottoman Turks in World War I, began resistance in 1920 against the British, who failed to honor their promise to end British occupation after the defeat of the Ottoman Empire. To crush the Iraqi national liberation movement, Winston Churchill, as British secretary of state for war, introduced new military tactics with massive bombing of villages as the original "shock and awe" doctrine, revived eight decades later by the US military. Churchill ordered the use of mustard gas against the Iraqi civilian population, stating: "I do not understand the squeamishness about the use of gas. I am strongly in favor of using poison gas against uncivilized tribes." Churchill argued that the military use of gas was a "scientific expedient" and it "should not be

prevented by the prejudices of those who do not think clearly". Whole villages were bombed and gassed. There was wholesale slaughter of civilians. Men, women and children fleeing from gassed villages in panic were mercilessly machine-gunned by low-flying British planes. The Royal Air Force routinely bombed and used poison gas against the Kurd, Sunni and Shi'ite tribes without discrimination. President George W Bush was highly selective when he proclaimed that the world was a better place with Saddam Hussein removed from power because Saddam used gas on the Iraqi Kurds. To be consistent, history without a double standard would have to say that the world would have been a better place had Churchill been removed from power. According to Churchill, Bush in calling Saddam evil for gassing Kurdish civilians merely "did not think clearly." Needless to say, no regime change was imposed on Britain. Notwithstanding the ruthless British response to Iraqi nationalist resistance with overwhelming military force, Britain soon was forced to face the inescapable fact that it would be impossible to effectively control the Arab country by military means. To avoid heavy casualties to the occupational force, the British were forced to restrict their control to only critical neighborhoods in key urban centers. This in turn allowed more attacks of British occupation forces. Britain then decided to form a pro-British Iraqi government as a proxy to protect British interests, just as the US is doing now in Iraq. The delineation of Iraq's borders was framed by Britain's objective of securing communication between British India and British Egypt. British commitment in the Balfour Declaration that the British government "views with favor" the establishment of a Jewish state in Palestine provided the context for additional political and strategic calculations. Britain aimed at turning her war-time obligations to her war-time Arab allies into a chain of proxy states across post-war northern Arabia ruled by branches of the pro-British House of Hashim under the protection and control of Britain. When it became clear that Iraq would not have a common border with the newly established communist Soviet Union, conflict between Britain and France over Mosul surfaced for lack of a common ideological enemy and was resolved by Britain's agreeing to grant France 10% of future oil revenue from the region. In exchange, British-controlled Iraq would be guaranteed access to water from the upper Tigris in French-controlled areas for use in the south and for irrigation needed for the cultivation of agricultural produce, such as tobacco, timber and grain, grown mostly in the north. An unnatural mismatch between Arabic/Iraqi history and the political borders imposed by European powers to resolve European rivalry affected Iraq's relationship with its surrounding neighbors as well as distant Western powers. Some 12 states were created in the Arabian Peninsula and 22 states divided the Arab world as a result of World Wars I and II. The borders between these states were so contested by local tribal inhabitants that peace had been maintained only by the creation of neutral zones. Justice was frequently preempted by arbitrary geopolitical decisions imposed by the side most able to enforce a solution militarily. This militaristic geopolitical game continues today.

Legalism, Confucianism, Taoism Legalism is one of the three main schools in Chinese philosophy, the other two being Confucianism

and Taoism (also transliterated as Daoism). Legalists believed that a nation should be governed by law, which must be clearly written and made public. All are equal before the law. Under the previous Zhou Dynasty (1122-256 BC), laws had been loosely written and controlled by tradition based on social classes. Legalism advocates that laws should reward those who obey them and punish those who break them. In addition, the legal system rules the state, not the officials. It is only through the impartial administration of law that a ruler can rule the state effectively. In contrast to Confucianism, Legalism restricts moral issues to the making of law, not the administering of the law. Strict enforcement of the law is the foundation of a stable society. Still, the term "rule of law" has distinctly different meanings in Chinese political culture than in the West. Critical theory views the Western concept of the rule of law as merely a method by which the ruling class can justify its rule, as it alone determines what laws get passed based on its own narrow interests. Legalism places importance on three aspects. The first is shi (influence) or legitimacy, the legal basis of power based on the legitimacy of the sovereign and the doctrinal orthodoxy of his policies. In a socialist society, legal legitimacy is inseparably tied to the interests of the people as represented by the socialist party. The second is shu (skill) in manipulative exercise of power in order to respond to the highest aspirations of the masses. The third is fa (law) which, once publicly proclaimed, should govern universally without exceptions. These three aspects Legalists consider the three pillars of a wellgoverned society. This concept of the rule of law is different from that used in the US legal system, in which laws are made by lobbyists, manipulated to serve special interests and applied by courts dominated by highpriced lawyers. The US legal system is blatantly undemocratic, with its courts packed with politically appointed judges and a legal-fee structure unaffordable by the average citizen. The so-called Gang of Four distorted Legalist politics in China toward the end of the Great Proletarian Cultural Revolution in the 1970s. For their power-usurping game, they used as shi (influence) for legitimacy; rote resuscitation of Marxist orthodox doctrine, reinforced by a co-opted Maoist personality cult that negates the very nature of Mao; party factionalism as shu (skill) for exercising power; and dictatorial rule as fa (laws) to be obeyed with no exceptions allowed for tradition, ancient customs or special relationships and with little regard for human conditions. These self-styled Legalists yearned for a perfectly administered state, even if the price was the unhappiness of its citizens. They sought an inviolable system of impartial justice, without extenuating circumstances, even at the expense of the innocent or the wrongly accused. Worst of all, they put themselves above the law. Feudalism with fascist, socialistic, democratic characteristics Feudalism in China has concurrent aspects of what modern political science would label as fascist, socialist and democratic. As a socio-political system, feudalism is inherently authoritarian and totalitarian. However, since feudal cultural ideals have always been meticulously nurtured by Confucianism to be congruent with the political regime, social control, while pervasive, is seldom consciously felt as oppressive by the contented public. Or more accurately, social oppression, both vertical, such as sovereign to subject, and horizontal, such as gender prejudice, is considered civilized self-restraint and natural for lack of a socially acceptable alternative vision. Concepts such as equality, individuality, privacy, personal freedom and democracy, are deemed antisocial, and only longed for by the mentally deranged, such as radical Taoists. This would be true in large measure up to modern times when radical Taoists would be replaced by other radical political and cultural dissidents. A distinction needs to be made between genuine indigenous dissent and dissent from those merely playing opportunistically for foreign imperialist favor. Dissidents who hide under foreign imperialist patronage and protection, conveniently enjoying bogus martyr status without the inconvenience of martyrs' fates, will pay for such free rides with loss of credibility. Economic self-interest, the foundation of market fundamentalism, is viewed in Chinese culture as a character flaw. Until modern times, merchants were ranked in social status below prostitutes in feudal society. The imperial system in China took the form of a centralized federalism of autonomous local lords in which the authority of the sovereign was symbiotically bound to, but clearly separated from, the authority of the local lords. Unless the local lords abused their local authority, the emperor's authority

over them, while all inclusive in theory, would not extend beyond national matters in practice, particularly if the sovereign's rule was to remain moral within its ritual bounds. This tradition continues to the modern time. This condition is easily understood by Americans, whose federal government is relatively progressive on certain issues of national standards with regard to community standards in backward sections of the union. Confucianism (Ru Jia), through the code of rites (li), seeks to govern the behavior and obligation of each person, each social class and each socio-political unit in society through self-constraint. Its purpose is to facilitate the smooth functioning and the perpetuation of the feudal system. Therefore, the power of the sovereign, though politically absolute, is not free from the constraints of behavior deemed proper by Confucian values for a moral sovereign, just as the authority of the local lords is similarly constrained. Issues of constitutionality in the US political milieu become issues of proper rites and befitting morality in Chinese dynastic politics. To a large extent, this approach continues to apply to the modern Chinese polity. The legitimacy of the dictatorship of the proletariat (defined in Chinese political nomenclature as the property-less class) lies in its intrinsic moral validity, upon which the CCP assumes its leadership role in government. Criticizing the CCP for not subjecting itself to election challenge is a debate that lies outside the range of its discourse. Morality is not an elective issue. The party must lead the people The Three Represents is a newly adopted theory put forward by former Chinese president Jiang Zemin. The official formal statement of the theory is as follows: "Reviewing the course of struggle and the basic experience over the past 80 years and looking ahead to the arduous tasks and bright future in the new century, our party should continue to stand in the forefront of the times and lead the people in marching toward victory. In a word, the party must always represent the requirements of the development of China's advanced productive forces, the orientation of the development of China's advanced culture, and the fundamental interests of the overwhelming majority of the people in China." The correct interpretation of the theory is still under study. Logic dictates that the "Three Represents" must be of equal priority. The ultimate test is "the fundamental interest of the overwhelming majority of the people" without which the first two "Represents" would be irrelevant. And the overwhelming majority in China is the Chinese peasant. The inclusion of capitalists and entrepreneurs in the party and the legitimization of private property in the constitution remain ideologically problematic in a political party of the proletariat. The ideal Confucian state rests on a stable society over which a virtuous and benevolent emperor rules by moral persuasion based on a Code of Rites, rather than on law. Justice would emerge from a timeless morality that governs social behavior. Man would be orderly out of self-respect for his own moral character, rather than from fear of punishment prescribed by law. A competent and loyal literatibureaucracy faithful to a just political order would run the government according to moral principles rather than following rigid legalistic rules devoid of moral content. The interest of the masses is the highest morality in politics. Confucian values, because they were designed to preserve the then-existing feudal system, unavoidably ran into conflict with contemporary ideas reflective of new emerging social conditions. It is in the context of its inherent hostility toward progress and its penchant for obsolete nostalgia that Confucian values, rather than feudalism itself, become culturally oppressive and socially damaging. When Chinese revolutionaries throughout history, and particularly in the late 18th and early 19th centuries, rebelled against the cultural oppression of reactionary Confucianism, they simplistically and conveniently linked it synonymously with political feudalism. Mao aimed to smash Confucian dominance These revolutionaries succeeded in dismantling the formal governmental structure of political feudalism because it was the more visible target. Their success was due also to the terminal decadence of the decrepit governmental machinery of dying dynasties, such as the ruling house of the threecentury-old, dying Qing Dynasty (1583-1911). Unfortunately, these triumphant revolutionaries remained largely ineffective in remolding Confucian dominance in feudal culture, even among the

progressive intelligentsia. Mao understood this reactionary aspect of Confucian culture. He aimed to reform not only the polity of the Chinese state but also the culture of Chinese society. Almost a century after the fall of the feudal Qing dynastic house in 1911, after countless movements of socio-political reform and revolution, ranging from moderate democratic liberalism to extremist Bolshevik radicalism, China has yet to find a workable alternative to the feudal political culture that would be intrinsically sympathetic to its aspirational social tradition of populist government. Chinese revolutions, including the modern revolution that began in 1911, through its various metamorphoses over the span of almost four millennia in overthrowing successive political regimes of transplanted feudalism, repeatedly killed successive infected patients - in the form of virulent governments. But these revolutions failed repeatedly to sterilize the infectious virus of Confucianism in its feudal political culture. The modern destruction of political feudalism produced administrative chaos and social instability in China until the founding of the People's Republic in 1949. That is the undeniable contribution of Mao Zedong to Chinese political history. But Confucianism still appeared alive and well as cultural feudalism, even under communist rule, and within the CCP. It continued to instill in its victims an instinctive hostility toward new ideas, especially if they were of foreign origin. Confucianism adhered to an ideological rigidity that amounted to blindness to objective problem-solving. Almost a century of recurring cycles of modernization movements, nationalist or communist, liberal or Marxist, did not manage to make even a slight dent in the all-controlling precepts of Confucianism in the Chinese mind. In fact, in 1928, when the CCP attempted to introduce a soviet system of government by elected councils in areas of northern China under its control, many peasants earnestly thought a new "Soviet" dynasty was being founded by a new emperor by the name of "So Viet". Mao Zedong recognized this feudal mentality as the central obstacle to China's revitalization. Confucianism considered Legalism an aberration During the Great Proletarian Cultural Revolution of 1966-76, the debate between Confucianism (Ru Jia) and Legalism (Fa Jia) was resurrected as allegorical dialogue for contemporary power struggle. Legalist concepts such as equal justice under law for all and none being above the law are considered by Confucians aberrations of social morals and corruption of moral governance. At the dawn the 21st century, Confucianism remained alive and well in Chinese politics regardless of ideology in political economy. Modern China was still a society in search of an emperor figure and a country governed by feudal relationships, but devoid of a compatible political vehicle that would turn these tenacious, traditional social instincts toward constructive purposes, instead of allowing them to manifest themselves as rationalization for corruption. Of the three great revolutions in modern history - the French (1789), the Chinese (1911) and the Russian (1917) - each overthrew feudal monarchial systems to introduce idealized democratic alternatives that had difficulty holding the country together without periods of terror. The French and Russian revolutions both made the fundamental and tragic error of revolutionary regicide and suffered decades of social and political dislocation as a result, with little if any socio-political benefit in return. In France, regicide did not even prevent eventual restoration of monarchy imposed externally by foreign victors. The Chinese revolution in 1911 was not plagued by regicide, but it prematurely dismantled political feudalism before it had a chance to develop a workable alternative, plunging the country into decades of warlordism. Worse still, it left largely undisturbed a Confucian culture while it demolished its political vehicle. The result was that almost a century after the fall of the last dynastic house, the culture-bound nation was still groping for an appropriate and workable political system, regardless of economic ideology. China vs the almighty dollar By Henry C K Liu

This article appeared in AToL on July 23, 2002

The Italian Marxist thinker Antonio Gramsci, while under Fascist imprisonment, developed the concept of cultural hegemony: control people's minds, and their hearts and hands will follow. Gramsci explained how one dominant class can establish its control over others through ideological dominance. Whereas orthodox Marxism explains social structure as shaped by economic forces, Gramsci adds the crucial cultural dimension. He showed how, once ideological authority (or "cultural hegemony") is established, the use of overt violence to impose control can become superfluous. Today, the world lives under the virtually undisputed rule of a market-dominated, ultra-competitive (yet not fairly competitive), globalized society with its cortege of manifold iniquities and legalized violence. Many public and private institutions in all nations that genuinely believe they are working for a more equitable world have unwittingly contributed to the violent triumph of neoliberalism. Field evidence, however, shows that perpetual prosperity for anyone, let alone all, under market fundamentalism is merely an empty promise of neoliberalism. And the time may be ripe for China, as Asia's largest economy, to break free of a global market economy that nears collapse. The chairman of the US Federal Reserve Board, Allan Greenspan, now proudly uses the term "hegemony", in congressional testimony to describe officially US financial preeminence and structural advantage. Unlike ideology, politics deal not only with moral validity, but also with power. The ideology of neoliberalism appears empirically operative because it has the hegemonic power to construct a "real" world that appears internally consistent and theoretically rational, with the aid of "scientific" neoclassical economics theories. No matter how many socioeconomic disasters the neoliberal globalized system of market fundamentalism has visibly caused, no matter what financial crises neoliberal free markets have engendered, no matter how many losers and outcasts it has created, market fundamentalism is still promoted as indispensable, like the word of God, as the only possible economic and social order available for human salvation. Margaret Thatcher's TINA (There Is No Alternative) explains it all. Economic slavery, though unfortunate, is preferable to starvation, according to neoliberal doctrine, which falsely poses slavery or death by starvation as natural alternatives of human civilization. The World Bank has estimated that neoliberal globalization has created 200 million newly poor people around the world in the past decade. Yet claims of globalization's contribution to global prosperity continue unabated. Former US president Bill Clinton's claim at the 2000 Asia Pacific Economic Cooperation (APEC) meeting that open economies have shown the highest growth rate is part of this cultural hegemonic push. Clinton had it backwards: it is the countries that have the highest growth rates resulting from complex conditions of structural advantage that are pushing for further selective openness in the poorer economies. The most fundamental flaw in the neoliberal logic is that the selective push for full and unregulated mobility for capital across national borders is not accompanied with the same mobility for labor. It is self-evident that capital cannot exist without labor. Without labor, capital is merely an idle asset, unable to contribute to productivity. Until labor can move freely in the globalized system, there is no real openness. The current system is not true globalization. It is merely a global expansion of US financial hegemony through dollar hegemony: the domination of the global economy by the US national currency. Dollar hegemony is a structural condition in world finance and trade in which the US produces dollars and the rest of the world produce things dollars can buy. In 1971, the late US president Richard Nixon abandoned the Bretton Woods regime of a gold-backed dollar and fixed exchange rates to stop the gold drain from the US Treasury caused by chronic lapses of US fiscal discipline. At that point, the dollar, as a fiat currency, theoretically abdicated its reserve-currency status for world trade. Yet for more than three decades since, the dollar has remained the reserve currency for world trade despite continued chronic US government and trade deficits and the transformation of the United States into the world's most indebted nation. Notwithstanding its role as the leading proponent of market fundamentalism, the United States maintains a strong-dollar policy as a matter of national interest, in defiance of market forces.

A reserve currency for world trade without the necessary disciplinary backup is in reality a tax by the issuing sovereign on all other sovereigns participating in world trade via that currency. The State Theory of Money (Chartalism) holds that the acceptance of a currency is based fundamentally on a government's power to tax. It is the government's willingness to accept the currency it issues for payment of taxes that gives the issuance currency within a nation. The Chartalist theory of money, as summarized by economist Randall Wray, claims that all governments, by virtual of their power to levy taxes payable with government-designated legal tender, do not need external financing and should be able to be the employer of last resort to maintain full employment. The logic of Chartalism reasons that an excessively low tax rate will result in a low demand for the currency and that a chronic budget surplus is economically counterproductive because it drains credit from the economy. The colonial administration in British Africa learned that land taxes were instrumental in inducing the carefree natives into using its currency and engaging in financial productivity. Thus, according to Chartalist theory, an economy can finance its domestic developmental needs to achieve full employment and maximum growth with prosperity without any need for foreign loans or investment, and without the penalty of hyperinflation. But Chartalist theory is operative only in closed domestic monetary regimes. Countries participating in free trade in a globalized system, especially in unregulated global financial and currency markets, cannot operate on Chartalist principles because of the foreign-exchange dilemma. Any government printing its own currency to finance domestic needs beyond the size of its foreign-exchange reserves will soon find its currency under attack in the foreignexchange markets, regardless of whether the currency is pegged to a fixed exchanged rate or is freefloating. Thus all economies must accumulate dollars before they can attract foreign capital. Even then foreign capital will only invest in the export sector where dollar revenue can be earned. But the dollars that Asian economies accumulate from trade surpluses can only be invested in dollar assets in the United States, depriving local economies of needed capital. The only protection from such attacks on currency is to suspend convertibility, which then will keep foreign investment away. Precisely to prevent such currency attacks, tight controls on the international flow of capital were set up by the Bretton Woods system of fixed exchange rates pegged to a gold-backed dollar after World War II. Drawing lessons from the prewar 1930s Depression, economic thinking prevalent immediately after the war had deemed international capital flow undesirable and unnecessary. Trade was to be mediated through fixed exchange rates pegged to a gold-backed dollar. The fixed exchange rates were to be adjusted only gradually and periodically to reflect the relative strength of the participating economies. Under principles of Chartalism, foreign capital serves no useful domestic purpose outside of an imperialistic agenda. Thus dollar hegemony essentially taxes away the ability of the trading partners of the United States to finance their own domestic development in their own currencies, and forces them to seek foreign loans and investment denominated in dollars, which the US, and only the US, can print at will. The Mundell-Fleming thesis, for which economist Robert Mundell won the 1999 Nobel Prize, states that in international finance, a government has the choice between (1) stable exchange rates, (2) capital mobility and (3) policy autonomy (full employment/low interest rates, counter-cyclical fiscal spending, etc). With unregulated global markets, a government can have only two of those three options. Through dollar hegemony, the United States is the only country that has managed to defy the MundellFleming thesis. For more than a decade, the US has kept the dollar significantly above its real economic value, attracted capital account surpluses and exercised unilateral policy autonomy within a globalized system dictated by dollar hegemony. The reasons for this are complex but the single most important reason is that all major commodities, most notably oil, are denominated in dollars, mostly as an extension of superpower geopolitics. This fact is the anchor for dollar hegemony. Thus dollar hegemony makes possible US finance hegemony, which makes possible US exceptionism and unilateralism. The Chinese economy is at a point where it also can defy the Mundell-Fleming thesis and free itself from dollar hegemony. China has the power to make the yuan an alternative reserve currency in world trade by simply denominating all Chinese export in yuan. This sovereign action can be taken unilaterally at any time of China's choosing. All the State Council (the Chinese government's cabinet) has to do is to announce

that as of, say, October 1, 2002, all Chinese exports must be paid for in yuan, making it illegal for Chinese exporters to accept payment in any other currencies. This will set off a frantic scramble by importers of Chinese goods around the world to buy yuan at the State Administration for Foreign Exchange (SAFE), making the yuan a preferred currency with ready market demand. Companies with yuan revenue no longer need to exchange yuan into dollars, as the yuan, backed by the value of Chinese exports, becomes universally accepted in trade. Members of the Organization of Petroleum Exporting Countries (OPEC), which import sizable amount of Chinese goods, would accept yuan for payment for their oil. In 2000, the United States exported US$781.1 billion (12.3 percent of world exports - 11 percent yearto-year growth) and imported $1.2576 trillion (18.9 percent of world imports - 19 percent year-to-year growth). Germany exported $551.5 billion (8.7 percent of world exports - 1 percent year-to-year growth) and imported $502.8 billion (7.5 percent of world imports - 6 percent year-to-year growth). Japan exported $479.2 billion (7.5 percent of world exports - 14 percent year-to-year growth) and imported $379.5 billion (5.7 percent of world imports - 22 percent year-to-year growth). France exported $298.1 billion (4.7 percent of world exports - 1 percent year-to-year decline) and imported $305.4 billion (4.6 percent of world imports - 4 percent year-to-year growth). The United Kingdom exported $337 billion (5.1 percent of world export - 5 percent year-to-year growth) and imported $284.1 billion (4.5 percent of world imports - 6 percent year-to-year growth). China exported $249.3 (3.9 percent of world exports - 28 percent year-to-year growth) and imported $225.1 billion (3.4 percent of world imports - 36 percent year-to-year growth). Hong Kong exported $214.2 billion (3.2 percent of world exports- 19 percent year-to-year growth) and imported $202.4 billion (3.2 percent of world imports - 16 percent year-to-year growth). China (including Hong Kong) exported more than $463 billion (7.3 percent of world exports) in 2000 and imported about $428 billion, yielding a trade surplus of around $35 billion. If all Chinese exports are paid in yuan, China will have no need to hold foreign reserves, which currently stand at more than $200 billion. And if the Hong Kong dollar is pegged to the yuan instead of the dollar, Hong Kong's $100 billion foreign-exchange reserves can also be freed for domestic restructuring and development. China's spectacular export growth has not reversed the shrinking of world trade volume since 1997. Its growth has come at the expense of the now wounded "tigers" of Southeast Asia. China is on the way to becoming a world economic giant but it has yet to assert its rightful financial power. There is no stopping China from being a powerhouse in manufacturing. With the Asian economies trapped in protracted financial crisis from excessive foreign-currency debts and falling export revenue resulting from predatory currency devaluation, the International Monetary Fund, orchestrated by the US, has come to their "rescue" with a new agenda beyond the usual IMF austerity conditionalities to protect Group of Seven (G7) creditors. This new agenda aims to open Asian markets for US transnational corporations to acquire distressed Asian companies so that their newly acquired Asian subsidiaries can produce inside Asian national borders. The United States, through the IMF, aims to break down the traditionally closed financial systems all over Asia that mobilize high national savings to serve giant national industrial conglomerates, for massive investment in targeted export sectors. The IMF, controlled by the US, aims at dismantling traditional Asian financial systems and forcing Asians to replace them with a structurally alien global system, characterized by open markets in products and, crucially, in finance and financial services. The real target is of course China. For the US knows: as China goes, so goes the rest of Asia. Trade flows under neoliberal globalization have put Asian countries in a position of unsustainable dependency on foreign loans and capital to finance export sectors that are at the mercy of saturated foreign markets while neglecting domestic development to foster productive forces and to support budding domestic consumer markets. In Asia, outside the small circled of well-heeled compradores, most people cannot afford the products that they produce in abundance for export or the high-cost imports. An average worker in Asia would have to work days making hundreds of pairs of shoes to earn enough to buy one McDonald's hamburger meal for his family while Asian compradores entertain their Western backers in luxurious five-star hotels with prime steaks imported from Omaha. Markets outside of Asia cannot grow quickly enough to satisfy the developmental needs of the populous Asian economies. Thus intra-region trade to promote domestic development within Asia needs to be the main focus of growth if Asia is ever to rise above the level of semi-colonial subsistence.

The Chinese economy will move quickly up the trade-value chain, in advanced electronics, telecommunications, and aerospace, which are inherently "dual use" technologies with military implications. Strategic phobia will push the United States to exert all its influence to keep the global market for "dual use" technologies closed to China. Thus "free trade" for the US is not the same as freedom to trade. Still, China will inevitably be a major global player in the knowledge industries because of its abundant supply of raw human potential. Even in the US, a high percentage of its scientists are of Chinese ethnicity. With an updated educational system, China will be the top producer of brain power within another decade. As China moves up the technology ladder, coupled with rising consumer demand in tandem with a growth economy, global trade flow will be affected, modifying the "race to the bottom" predatory competitive game of a decade of globalization among Asian exporters. Asian economies will find in China an alternative trading partner to the United States, and possibly with more symbiotic trading terms, providing more room to structure trade to enhance domestic development along the path of converging regional interest and solidarity. The rise in living standards in all of Asia will change the path of history, restoring Asia as a center of advanced civilization, putting an end to two centuries of Western economic and cultural imperialism. The foreign-trade strategies of all trading nations in the decade of neoliberal globalization have contributed to the destabilizing of the global trading system. It is not possible or rational for all countries to export themselves out of domestic recessions or poverty. The contradictions between national strategic industrial policies and neoliberal open-market systems will generate friction between the United States and all its trading partners, as well as among regional trade blocs and inter-region competitors. The US engages in global trade to enhance its superpower status, not to undermine it. Thus the US does not seek equal partners. With economic sanctions as a tool of foreign policy, the US government is preventing, or trying to prevent, an increasing number of US companies, and foreign companies trading with the US, from doing business in an increasing number of countries. Trade flows not where it is needed most, but to where it best serves the US national interest. Neoliberal globalization has promoted the illusion that trade is a win-win transaction for all, based on the Ricardian model of comparative advantage. Yet economists recognize that without global full employment, comparative advantage is merely Say's Law internationalized (Say's Law states that supply creates its own demand, but only under full employment, a condition supply-siders conveniently ignore). After a decade, this illusion has been shattered by concrete data: 30 percent of the world's population live on less than $1 a day, and global wages, already low to begin with, have declined since the Asian financial crisis of 1997, and by 45 percent in Indonesia. Yet export to the United States under dollar hegemony is merely an arrangement in which the exporting nations, in order to earn dollars to buy needed commodities denominated in dollars and to service dollar loans, are forced to finance the consumption of US consumers by the need to invest their trade surpluses in US assets (as foreign-exchange reserves), giving the US a capital account surplus to finance its current account deficit. Furthermore, the trade surpluses are achieved not by an advantage in the terms of trade, but by sheer self-denial of basic domestic needs and critical imports. Not only are the exporting nations debasing the value of their labor, degrading their environment and depleting their natural resources for the privilege of running on the poverty treadmill, they are enriching the US economy and strengthening dollar hegemony in the process. Thus the exporting nations allow themselves to be robbed of needed capital for critical domestic development in such vital areas as education, health and other social infrastructure, by assuming heavy foreign debt to finance export, while they beg for even more foreign investment in the export sector by offering still more exorbitant returns and tax exemptions. Yet many small economies around the world have no option but to continue to serve dollar hegemony like a drug addiction. Japan provides the perfect proof that even a dynamic, successful export machine does not by itself produce a healthy economy. Japan is aware that it needs to restructure its domestic economy, away from its export fixation and upgrade the living standard of its overworked population and to reorder its domestic consumption patterns. But Japan is trapped into helplessness by dollar hegemony. Japan sees its sovereign credit rating lowered by international rating agencies while it remains the

world's biggest creditor nation. Moody's Investor Service downgraded Japanese government bonds by two notches recently to A2, or one grade below Botswana's, not to mention Chile and Hungary. Japan has the world's largest foreign-exchange reserves: $446 billion; the world's biggest domestic savings: $11.4 trillion (US gross domestic product was $10 trillion in 2001); and $1 trillion in overseas investment. And 95 percent of the sovereign debt is held by Japanese nationals, which rules out risk of default similar to Argentina. Japan has given Botswana, where half of the population is infected with the AIDS virus, $12 million in grants and $102 million in loans. Why does the New York-based rating agency prefer Botswana to Japan? The Botswanan government budget is controlled by the foreign diamond-mining interests to protect their investment in the mines. Botswana does not run a budget deficit to develop its domestic economy or help its poverty-stricken people. Thus Botswana is considered a good credit risk for foreign loans and investment. Japan, on the other hand, is forced to suffer the high interest cost of a low credit rating because its government attempts to solve, through deficit financing, the nation's economic woes that have resulted from excessive focus on export. Dollar hegemony denies a good credit rating even to the world's largest holder of dollar reserves. The Asia-Pacific trade system has been structured to serve markets outside of Asia by providing low manufacturing production cost through the use of cheap Asian labor. This enables the United States to consume more without inflation and without raising domestic wages. Yet all the trade surpluses accumulated by the Asian economies have ended up financing the US debt bubble, which is not even good for the US economy in the long run. Cheap imports allow the US to keep domestic wages low and contribute to a rising disparity of both income and wealth within the US where consumer purchasing power comes increasingly from capital gain rather than rising wages. The result is that when the equity bubble of inflated price-earning ratio finally bursts, wages are too low to keep the economy from crashing from a collapse of the wealth effect. After thoroughly impoverishing the Asian economies with financial manipulation of crisis proportions, the US now works to penetrate the remaining Asian markets that have stayed relatively closed: notably Japan, China and South Korea. Control of access to its markets has been Asia's principal instrument for its sub-optimized trade advantage and distorted industrial development. This strategy had been practiced successfully first by Japan and copied with various degree of success by the Asian tigers. Protectionism will survive in Asian economies long after formal accession to the World Trade Organization (WTO). China, with a giant integrated market composed of a fifth of the world population, can swap market access for technology transfer from the world's transnational technology corporations. Once free from dollar hegemony, China can finance its domestic development without foreign loans and capital. The Chinese economy then will no longer be distorted by excessive reliance on export merely to earn dollars that by definition must be invested in dollar assets, not yuan assets. The aim of development is to raise wage levels, not to push wages down to achieve predatory competitiveness. Yet export under dollar hegemony requires keeping wages low, a prerequisite that condemns an economy to perpetual underdevelopment. Terms such as "openness" need to be reconsidered away from the distorted meanings assigned to them by neoliberal cultural hegemony. The contradiction between globalizing and territorially based national social and political forces is framed in the context of past, present and future world orders. The emerging world order has always been, and will again be, the result of a struggle for the direction of structural transformation of the current order, involving economic, political and sociocultural changes. The prevailing trend of the past two decades toward the marketization and commodification of social relations has led to the argument that socialism needs to be redefined away from the total visions associated with Marxism-Leninism, and toward the idea of the self-defense of society and social choice to counter the disintegrating and atomizing effects of globalizing and unregulated market forces. But this is precisely a Marxist-Leninist vision: that under globalization, national sovereignty in the form of nation-states and governments will give way to a pervasive socioeconomic order. In other words - the withering away of the state. The sole function of government is to protect the weak, because the strong is itself government and needs no other. This truth gave birth to monarchism: the king's function was to protect the peasants

from aristocratic abuse. So in modern terms, the government's function is to maintain socialist/populists values in the context of capitalist market fundamentalism. So the withering away of the state prior to the end of economic exploitation is putting the cart before the horse. The unwitting by-product of the rightist quest to get government off the back of the people is a Marxist dialectic. The only flaw is the economic structure. The right wants the withering away of the state prior to the progressive transformation of capitalism into socialism. The perpetual boom has not replaced the business cycle, new economy or not. In the age of information and communication, the majority interest will prevail - with luck, without violence. Despite US fixations, majority interest does not necessarily spell capitalism, corporatism or representative democracy. Socialism collapsed in the 1980s not because its economic theories were inoperative, but because in defending the authority to make socialist principles work, socialist governments had to adopt a garrison-state mentality that overshadowed all other potential benefits. On the other hand, capitalist market fundamentalism appeared more desirable as long as this mutation of socialism was posed as a false alternative. Now, as the sole surviving operative system, capitalist market fundamentalism is faced squarely with its own internal contradictions. Unregulated markets have produced the debt bubble and financial manipulation and corporate fraud that impoverish unsuspecting investors and workers who placed their pensions in the shares of the companies that employed them. And the war on terrorism runs the risk of instilling in the United States the same garrison-state mentality that brought about the demise of the Soviet bloc. Finance capitalism may turn out to be the deadliest enemy of industrial capitalism, and it may well be the last transformation of capitalism. There are clear indications that insufficient demand is caused by the abandonment of the labor theory of value and the wholesale acceptance by neoliberalism of the theory of marginal utility. Lack of demand caused by insufficient wages is more deadly to finance capitalism than the fear of socialism. Technology has finally turned Charlie Chaplin's Modern Times into reality. The rhetoric of the current political debate in the United States on corporate fraud is more populist than those of the New Deal, and the recession has yet to begin in earnest. Socialism, by other names (the Wall Street Journal calls it mass capitalism), is now about to be viewed as the vaccine against a catastrophic implosion of the capitalist system in its home garden. Globalization is not a new trend. It is the natural policy for all empire building. Globalization under modern capitalism began with the British Empire, marked by the repeal of the Corn Laws in 1846, five years after the Opium War with China (I have written on the historical parallel between the Corn Laws and WTO), and two years before the Revolutions of 1848. Great Britain embarked on a systemic promotion of free trade and chose to depend on imported food, which gave a survivalist justification to empire. France adopted free trade in 1860 and within 10 years was faced with the Paris Commune, which was suppressed ruthlessly by the French bourgeoisie, who put to death 20,000 workers and peasants, including children. Despite a backlash movement toward protective tariffs in Britain, Holland and Belgium, the global economy of the 19th century was characterized by high mobility of goods across political borders. As Europe adopted political nationalism, international economic liberalism developed in parallel, until 1914. Only World War I, the 1929 Depression and World War II caused a temporary halt of free trade. Like the United States now, Britain was a predominantly importing economy by the close of the 18th century. Despite the Industrial Revolution's expanded export of manufacturing goods, import of raw material, food and consumer amenities grew faster than export of manufacturing goods and coal. The key factor that sustained this imbalance was the predominance of the British pound, as it is today with the US dollar and its impact of the trade deficit. British hegemony of marine transportation and financial services (cross-currency trade finance and insurance) earned Britain vast amounts of foreign currencies that could be sold in the London money markets to importers of Argentine meat and Canadian bacon. International credit and capital markets were centered in London. The export of financial services and capital produced the the returns which serves as hidden surplus to cushioned the trade deficit. To enhance financial hegemony, the British maintain separate dependent currencies in all parts of the empire under pound-sterling hegemony. This financial hegemony is now centered on New York with the dollar as the base currency. When the Asian tigers export to the United States, all they get in return are US Treasury bills, not direct investment in Asia. Asian labor in fact is working at low wages mainly to finance the expansion of the US economy.

Market fundamentalism, a modern euphemism of capitalism, is thus made necessary by the finance architecture imposed on the world by the hegemonic finance power, first 19th-century Great Britain, now the United States. When the developing economies call for a new international finance architecture, this is what they are really driving at. Foreign-exchange markets ensure the endless demand for dollar capital import by the poor exporting nations. John A Hobson and Lenin identified the surplus of capital in the core economies and the need for its export to the impoverished parts of the world as the material basis of imperialism. For neo-imperialism of the 21st century, this remains fundamentally true. Then and now, the international economy rests on an international money system. Britain adopted the gold standard in 1816, with Western Europe and the US following in the 1870s. Until 1914, the exchange rates of most currencies were highly stable, except in victimized, semi-colonial economies such as Turkey and China. The gold standard, while greatly facilitating free trade, was hard on economies that produced no gold, and the gold-based monetary regime was generally deflationary (until the discovery of new gold deposits in South Africa, California and Alaska), which favored capital. William Jenning Bryan spoke for the world in 1896 when he declared that mankind should not be "crucified upon this cross of gold". But the 50-year lead time of the British gold standard firmly established London as the world's financial center. The world's capital was drawn to London to be redistributed to investment of the highest return around the world. Borrowers around the world were reduced to playing a game of "race to the bottom". The bulk of economic theories within the context of capitalism were invented to rationalize this global system as natural truth. The fundamental shift from the labor value theory to the marginal utility theory was a circular self-validation of the artificial characteristics of an artificial construct based on the sanctity of capital, despite Karl Marx's dissection that capital cannot exit without labor - until assets are put to use to increase labor productivity, it remains idle assets. Mergers and acquisitions became rampant. Small business capitalism disappeared between 1880 and 1890. Workers and small businesses found that they were not competing against their neighbors, but those on other sides of the world, operating from structurally different socioeconomic systems. The corporation, first used to facilitate the private ownership of railroads, became the organization of choice for large industries and commerce, issuing stocks and bonds to finance its undertakings that fell beyond the normal financial resources of individual entrepreneurs. This process increased the power of banks and financial institutions and brought forth finance capitalism. Cartels and trusts emerged, using vertical and horizontal integration to eliminate competition and manipulate markets and prices for entire sectors of the economy. Middle-class membership was mainly concentrated in salaried workers of corporations, while the working class were hourly wage earners in factories. The 1848 Revolutions were the the first proletariat revolutions in modern time. The creation of an integrated world market, the financing and development of economies outside of Europe and the consequence of rising standards of living for Europeans were the triumphs of the 19th-century system of unregulated capitalism. In the 20th century, the process continued, with the center shifting to the United States. Friedrich List, in his National System of Political Economy (1841), asserted that political economy as espoused in England at that time, far from being a valid science universally, was merely British national opinion, suited only to English historical conditions. List's institutional school of economics asserted that the doctrine of free trade was devised to keep England rich and powerful at the expense of its trading partners and that it had to be fought with protective tariffs and other protective devices of economic nationalism by the weaker countries. List influenced revolutionaries in Asia, including Sun Yatsen, who until coming under the influence of Marx and Lenin after the October Revolution was primarily relying on List in formulating his policy of economic nationalism for China. List was also the influence behind the Meiji Reform Movement in Japan. The current impending collapse of neoliberal globalized market fundamentalism offers Asia a timely opportunity to forge a fairer deal in its economic relation with the West. The United States, as a bicoastal nation, must begin to treat Asian-Pacific nations as equal members of an Asian-Pacific commonwealth in a new world economic order that makes economic nationalism unnecessary. China, as the largest economy in the Asia-Pacific region, has a key role to play in shaping this new

world order. To do that, China must look beyond its current myopic effort to join a collapsing global market economy and provide a model of national domestic development in which foreign trade is reassigned to its proper place in the economy from its current all-consuming priority. The first step in that direction is for China to free itself from dollar hegemony.

Part IV: Brzezinskis G2 Grand Strategy This article appeared in AToL on April 22, 2009

The proposal by Larry Summers, former Clinton Treasury Secretary and now Obamas top economic advisor and Director of the White House National Economic Council, of a multilateral approach with a new group larger than the G-7 rich countries with advanced economies to deal with multilateral global economic problems moves in the opposition direction of the geopolitical call by Zbigniew Brzezinski for Washington and Beijing to set up a new informal Group of Two (G2 US and China) in a leadership bid to jointly address a wide range of global challenges of bilateral interests.

Brzezinski made his proposal for a US-China G2 in a speech delivered during a conference in Beijing on January 13, 2009, a week before Obama was scheduled to be inaugurated as president, to commemorate the 30th anniversary of the establishment of diplomatic relations between the US and China. The conference was sponsored by the Chinese Peoples Institute of Foreign Affairs and the Kissinger Institute on China and the United States, and co-sponsored by the National Committee on US-China Relations, with support from both the US Embassy in Beijing and the Chinese Ministry of Foreign Affairs. Led by former president Jimmy Carter during whose administration diplomatic relations was established, the large US delegation included key figures such as former Republican Secretary of State Henry Kissinger, and former Republican and Democratic National Security Advisers Brent Snowcroft and Brzezinski, who were formally received by Chinese leaders President Hu Jintao, Vice President Xi Jinping and Premier Wen Jiabao. Unbalanced Relationship Perhaps reflective of the unbalanced state of relationship between the two countries, the Beijing memorial conference was a mostly unilateral affair on the Chinese side, with no official counterpart observation in the US. The New York Times buried the story in a report on the conference deep in page A8 of its New York edition. Reflective of the depressed state of international trade, the event was cosponsored by Mary Kay, the US direct sale cosmetics maker active in the emerging Chinese market, with attendees each receiving a pink cosmetics bag filled with promotional samples. General Motor, for whom the China car market was the distressed global automakers only profitable operation, who normally would have been an eager sponsor, was notably absent, busy fending off bankruptcy with government aid. Also absent were transnational financial giants, such as GE, Citibank, AIG, Goldman Sachs, Morgan Stanley, all mere shadows of their former grandeur, whose luxurious corporate jets would have normally carried their top executives to Beijing in style for events of much less historical and political significance. In his speech, Chinese State Counselor Tang Jiaxuan, former foreign minister, recalled the NATO bombing of the Chinese Embassy in Belgrade in 1999 not as evidence of ominous undercurrent, but as proof of how relations between the two countries have survived provocative tension. He also noted some of the still unresolved longstanding obstacles to better relations between the two nations, saying the two sides need to properly handle issues that concern Chinas core interests such as those related to Taiwan and Tibet so as to safeguard the larger interests of China-U.S. relations, in contrast to US intransigence on the need for China to adjust its policy on both Taiwan and Tibet to met US requirements of moral imperialism. Brzezinski outlined a well-worn laundry list of international problems for which he thinks China could help the US find solutions, such as the global financial crisis, the challenges of climate change, North Korea and Iran nuclear ambitions, India and Pakistan tension and the Israeli-Palestinian conflict. The Group of Two that could change the world Rescuing the Beijing memorial conference from the fate of a nonevent in the US, Brzezinski attracted worldwide attention by elaborating his G2 idea with an article in the Financial Times entitled: The Group of Two that could change the world. In the article, Brzezinski asserts that normalization of relations between the US and China precipitated almost from the start security co-operation that has been of genuine benefit both to the US and China. The effect was to change the Cold Wars global chessboard to the disadvantage of the Soviet Union. Indirectly, the normalization facilitated Chairman Deng Xiaopings decision to undertake a comprehensive economic reform. Chinas growth would have been much harder without the expansion in US-Chinese trade and financial relations that followed normalization. Commenting on the current geostrategic status of the US-China relationship, Brzezinski cites an article in Liaowang magazine (July 14, 2008) published by the official Xinhua News Agency, which describes the relationship as one of complex interdependence, in which both sides evaluate each other in pragmatic and moderate terms and in which the two sides can compete and consult within existing international rules. Yet the reality of US-China relations is one of unending US provocation and hostility on a compliant China.

China faces surging protests and riots in 2009 In its January 6, 2009 edition, a week before the conference, Liaowang ran a story that China faces surging protests and riots in 2009 as rising unemployment stokes popular discontent, in a blunt warning of possible tarnish of the image of effectiveness of Communist Party governance from a sharp economic downturn. The uncharacteristically stark report warned that stalled growth could spark latent anger among millions of migrant workers and university graduates left jobless. Huang Huo, a senior Xinhua reporter and bureau chief in the southwest city of Chongqing, was quoted in the Liaowang report: In 2009, Chinese society may face even more conflicts and clashes that will test even more the governing capacity of all levels of the Party and government. Including students who graduated in 2008 and had not found work, there would be more than 7 million university/college graduates hunting for jobs in 2009, Huang calculated, adding that the governments goal of annual GDP growth for 2009 of 8% would generate only 8 million new jobs for the whole country. If in 2009 there are large numbers of unemployed rural migrant laborers who cannot find work for half a year or longer, milling around in cities with no income, the problem will be even more serious, said Huang. By the end of 2008, there were reportedly 20 million unemployed migrant workers in the export sector located in the coastal regions. President Hu Jintao has set a goal of building in China a harmonious society, but the goal is being tested by rising tension over shrinking jobs opportunities and income disparity, as well as simmering public anger over headlines of official corruption and illegal farm land seizures by private developers, all part of the structural social ills that came with three decades of market economy. Chinese Foreign Ministry spokesman Qin Gang asserted that the government was confident it would be able to handle the difficult times. We have the ability and the confidence to ensure the Chinese economys stable and relatively fast growth and to ensure social stability, he said repeatedly in recent news briefings. The Goal of 8% GDP Growth Yet the problem is less on of sustaining a floor of 8% GDP growth, but where and how the benefits of growth are being distributed. Xu Shanda, former vice director of the State Administration of Taxation, and a member of the National Committee of the Chinese Peoples Political Consultative Conference (CPPCC) told a March 8, 2009 plenary meeting of the countrys top political advisory body that Chinas consumer spending has been declining over the past ten years, both when the economy was either overheating or contracting and that more than economic cycles are behind the falling consumer spending. Xu said the market economy would lead to a structural income gap that suppresses spending, as highincome people tend to invest rather than consume, while low-income people do not have spare purchasing power to spend. The decline in new jobs and consumer spending, which was coupled with increases in the societys wealth in China over the past 10 years, is another testimony to the trend, Xu explained, urging the government to address such structural imbalances inherent in a market-oriented economy. Xu called on China to narrow the countrys income gap to stimulate consumer spending. He advised the government to compile income statistics of different groups and routinely announce these figures, making such figures as important as targeted GDP growth and energy efficiency in evaluation of local governments. He also suggested changing the strategy of keeping prices of farm produce stable into working to moderately increase prices of farm produce in the long run to enhance farmers income and to narrow income disparity generally. Without saying so explicitly, Xu is advocating a much needed income policy for China. Xu proposed that China should raised the ratio of social security taxes to GDP up to over 10%, to be exclusively dedicated to the social security fund. In the US, the annual cost of Social Security benefits represented 4.3% of GDP in 2007 and is projected to increase to 6.1 percent of GDP in 2035, and then decline to 5.8% of GDP by 2048 and remain at that level. US Medicares annual costs were 3.2% of GDP in 2007, or nearly three quarters of Social Securitys. They are projected to surpass Social Security expenditures in 2028 to reach 10.8% of GDP. Together, Social Security and Medicare would take up to 18% of GDP within a decade. And the US is not a socialist economy.

China needs Full Employment with an Income Policy Financed by Sovereign Credit In public lectures in Beijing in September 2008 and March 2009, I proposed for China to adopt a full employment objective and an income policy financed by sovereign credit to develop a vibrant domestic market to absorb the sharp shrinkage of its export sector resulting form the global financial crisis. The way for China to use sovereign credit to finance domestic economic development is to free China from dollar hegemony by demanding settlement of its export trade to be denominated in RMB. Brzezinski Mistakes China as a Revisionist Power Brzezinski observes that a globally ascending China is a revisionist power in that it desires important changes in the international system but it seeks them in a patient, prudent and peaceful fashion. Americans who deal with foreign affairs especially appreciate the fact that Chinese strategic thinking has moved away from notions of a global class conflict and violent revolution, emphasizing instead Chinas peaceful rising in global influence while seeking a harmonious world. Such common perspectives also make it easier for both sides to cope with residual or potential disagreements and to co-operate on such challenges as those posed by North Koreas nuclear program. If we at all times keep in mind the centrality of our interdependence, we will be able to cope with other contentious issues. It would be hard put to find any responsible Chinese government official who would describe China today as a revisionist power. Rather, China has been trying to find a path to engage a largely capitalistic world without compromising its socialist principles. It is reasonable to assume that with the bankrupt of the global market economy, China, as with many other countries, even including the US, is beginning to recognize the limits of the market economy to revert back to a balanced application of institutional economics principles. Brzezinskis G2 Logic Brzezinski asserts that the shared grand goal is to expand bilateral relationship to widen and deepen our geostrategic cooperation, beyond the immediate need for close collaboration in coping with the economic crisis. He sees China as needing to be a direct participant in the US dialogue with Iran; close US-China consultations regarding India and Pakistan, to become actively involved in helping to resolve the Isreael-Palestinian conflict to reduce risk of a radicalized and unstable Middle East. He sees the need for US-China cooperation in dealing with climate change; exploring the possibility of creating a larger standby UN peacekeeping force for deployment in failed states; on an international initiative towards a global adoption of the zero-nuclear weapons option; on the need to collaborate closely in expanding the current Group of Eight leading industrial nations to a G14 or G16, in order to widen the global circle of decision-makers and to develop a more inclusive response to the economic crisis. Brzezinski sees the need for an informal G2 composed of the US and China, a comprehensive partnership, paralleling US and Chinese relations with Europe and Japan. Chinese and US top leaders should therefore meet informally on a regular schedule for personal in-depth discussions not just about our bilateral relations but about the world in general. Rejecting Bush neoconservative foreign policy, Brzezinski, sees the Chinese emphasis on harmony as serving as a useful point of departure for future US-Chinese summits. In an era in which the risks of a massively destructive clash of civilizations are rising, the deliberate promotion of a genuine conciliation of civilizations is urgently needed. It is a task that President-elect Barack Obama who is a conciliator at heart should find congenial, and which President Hu Jintao who devised the concept of a harmonious world should welcome. It is a mission worthy of the two countries with the most extraordinary potential for shaping our collective future. Brzezinski is acknowledged as a key adviser to President Obama on foreign policies during and since the presidential election, while acting as foreign policy advisor to Hillary Clinton during the primaries. Many analysts consider Brzesinski as the spokesman for previously anti-Soviet, now anti-Russia hawk faction in the US foreign policy establishment. Brzezinskis speech in Beijing was addressed to Washington through talking to Beijing. The message is for the US not to waste financial, political and military resources confronting a China destined to process enormous and rising economic, political and military strength and potentials that will surge further over time unstoppably. US national interests globally would be better served by a strategy of making friends with China by sharing power globally

because eventually the US will need the support of the worlds most populous country to preserve and shore up its own global dominance. By contrast, conflicts with China will drain US capacity to maintain its global dominance. Brzezinskis statement aims at preserving US dominance in an existing world order that is facing fast and fundamental changes by drawing China into regions previously laid beyond a weak modern Chinas sphere of influence. If adopted by the Obama administration, a likely possibility as US foreign policy of the past three decades reflects an increasing acceptance of a scenario of a future world described in Brzezinskis 1997 book, written six years after the dissolution of the Soviet Union in 1991, The Grand Chessboard: American Primacy And Its Geostrategic Imperatives: A geostrategic issue of crucial importance is posed by Chinas emergence as a major power. (page 54) Chinas growing economic presence in the region [Central Asia] and its political stake in the areas independence are also congruent with Americas interests. (p.149) Potentially, the most dangerous scenario [for the US] would be a grand coalition of China, Russia, and perhaps Iran, an anti-hegemonic coalition united not by ideology but by complementary grievances. Brzezinski, the grand master of geopolitical chess, plots his strategy several moves ahead of the game. Geopolitical pluralism must first be promoted to defuse challenges to US superpower, followed by encouraging compatible key partners to cooperate under US leadership, and finally the pragmatic sharing of global geopolitical responsibility can be rewarded with a sharing of power. The twin poles of this strategy are a united Europe in the West and strong China in the East; with the problematic central regions stabilized within a new balance of power. With the idea of forming a G-2, Brzezinski concedes that the days are numbered for a unipolar world order dominated by a single superpower that had emerged since the dissolution of the Soviet Union in 1991. The US, in view of the self-inflicted damage to its freewheeling market economy that can be expected to leave the US in a protracted depression, will need a trade partner with high growth potential to absorb its overcapacity. China emerges in the 21st century as the ideal candidate for the new ally with a special relationship with the US. From the US security perspective, an alliance with China will spare the US from again involve directly in a war in Asia, a role the US alliance with Japan had repeatedly failed to accomplish. From the US economic perspective, US-China economic interdependence has the potential of a win-win symbiosis. Brzezinski anticipates that a G-2 would be more effective in dealing with multilateral global issues than the G-5 (France, Germany, Italy, UK, US) or G6 (G5+Japan) or G7 (G6+Canada) or G8 (G7+ Russia) or even the G-20 (G7+Developing countries including China). Brzezinskis G2 Vision not Shared by All in US Brzezinskis vision of harmony with China is not shared by all in the US. Within days after Hillary Clintons maiden foreign visit to Beijing as Secretary of State, in which she declared US-China cooperation as imperative for enhancing the national interests of both countries and for pulling the world from the current financial crisis, the US Navy staged a provocative intrusion into Chinese territorial waters by a US low-frequency sonar surveillance ship near Chinas submarine base on Hainan Island in the South China Sea, mapping deep-sea routes for submarines leaving and entering their base. Press reports on computer hackers allegedly associated with the governments of Russia and China having embedded software in the US electricity grid and other infrastructure that could potentially disrupt service or damage equipment are suddenly appearing even though such concerns have been simmering for years within government security establishment. President Obama reportedly has started a 60-day review of all the nations efforts at cyber security that is expected to be completed by April 17. Chinese Foreign Ministry spokeswoman Jiang Yu at a regular press conference on April 8 denied China had any involvement with mapping or hacking into the US electrical grid to leave behind software programs that could be used to disrupt the system, noting that the White House had denied the media reports. Meanwhile, the omnipotent US Navy appears to be helpless in dealing with a handful of enterprising

pirates highjacking US merchant ships for money of the coast of Salia in the Gulf of Aden, inducing the New York Times to headline: Navys Standoff with Pirates Shows Limits of Military Might. (Please see my April 5, 2003 AToL article: The War that may end the Age of Superpower) G2 Concept Requires Fundamental Adjustment in US Foreign Policy For the idea of G2 to work, the US has to adjust fundamentally its foreign policy since the end of WWII away from neo-imperialism toward Wilsonian/FDR liberalism and give up its aim of peaceful evolution of Chinese society toward market capitalism. G2 would have to be a leading force in building a new world order of social justice and economic equity. China Not Likely to Play Brzezinskis New Great Game The big question is whether China will play Brzesinskis geopolitical chess game. There is a sizable pro-US faction in Chinas foreign policy establishment who would welcome Brzesinski proposal. Formal US recognition of great power status for China will strengthen the influence of this pro-US faction in internal Chinese politics and policy deliberation. Yet, not withstanding Brzezinskis assertion, China is not a revisionist power, but a non-expansionist revolutionary state aiming at restoring its natural historical status before the arrival of Western imperialism in Asia. China is not interested in bringing back a pre-WWII world order of imperialist exploitative expansion. China is not Japan who as a defeated nation has been willing to play the role of a submissive ally with a benevolent victor. Chinese Foreign Policy Legacy Foreign policy of the Peoples Republic since its founding in 1949 has a long legacy of nonalignment. Mao Zedong had made repeated overtures to Washington for peaceful and friendly relations with the new socialist China but such overtures were categorically rejected by a US caught up in anticommunist phobia during the Cold War. Nixons opening to the China in 1972 was partly driven by US perception of Chinas concern for imminent threat from Soviet imperialism. Specifically, Nixons opening to China was aimed more at forcing the USSR into the US strategy of Dtente. In fact, China would have accepted Nixons overture even without a Soviet threat, as evidenced by the fact the Chinese attitude towards the US remain positive even after the collapse of the Soviet Union. China was not nave enough to think the US would risk a nuclear exchange with the USSR merely to save China from a nuclear attack by the USSR. Maos vision of US-China relations transcends fleeting geopolitical tactics of balance of power, towards a long-range peaceful coexistence of two of the worlds largest nations. China as Protector of Developing Countries Chinas view of itself is one of a natural member of what during the Cold War was called the Third World, now generally known as developing countries, in the struggle against Western imperialism, now known as neoliberalism, but not as its leader either by design or by default, as each country must seek its own way of struggle according to its historical conditions. Nor does China maintain a foreign policy of exporting revolution to other countries that do not want a revolutionary path. China has formally declared its determination never to seek hegemony and has openly declared a policy of no-first-use of nuclear weapons. Brzezinskis G2 strategy runs counter to Deng Xiaopings strategy of hide capacity, bide time ( tao guang yan hui), a strategy of keeping a low profile to avoid attracting unnecessary hostility in a period when the worlds sole remaining super power was intoxicated with imposing its will on other countries by its overwhelming military power. A G2 regime will inflict on China the side effects of rising anti-US sentiments from around the world at a time when US power is declining from self-inflicted wounds. If G2 is patterned after G5, then there is no geopolitical purpose for China to become a member, because G5 is a tool of US hegemony and neoliberal imperialism. Unless G2 is based on true equality between the partners, which is unlikely as the power disparity between the US and China is still too wide and at any rate not possible without a new just world order, then the cost for China from being a member of G2 is too high and the benefits negative. By being a member of the proposed G2, China would be necessarily saddled with the burdens of being a special ally of a superpower without the benefits or even the need of being a superpower itself.

China and Asia In the long run, Chinese foreign policy should stay on track with nonalignment and be on the side of developing countries and oppressed peoples. A G2 will create unavoidable geopolitical problems for China in Asia, and also relating to the US global war on terrorism. It will exacerbate Chinas problem with Islamic separatists, who if devoid of US instigation and support, would be a problem of infinitely less complexity than the US global war on terrorism. Chinas first priority should be to secure her position as the leading protector of Asian interests against neo-imperialism from the G5. Antiimperialism does not need to be associated with anti-Western zenophobia if the West would abandon residual imperialist policies. A strong China needs also a strong, independent Asia free from undue manipulation by external forces. China must not make the same mistakes as Japan did in allying itself first with imperialist Britain and then fascist Germany against other Asian countries that led eventually to World War II. China and Japan China needs to do everything it can to improve Chinese-Japanese relations, even to the extent of appeasing Japanese national interests. China should reverse the past policy of tilting toward the US with undignified concessions while adopting antagonistic posture toward Japan. China should tilt towards Japan as a friendly neighbor and not fantasize about unrealistic US friendship with a socialist China. It France and Germany can be members of the EU to their mutual benefit, there is no reason why China and Japan cannot be symbiotic partners in a united Asia. Asymmetrical Observance The celebration of the 30th Anniversary of US-China diplomatic relations was held only in Beijing. In the US, no one cared. Obamas inauguration speech is indicative of deep-rooted US national psyche in which he sees the US as a holy defender of the world against Fascism and Communism, as if the two were one equal evil. China needs to be prepared for the penchant on the part of US Democrats for tough China-bashing policies in trade and human rights. Early indications suggest that the Obama team will likely not be able to revive the US economy within the four years of its first term and China may become the convenient scapegoat for US policy failure. Chinese policymakers will be disappointed if they are not realistic about deep-rooted US hostility toward China. China must avoid open conflict with the US, but Chinese policymakers must understand that the US will never be Chinas friend as long as the Chinese Communist Party is in control of China. New US Realpolitik on China Obama administration Secretary of State Hillary Clintons current overture of peace and cooperation to China is merely an emergency measure in response to a collapsed economy and exhaustion from undeclared foreign wars. China should welcome this pragmatic gesture of realpolitik friendship from the US but not be lured into geopolitical complacency about a fundamental change in US foreign policy. Just as China had been lured into market capitalism at a time when market capitalism was rushing towards its final phase of self destruction, China now needs to carefully consider any disingenuous invitation to join and save the precarious US-constructed and dominated world system at a time when conditions around the world are making the prospect of a new, just world order on the horizon a welcome possibility. It is true that the current financial/economic crisis is a global problem and can only be solved with global cooperation. It is also true that the crisis was created by the US. It is however, far from clear that the solution can come from discredited US leadership to restore a broken world order to its pre-crisis ways. Obamas Change The Obama policies on economic recovery and foreign relations have so far been more business-asusual than real change, despite the Presidents populist and optimistic rhetoric of hope and change. Even Lawrence Summers, director of the White Houses National Economic Council, admits the economy will be in for a rough time for a while and that unemployment will continue to rise even with the massive stimulus package. Treasury Secretary Tim Geithner has failed so far to exert any bold

leadership. There are reports that the Treasury Department is having difficulty staffing up key positions because of the Obama administrations strict vetting procedures. Geithners Failing Rescue Geithners three-part program for tackling the credit crisis: 1) Inject fresh government capital into some of the countrys biggest financial institutions; 2) Start a program of up to $1 trillion to promote new lending to consumers and businesses; and 3) Establish a toxic-debt fund, appeared stalled for details as the Treasury Department suffers from vacant offices at the Undersecretary and Assistant Secretary levels. Details of the toxic debt fund are still not been fully released to the public, leaving unresolved a key challenge in the competing incentives in the proposed partnership between the public and private sectors. Distressed-asset investors typically want the cheapest possible price to protect their returns on investment. However, sales at such low prices would result in further large write-downs for banks and potential failure of some, something the administration wants to avoid. Many economists are pointing out that the Obama bailout plan for distressed banks is too small for the scale of the problem, that taxpayer money is being misdirected to save banks without adequate control on the banks as to how to use the money to help the injured public, and that it is a hybrid solution that combines the worst aspects of nationalization and the worst aspect of private enterprise without the benefits of either. Government efforts to buy toxic assets and spur bank lending may not work, according to a study by three economists. The study, titled The Pricing of Investment Grade Credit Risk during the Financial Crisis by Joshua Coval and Erik Stafford of Harvard University and Jakub Jurik of Princeton University suggests that recent credit market prices are actually highly consistent with fundamentals, and that bonds and credit derivatives should have experienced a significant repricing in 2008 as the economic outlook darkened and volatility increased. The analysis also confirmed that the severe mispricing existed in the structured credit tranches prior to the crisis and that a large part of the dramatic rise in spreads has been the elimination of this mispricing. The authors conclude that any use of taxpayer money to buy toxic assets will simply transfer wealth to the current owners of these securities. This conclusion has been independently reached by a large number of market participants in the past two years. As part of Treasurys wide-ranging effort to restore stability to a banking sector hit by huge mortgagerelated losses, coupled with a public-private program to buy toxic assets from banks to clear the way for banks to attract private capital, 19 of the countrys largest banks will be subjected to stress tests by regulators to determine whether they can weather aftershocks and future shocks. The Treasury is planning to delay the release of any completed bank stress test results until the first-quarter earnings reporting after April 24, 2009 to avoid complicating stock market reaction. Discussions are reportedly on-going about how the results of the regulatory stress tests on the 19 largest US banks will be released, possibly as summary results that are not institution-specific. Frankly, we dont have as accurate an assessment of the situation of a number of institutions as wed like to because we havent really done the stress test against a range of scenarios, admits Summers, who as Treasury secretary in the Clinton administration cannot escape responsibility for the current crisis. He did not rule out the possibility that some banks might be shut down as a result of the stress tests. When supervisors deem it appropriate, then institutions are intervened, he added. In other word, the administrations top economist still does not have a handle on the scale of the banking crisis almost two years after the crisis began in July 2007. US banks have written down $758 billion in credit losses since the crisis began and have warned of more losses to come, though no one in or out of government can say how much more. Rescue by Changing Accounting Rules The American Bankers Association asked the Securities and Exchange Commission on October 13, 2008 to override new guidelines on mark-to-market accounting, saying they inaccurately reflect distressed asset values over the longer term. The once-obscure accounting rule that had upset bankers who blamed it for exacerbating the financial crisis, was changed April 2, 2009 to give banks more

discretion in reporting the potential value of mortgage securities. The move compromised the independence of the Accounting Standards Board (FASB) which was widely viewed as having yielded to intense political pressure. Robert H. Herz, chairman of FASB, said he voted for the change because the new disclosures would help investors. The change will allow banks to report higher profits by assuming that the securities are worth more than anyone is now willing to pay for them in the open market. Banks are allowed by the rule changes to keep some declines in asset values off their income statements. Critics warned that the change could further damage the credibility of financial institutions by enabling them to avoid recognizing losses from bad loans they have made. During the financial crisis, the market prices of many securities, particularly those backed by subprime home mortgages, have plunged to fractions of their marked-to-model prices, forcing banks to report huge losses because such securities must be reported at market value each three months, with the banks showing a profit or loss based on the change. Bankers bitterly complained that current market prices were the result of distressed sales and that they should be allowed to ignore those prices and value the securities instead at their potential value in a normal market. The measure in the new guidelines that drew the most dissent will allow banks to keep part of such declines off their income statements, although the decline would still show on the institutions balance sheets. Since old accounting rules already allowed the fiction that all banks are well capitalized, the changes would make banks appear better capitalized than they actually are. Bank share soared in price the day the changes were announced. FASB had resisted making the changes at first, but yielded within a few days of a Congressional hearing at which legislators from both parties demanded the FASB to act. Ironically, the erosion of integrity of rating agencies has been generally recognized as one of the causes of the financial crisis. The application of an accounting rule had become a political issue. The International Accounting Standards Board held an emergency meeting to change its rule after such a move was demanded by the President of France. In the United States, FASB acknowledged investor criticism of its rule changes after the Congressional hearing. While it was the banks who pressed for the new rules, the change will affect all non-blank financial institutions as well. But the FASB said it would make small changes to assure to avoid affecting accounting in mutual funds which must mark their assets to market value every day. Bank regulators already have the power to adjust accounting in computing capital, and some investor groups argued they should do that, rather than give the banks more freedom to value assets at what they think they should be worth, rather than what someone will pay for them. The FASB vote drew condemnation from the Investors Working Group headed by two former SEC chairmen, Bush appointee William H. Donaldson and Clinton appointee Arthur Levitt Jr. Back in unusually heavily attended 2002 annual Bond Market Association meeting in New York featuring then Treasury Secretary Paul O'Neill, Securities and Exchange Committee chairman Harvey Pitt, and former Fed chairman Paul Volcker, a swarm of reporters, looking for the next Enron fiasco, turned up to ask questions about special-purpose entities (SPEs) and other means of moving risk off corporate balance sheets. One association member asked Pitt how the market could distinguish between how SPEs now were different from those used by Enron which had been deemed legally fraudulent. Pitt had no ready answer. The off-balance-sheet genie had been let out of the bottle, and there was no easy way to put it back in. New Accounting Rules on Off-Balance-Sheet Obligations The Financial Accounting Standards Board (FASB) adopted new rules for consolidating SPEs and disclosing off-balance-sheet activities. SPEs can no longer be all-purpose entities, especially not the kind of debt-hiding entities that Enron used and abused to puff up its profits. Interpretation No. 46, Consolidation of Variable Interest Entities, expands on existing rules to more precisely specify under what conditions a parent company must consolidate an off-balance-sheet SPE. Now, the question of consolidation is a matter of who takes the risks and who reaps the rewards of the enterprise. Hundreds of US companies keep trillions of dollars in debt in off-balance-sheet subsidiaries and

partnerships, skirting the consolidation rules of FASB 94, FASB 125 and FASB 140. If a company creates a legal structure, called a special-purpose entity (SPE) with a 3% minimal equity infusion, they do not have to consolidate the transaction under SEC and FASB rules. Banks arrange many of the devices and are big users themselves. JP Morgan revealed in the Enron bankruptcy that it had nearly $1 billion in potential liabilities stemming from a single 49%-owned Channel Islands entity called Mahonia that traded with Enron. Dell Computer had a joint venture with Tyco called Dell Financial Services (DFS) that originated $2.5 billion in customer financing, mentioned only as a footnote to Dells accounts. Dell owned 70% of DFS, but did not control it and therefore could keep DFS debts off its own balance sheet. To move assets off its books, a company typically sells them to an SPE, funding the purchase by borrowing cash from institutional investors. As a sweetener to protect investors, many SPEs incorporate triggers that require the parent to repay loans or give them new securities if its stock falls below a certain price or credit-rating agencies downgrade its debt or other triggering events. However, the International Accounting Standards Board (IASB) resisted this type of treatment. Under pending European Union legislation, all listed companies in the EU had to report under IASB by 2005, except those that report under US GAAP, which would have to move to IASB by 2007 Moving debt off the balance sheet is more difficult in Europe than in the US under IASB rules which use the standard of whether a company participates in the risks and rewards attached to that debt in deciding whether debt can be off-balance-sheet. By contrast, US GAAP uses the standard of what legal form such an entity takes. In the post-Enron world, the rules on off-balance-sheet debt have tightened up, but new loopholes have been exploited. Under existing accounting rules, the assets of SPEs must be consolidated when outside investors stakes are protected in that fashion. Yet Some 42% of offbalance-sheet debt provide guarantee for outside investors in indirect ways to get around the rules. (Please see my December 1, 2007 AToL article: PATHOLOGY OF DEBT - PART 5: Off-balance-sheet Debt) Much of the losses came from mortgage-related investments as the housing market began to collapse. Yet the bottom appears to be a long way off. Home foreclosures in the US surged 81% in 2008 to 2.3 million, the highest on record. More than 274,000 homes received at least one foreclosure-related notice in January 2009, down 10% from December 2008, but still 18% higher than a year ago. Insolvency is spreading throughout the US and global financial systems like a wild fire beyond the housing sector to the entire economy. The market has so far been showing disappointment after disappointment on Obamas disjointed approach to stopping the economic hemorrhage, let alone a comprehensive strategy for recovery. Imprecise information and policy indecision continue to plague the credit market bailout, the bank bailout, the housing bailout, the auto bailout, the coming commercial real estate bailout, while a general consensus is building that the bottom is not yet in sight by a long shot. US policy initiatives presented at the G20 London summit on April 2, 2009 met with resistance from European allies. Stalled US Economy Weakens US Diplomatic Initiatives On her first overseas trip to Asia that included China as a final stop, Secretary of State Hilary Clinton acted like a salesperson peddling US sovereign debt to reluctant Chinese buyers and promoting joint efforts to develop clean energy as the way out of the financial crisis, an issue on which China holds fundamentally different views from the US. The US promotion of clean energy as a way to revive the global economy rests on keeping oil prices high in order to justify investment in alternative energy while China at this stage of her development needs not just clean but also low cost energy, oil or otherwise. The US intents to use alternative renewable energy to replace its fully developed, massive fossil fuel network, while China can take advantage of alternative renewal energy to fulfill her growing energy needs without having to amortize massive sunk investment in fossil fuel network. The global economic crisis is sapping US influence around the world and weakening the foundation of US foreign policy.

The Eurozone Sovereign Debt Crisis By Henry C.K. Liu Part I: A Currency Union Not Backed by Political Union The Eurozone sovereign debt crisis is rooted in the dysfunction of a monetary union without political union. The fundamental cause for the crisis lies in the arrangement under which the euro is legal tender for all member states in the eurozone, yet monetary policy for the eurozone is the exclusive responsibility of the European Central Bank, for which common representation of all member states, governance and fiscal policy union in support of currency union does not formally exist. This essentially makes sovereign debt of eurozone member states denominated in euro foreign currency debts. Since individual eurozone member states do not have sovereign authority over their common currency, they are deprived of the option of solving their sovereign debt problem with monetary measures, such as devaluing their common currency or lowering interest rates. The eurozone, also known as euro area (EA17), is an economic and monetary union (EMU) of 17 out of the 27 member states of European Union (EU27) that have adopted the euro () as their common currency and sole legal tender that is freely convertible at market exchange rates. The euro is also legal

tender in a five other non-EMU European political entities (Montenegro, Andorra, Monaco, San Marino and Vatican City) and the disputed territory of Kosovo. The euro is the common currency used daily by some 332 million Europeans and their separate governments. Additionally, over 175 million people worldwide use currencies which are pegged to the euro, including more than 150 million people in Africa. A Political Crisis with Financial Dimensions The European sovereign debt crisis is at its base a intergovernmental political crisis in the eurozone-17 with financial and economic dimensions that reaches beyond the eurozone to all its trading partner regions as well as financial and trading markets in the entire world. The crisis is centered around the difficulty in achieving policy consensus among all eurozone member states and the inability of any eurozone member state under financial distress from sovereign debt difficulties to employ monetary measures individually, such a currency devaluation or interest rate measures, to solve its euro denominated sovereign debt problems, since no member state has individual authority to set or revise monetary policy or exchange rate value for the euro to address its public finance problems. Furthermore, the economic and public finance problems of eurozone member states are not congruent, thus giving rise to varying and often contradicting political incentives in different member states, pitting the political dynamics of richer economies against those of poorer economies. Debt Crisis of a Rich Economy On many levels, the eurozone (EA17) is a very rich economy. It has a population of 320 million with a 2010 GDP of 9.2 trillion ($12.2 trillion), albeit with an wide range of per capita GDP, ranging from 30,600 in Austria to 19,700 in Romania. Little Luxembourg's per capita GDP was 70,000 in 2010. Despite of the fact that eurozone membership involves only 17 of the 27 member state of the EU27, the eurozone is essentially the economic and financial core of the EU, which has the highest GDP ($16.2 trillion in 2010) in the world, larger that the US GDP ($14.7 trillion). A sovereign default in any eurozone member state will put in doubt the continuance of the euro as a common currency in the eurozone and as prime reserve currency for international trade. Collapse of Aggregate Demand The reason why a rich economy like that of the eurozone suffers such a sudden collapses in aggregate demand caused by a banking sector and sovereign debt crisis around a common currency lies squarely on a breakdown of political consensus among eurozone member state governments. The sovereign debt crisis in the eurozone began with the global economic recession that began in mid 2007 in New York, caused by a massive meltdown in electronically linked credit markets in all major open economies due to excessive private and public debts to compensated for decades of low wages. This global recession has thus far stubbornly resisted all coordinated efforts by governments and central banks of trading economies around the world to stimulate a quick economic recovery through the injection of liquidity via aggressive central bank interest rate policy and massive quantitative easing. The penalty for direct government bailout of too-big-to-fail financial entities to defuse a market meltdown will be a decade of slow growth for the world economy, because the debt crisis that had been caused by low wages is being solved with government austerity measures that will push wages further down. Slow economic growth is highly problematic for countries with high levels of sovereign debt. And for any country whose sovereign debt is denominated in currency not subject to the monetary authority of its central bank, the problem can be fatal. The reason for the long and weak recovery in global economy is that the excessive debt in the global economy has not been extinguished by government bailouts. The debt has only been shifted from the private sector to the public sector, from the balance sheets of distressed commercial and investment banks to the balance sheets of central banks. The penalty for this liquidity play on the part of central banks to save insolvent financial institutions from collapse will be an extended anemic global economy in which banks, companies and households are all trying to deleverage from undistinguished debt with the new liquidity of no economic substance released by central bank quantitative easing. Also, government austerity programs needed to secure more debt will further reduce wage income and exacerbate further fall in aggregate demand in a downward vicious cycle.

ECB Quantitative Easing A look at the way the Federal Reserve has dealt with the debt propelled recession since mid 2007 is instructive on what the ECB will likely also do to deal with the European sovereign debt crisis of 2011. Central bank monetary policy ammunition of low interest rate has long been exhausted ever since the Federal Reserve lowered the target for the short-term Fed funds rate to between 0% and 0.25% on December 16, 2008, and keeping it there open-ended, by now for almost three years, and possibly has to for another year or two more. When central bank inflation targeting is finally put in place, the Fed funds rate will go negative. In the accompanying statement on the zero interest rate move on December 16, 2008, already a year and a half into the recession, the Fed said: Since the last Open Market Committee meeting (August 5, 2008), labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further. Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters. The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time. The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year (2009), the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility (TALF) to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity. Term Asset-Backed Securities Loan Facility (TALF) On November 25, 2008, not waiting until 2009 as announced, The Fed launched TALF to support the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA). The on-going record of the ineffectiveness of TALF will give some idea of what the ECB swill face since it is now being pushed to take similar measures by US Treasury Secretary Geithner, even though TALF was designed to deal with commercial and consumer debt while the ECB is facing a crisis of sovereign debt. The Fed said in 2008 that under TALF, the Federal Reserve Bank of New York (NY Fed) would lent up to $1 trillion (originally planned to be $200 billion) on a non recourse basis to holders of certain AAArated ABS backed by newly and recently originated consumer and small business loans. As TALF money did not originate from the Treasury, the program did not require congressional approval to disburse funds, but a new act of Congress forced the Fed to reveal how it actually spent the money. The Fed explained the reasoning behind the TALF as follows: New issuance of ABS declined precipitously in September and came to a halt in October. At the same

time, interest rate spreads on AAA-rated tranches of ABS soared to levels well outside the range of historical experience, reflecting unusually high risk premiums. The ABS markets historically have funded a substantial share of consumer credit and SBA-guaranteed small business loans. Continued disruption of these markets could significantly limit the availability of credit to households and small businesses and thereby contribute to further weakening of U.S. economic activity. The TALF is designed to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more normal interest rate spreads According to the plan, the NY Fed would spend up to $200 billion in loans to spur the market in securities backed by payments from loans to small business and consumers. Yet, the program closed after only funding the purchase of $43 billion in distress loans. Under TALF, the Fed lent $1 trillion to banks and hedge funds at nearly interest-free rates. Because the money came from the Fed and not the Treasury, there was no congressional oversight of how the funds were disbursed, until an act of Congress forced the Fed to open its books. Congressional staffers then examined more than 21,000 transactions. One study estimated that the subsidy rate on the TALFs $12.1 billion of loans to buy Commercial Mortgage-Backed Securities (CMBS) was 34 percent. Special Purpose Vehicle Financial Neutron Bomb TALF money was designed not to go directly to targeted small businesses and consumers, but to the institutional issuers of asset-backed securities (ABS). The NY Fed would take the securities as collateral for more loans to the issuers of ABS. To manage the TALF loans, the NY Fed created a Special Purpose Vehicle (SPV) that would buy the assets securing the TALF loans. The function of a SPV is to isolate risk from the creator, in this case the NY Fed, as a device to hide debt from the balance sheet of the creator. In the case of TALF, the SPV creator is ultimately the NY Fed's parent, the Federal Reserve, the nations lender of last resort to banks. SPVs are financial neutron bombs, used in war to kill enemy population without causing damage to physical assets, thus saving reconstruction time and cost in captured enemy territories. A neutron bomb is a fission-fusion thermonuclear weapon (hydrogen bomb) in which the burst of neutrons generated by a fusion reaction is intentionally allowed to escape from the weapon, rather than being absorbed by its containing components. The weapons X-ray mirrors and radiation case, normally made of uranium or lead in a standard bomb, are instead made of chromium or nickel so that the neutrons can escape to kill enemy troops and civilians, leaving empty undamaged cities for occupation by the winner in a battle. SPV to Skirt Basel II Capital Requirements In a May 14, 2002 AToL article: The BIS vs National Banks, I warned about Special Purpose Vehicles (SPV) five years before the credit crisis broke out in July 2007: While Third World banks that do not meet BIS capital requirements are frozen from the global interbank funds, BIS rules have been eroded by so-called large, complex banking organizations (LCBOs) in advanced economies through capital arbitrage, which refers to strategies that reduce a banks regulatory capital requirements without a commensurate reduction in the banks risk exposures. One example of such arbitrage is the sale, or other shift-off, from the balance sheet, of assets with economic capital allocations below regulatory capital requirements, and the retention of those for which regulatory requirements are less than the economic capital burden. Aggregate regulatory capital thus ends up being lower than the economic risks require; and although regulatory capital ratios rise, they are in effect merely meaningless statistical artifacts. Risks never disappear; they are always passed on. LCBOs in effect pass their unaccounted-for risks onto the global financial system. Thus the fierce opponents of socialism have become the deft operators in the socialization of risk while retaining profits from such risk socialization in private hands. Set for 2004, implementation of the new Basel II Capital Accord is meant to respond to such regulatory erosion by LCBOs. Synthetic securitization refers to structured transactions in which banks use credit derivatives to transfer the credit risk of a specified pool of assets to third parties, such as insurance companies, other banks, and unregulated entities, known as Special Purpose Vehicles (SPV), used widely by the likes of Enron and GE. The transfer may be either funded, for example, by issuing credit-linked securities in tranches with various seniorities (collateralized loan obligations or

CLOs) or unfunded, for example, using credit default swaps. Synthetic securitization can replicate the economic risk transfer characteristics of securitization without removing assets from the originating banks balance sheet or recorded banking book exposures. Synthetic securitization may also be used more flexibly than traditional securitization. For example, to transfer the junior (first and second loss) element of credit risk and retain a senior tranche; to embed extra features such as leverage or foreign currency payouts; and to package for sale the credit risk of a portfolio (or reference portfolio) not originated by the bank. Banks may also exchange the credit risk on parts of their portfolios bilaterally without any issuance of rated notes to the market. Central Bank uses SPV to Hide Expansion of Balance Sheet The Treasury's Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008 would finance the first $20 billion of troubles assets purchases by buying distressed debt in the NY Feds SPV. If more than $20 billion in assets are bought by the SPV through TALF, the NY Fed will lend the additional money to the SPV. Since a loan is treated in accounting as an asset, the NY Fed, by providing the funds to buy distress debt, actually expands it balance sheet positively while its SPV assumes more liability. Troubled Assets Relief Program (TARP) TARP allows the US Treasury to purchase or insure up to $700 billion of troubled assets, defined as: A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress. TARP allows the Treasury to purchase illiquid, difficult-to-value assets at full face value from banks and other financial institutions. The targeted assets can be collateralized debt obligations (CDO), which were sold in a booming market until July 2007, when they were hit by widespread foreclosures on the underlying loans. TARP is intended to restore liquidity of these assets in a failed market with no other buyers, by purchasing them using secondary market mechanisms, thus allowing participating institutions to stabilize their balance sheets and avoid further losses. TARP does not allow banks to recoup losses already incurred on troubled assets, but Treasury officials expect that once trading of these assets resumes, their prices will stabilize and ultimately increase in value, resulting in gains to both participating banks and the Treasury itself. The concept of future gains from troubled assets comes from the hypothesis in the financial industry that these assets are oversold, as only a small percentage of all mortgages are in default, while the relative fall in prices represents losses from a much higher default rate. Yet the low default rate was not produced by economic conditions, but by the Feds financial manipulation. Thus the banks are saved, but not the economy as a whole, which ultimately still has to pay off the undistinguished debt. The Emergency Economic Stabilization Act of 2008 (EESA) requires financial institutions selling assets to TARP to issue equity warrants (a type of security that entitles, but without the obligation, its holder to purchase shares in the company issuing the security for a specific price), or equity or senior debt securities (for non-publicly listed companies) to the Treasury. In the case of warrants, the Treasury will only receive warrants for non-voting shares, or will agree not to vote the stock. This measure is supposedly designed to protect taxpayers by giving the Treasury the possibility of profiting through its new ownership stakes in these institutions. Ideally, if the financial institutions benefit from government assistance and recover their former strength, the government will also be able to profit from their recovery. Another important goal of TARP is to encourage banks to resume lending again at levels seen before

the crisis, both to each other and to consumers and businesses. If TARP can stabilize bank capital ratios, it should theoretically allow them to increase lending instead of hoarding cash to cushion against future unforeseen losses from troubled assets. The Fed argues that increased lending equates to loosening of credit, which the government hopes will restore order to the financial markets and improve investor confidence in financial institutions and the markets. As banks gain increased lending confidence, the interbank lending interest rates (the rates at which the banks lend to each other on a short term basis) should decrease, further facilitating lending. So far, this goal has not been achieved as bank merely used TARP money to deleverage rather than increase lending. TARP will operate as a revolving purchase facility. The Treasury will have a set spending limit, $250 billion at the start of the program, with which it will purchase the assets and then either sell them or hold the assets and collect the coupons. The money received from sales and coupons will go back into the pool, facilitating the purchase of more assets. The initial $250 billion can be increased to $350 billion upon the president's certification to Congress that such an increase is necessary. The remaining $350 billion may be released to the Treasury upon a written report to Congress from the Treasury with details of its plan for the money. Congress then has 15 days to vote to disapprove the increase before the money will be automatically released. The first $350 billion was released on October 3, 2008, and Congress voted to approve the release of the second $350 billion on January 15, 2009. One way that TARP money is being spent is to support the Making Homes Affordable plan, which was implemented on March 4, 2009, using TARP money by the Treasury. Because at risk mortgages are defined as troubled assets under TARP, the Treasury has the power to implement the plan. Generally, it provides refinancing for mortgages held by Fannie Mae or Freddie Mac. Privately held mortgages will be eligible for other incentives, including a favorable loan modification for five years. The authority of the Treasury to establish and manage TARP under a newly created Office of Financial Stability (OFS) became law October 3, 2008, the result of an initial proposal that ultimately was passed by Congress as H.R. 1424, enacting the Emergency Economic Stabilization Act of 2008 and several other related acts. Collateral assets accepted by TARP include dollar-denominated cash ABS with a long-term credit rating in the highest investment-grade rating category from two or more major nationally recognized statistical rating organizations (NRSROs) and do not have a long-term credit rating below the highest investment-grade rating category from a major NRSRO. Synthetic ABS (credit-default swaps on ABS) do not qualify as eligible collateral. The program was launched on March 3, 2009. Zero Interest Rate and Quantitative Easing As interest rates cannot go below zero, central banks are forced to resort to quantitative easing to inject money into the financial system which allows insolvent financial institutions to deny the disastrous reality of insolvency from the collapse of the market value of collaterals to pretend that the global financial market is merely facing a temporary liquidity problem and that massive liquidity injection from the central bank would allow an orderly restructuring of the massive overhanging distressed private debt by shifting it to the public sector with no borrower defaults and therefore no haircuts for exposed creditors. The price for this strategy of short-term crisis resolution of excessive private sector debt by increasing public sector debt is the long-term stagnation of the global economy. This is because private sector deleveraging with public sector money drains economic vitality that will take a long time to work through. The Cure Worse than the Disease It is now becoming clear that notwithstanding the Feds assertion that its bailouts prevented a systemic melt down of global financial markets, the cure of saving the banking sector at the expense of the economy is looking more like a cure worse than the disease. A faster recovery might have been the net

bonus if the banks were left to go belly up on their own. As it happened, the panic rescue by central banks left the global economy a fate of a lost decade. This is critical because economic recovery and the existing international financial architecture depends on a high rate of growth. And three years after the outbreak of the global financial crisis that began in mid July 2007, the global economy is still plagued by high unemployment and stagnation despite massive amount of liquidity injection by center banks. Sovereign Debt Denominated in Foreign Currency To make matters worse, all trading economies, particularly the exporting emerging market economies, that denominate their debts in one of the two prime reserve currencies for international trade, such as the dollar and the euro, will find critically needed counter cyclical monetary measures unavailable to their governments because their central banks cannot issue dollars or euros, thus have to earn more dollars or euros from the global trading system at a time when the global economy has been condemned to suffer demand deficit with a decade of economic decline engineered by central bank monetary measures to save the banking sector in the advanced economies. These emerging economies also cannot borrow more dollars or euros from global capital and debt markets because their credit ratings are being cut by suddenly less-permissive credit rating agencies. They invariably become financial wards of the stronger economies and prisoners of the International Monetary Fund (IMF) conditionalities. A Complex Rescue Plan for Europe with a Special Purpose Vehicle A European official told CNBC on the sideline of the IMF meeting in Washington on Saturday, September 17, 2011 that the EU is working on a detailed plan aimed at shoring up the stability of European banks. The plan appears to involve a complex flow of funds. It would involve money from the European Financial Stability Facility (EFSF), a bailout vehicle created in 2010 to alleviate the sovereign debt crisis in Europe, to capitalize a special purpose vehicle (SPV) that would be created by the European Investment Bank (EIB), the European Unions finance institution. EFSF shareholders are the 27 member states of the EU, which have jointly subscribed its capital. The Board of Governors of the EIB is composed of the finance ministers of these 27 member states. The role of the EIB in this plan is to provide long-term financing in support of investment projects. The SPV serves the purpose of isolating the parent (EIB) from financial risk of the plan, a device commonly used in complex financing to separate different layers of equity infusion. The EIBs SPV would issue bonds to investors and use the proceeds to purchase sovereign debt of distressed eurozone member states from their state central banks. The hope is that this would alleviate the pressure on the financially distressed member states and on the eurozone banks (primarily French and German banks) that hold a lot of the distressed sovereign debt. The bonds issued by EIBs SPV could then be used by the EIB as collateral for borrowing from the European Central Bank (ECB), allowing the member state central banks to make loans to commercial banks faced with liquidity shortages. Banks loaded down with distressed eurozone sovereign debt would be able to sell the debt to the EIBs SPV financed by the ECB with the distressed sovereign debts as collaterals at full face value so that eurozone commercial banks can access the liquidity facilities of the ECB. Although the structure is complex, the underlying objective is relatively simple. Banks would essentially be allowed to exchange their distressed sovereign debt at face value for debt issued by a special purpose vehicle created by the EIB capitalized with funds from the EFSF. In some ways, this resembles the original plan for the Troubled Asset Relief Program (TARP) used by the Federal Reserve on 2008. As originally conceived, the TARP would have purchased toxic securities from banks. (This plan was abandoned when U.S. regulators concluded that it was too difficult to price the securities and that the plan would take too long to implement.) In the European case, the toxic securities would be distressed sovereign debt rather than securitized mortgage bonds.

Plan to Stabilize Banks Holding Eurozone Sovereign Debt Over the weekend of September 17, finance leaders from around the world met in the annual IFM/World Bank conference in Washington to discuss the global economic state of affairs. At this meeting European finance ministers said that they would take bolder steps to fight the sovereign debt crisis, which is plaguing recovery of the global economy. A focal point for the European officials is the stabilization European commercial banks, which have been under a heavy market pressure. European commercial banks, particularly French and German banks, hold significant amounts of sovereign debt from the peripheral eurozone member states, know as PIIGS (Portugal, Italy, Ireland, Greece and Spain). Concern over Greek sovereign default is threatening a European banking crisis. European TARP Suggestions have surface for Europe to deal with this possible banking crisis by creating a plan similar to that of the US TARP program of 2008, following the collapse of the US housing market and the bankruptcy of Lehman Brothers, Troubled Asset Relief Program (TARP) was created by the US government to strengthen financial institutions. Under TARP $700 billion of capital was injected into US banks. For a EuroTARP, it is estimated that at least $202 billion of capital will need to be injected into the European Financial Stability Facility (EFSF) to purchase distressed sovereign debt from the European commercial banks. The hope is that this would alleviate the pressure on the peripheral European member states and on the European commercial banks. Ambereen Choudhury, an analyst at JP Morgan Cazenove, a leading investment bank focused on mergers & acquisitions, debt and equity placements and equity research and distribution based in the UK, wrote in a report issued on September 26, 2011 that eurozone banks need at least 150 billion ($202 billion) of capital provided through a Europe wide Troubled Asset Relief Program akin to the U.S. plan. We assume Euro-Tarp rather than specific support only for the most distressed institutions, as we believe a general solution is required to restore general confidence and reopen the funding markets for all institutions, Choudhury said in the report. Goodman Sates president Gary Con said that modeling a European financial rescue on TARP would be a good solution. Higher Leverage as Cure for High Leverage One question is what the JP Morgan Cazenove approach would mean for the balance sheet of the EFSF, which already carries committed emergency loans to Ireland, Portugal and Greece. It is expected to provide over 100 billion ($134.9 billion) in additional funding for a Greek bailout. After committed loans, the Feds war chest will be down to about 298 billion ($402 billion). German Finance Minister Wolfing Schaeuble said on Monday, September 19, that there is no plan to expand the EFSF. This plan will catapult the EFSF into the category of a highly leveraged fund, which borrows more than its equity capital provided by EU member governments. No official plans have been released. Details of the structure will change as European policymakers fight over the best course of action from the perspective of their different national interest. Many of the proposed options to expand further the 440 billion ($596 billion) European Financial Stability Facility (EFSF) have problems, including opposition from countries like Germany, which fears a replay of its disastrous inflationary monetary policies of the 1920s during the Weimar Republic. Meanwhile, euro zone officials played down rumor on Monday, September 19, of emerging plans to cut by half Greeces sovereign debts and to recapitalize European banks to cope with the fallout, stressing that no such scheme is on the table yet. Rough calculations suggest the EFSF, which borrows its funds from credit markets backed by

guarantees from eurozone member states, might cope with a bailout of Spain but that it would not have enough financial power if Italy needed help. The EFSF is already committed to providing 17.7 billion ($24 billion) in emergency loans to Ireland and 26 billion ($35.3 billion) to Portugal. In addition, the EFSF takes over the remainder of Europes contribution to an initial bailout of Greece, which is likely to require around 25 billion ($34 billion), and is expected to provide two-thirds of a 109 billion ($147.7 billion) second bailout of Greece. Taken together, the EFSFs current commitments total at least 142 billion ($193 billion), leaving it 298 billion ($405 billion). A package for Spain might top 290 billion ($395 billion), while a rescue bill for Italy could total almost 490 billion ($666 billion). If Greece defaults on its sovereign debt, contagion will spread to cause sovereign defaults by all the other PIIGS governments and a massive failure in financial markets world wide. Some suggest doubling the funding of EFSF, while others talk of boosting it to several trillion. But the way to restore confidence, which will be determined by the reaction of already stressed markets, goes beyond simple mathematics. Greece only a Detonator of European Sovereign Debt Bomb The sovereign debt default haunting Europe has its detonator in Greece, one of the smallest yet most heavily indebted economies in Europe. Greece, while not a poor country, desperately needs a next aid payment of $11 billion to avoid running out of cash within weeks, but negotiations between the Greek government and the troika of the European Union, European Central Bank, and International Monetary Fund have stalled. The problem is no one believes that the next payment of $11 billion will by itself solve Greeces sovereign debt problem. Considered unthinkable not too long ago, a Greek default now seems imminent a subsequent exit from the eurozone no longer improbable. Orderly Default Option Talks of a potential orderly default of Greek sovereign debt have emerged, even suggestions of a Greek exit from the eurozone as a possible scenario. Time is running out for continuing indecision and denial. In the end, the governments of the stronger economies, such as Germany and France, will have to step up to the plate, as their economies had the most to lose from a wave of falling dominos of sovereign debt default in the eurozone. French and German Responsibility In many ways, France and Germany were responsible for the sad state of affair facing eurozone governments today. Financial stability in the eurozone had been guaranteed by the euro convergence criteria as spelled out in the Stability and Growth Pact (SGP) are: 1. Inflation rates: No more than 1.5 percentage points higher than the average of the three best performing (lowest inflation) member states of the EU. 2. Government finance: Annual government fiscal deficit: The ratio of the annual government fiscal deficit to GDP must not exceed 3% at the end of the preceding fiscal year. If not, it is at least required to reach a level close to 3%. Only exceptional and temporary excesses would be granted for exceptional cases. Government debt: The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to the specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace. 3. Exchange rate: Applicant countries should have joined the exchange rate mechanism (ERM II) under the European Monetary System (EMS) for two consecutive years and should not have devaluated its currency during the period.

4. Long-term interest rates: The nominal long-term interest rate must not be more than 2 percentage points higher than in the three lowest inflation member states. Had these criteria set by the Stability and Growth Pact (SGP) been observed, it is unlikely that eurozone governments would face any sovereign debt crisis today. Ironically, the watering down of the SGP, which led to the current sovereign debt crisis in the eurozone, had been at the request of Germany and France, two of the strongest of the then 16 eurozone member states. Eurozone financial markets had been imitating the rush to phantom wealth creation through synthetic structured finance and debt securitization invented by fearless young traders in New York and London working with money provided by loose monetary measures of all central banks led the Federal Reserve. In March 2005, the EUs Economic and Financial Affairs Council (ECOFIN), under the pressure of France and Germany, relaxed SPG rules to respond to criticisms of insufficient flexibility and to make the pact more enforceable. Permissiveness infested the European theoretical regulatory framework, following the US example. ECOFIN, one of the oldest configurations of the Council of the European Union, is composed of the Economic and Finance Ministers of the 27 European Union member states, as well as Fiscal Budget Ministers when budgetary issues are discussed. The EU Council covers a number of EU policy areas, such as economic policy coordination, economic surveillance, monitoring of member state budgetary policies and public finances, the shape of the euro (legal, practical and international aspects), financial markets and capital movements and economic relations with third countries. It also prepares and adopts every year, together with the European Parliament, the budget of the European Union which is about 100 billion ($136 billion). The Council meets once a month and makes decisions mainly by qualified majority, in consultation or co-decision with the European Parliament, with the exception of fiscal matters which are decided by unanimity. When the ECOFIN examines dossiers related to the euro and EMU, the representatives of the member states whose currency is not the euro do not take part in the vote of the Council. At the urging of Germany and France, the ECONFIN agreed on a reform of the SGP. The ceilings of 3% for budget deficit and 60% for public debt were maintained, but the decision to declare a country in excessive deficit can now rely on certain new parameters: the behavior of the cyclically adjusted budget, the level of debt, the duration of the slow growth period and the possibility that the deficit is related to productivity-enhancing procedures. The pact is part of a set of Council Regulations, decided upon the European Council Summit 22-23 March 2005. Greece a Victim of Structured Finance Greece fell into the euro debt trap by yielding to the temptation of structured finance, the instruments of which were first developed in the US and adopted by US transnational financial institutions such as Goldman Sachs, Citibank, JPMorgan Chase and Bank of America to generate phenomenal profit for them in deregulated global markets fueled by floods of dollar-denominated liquidity release by the Federal Reserve, the US central bank, through the virtual transaction of synthetic derivatives known as synthetic collateralized debt obligations (CDO). This new game of phantom wealth creation was soon joined by copycats in Europe such as Barclay, Socit Gnrale, Deutsche Bank and ING. Such synthetic instruments were designed to, among other things, help banks hide their liabilities by pushing them off their balance sheets and thus lowering their capital requirement to increase profit from expanded loan-making to yield higher return on capital. (Please see my May 9, 2007 AToL article: Liquidity Boom and Looming Crisis, written and published two months before the credit crisis first imploded in New York in July 2007.) Later, expanding from the private sector, such schemes were sold to EMU member governments to help them mask their true public debt levels to skirt strict EMU rules, in order to engage in permanent monetary easing. Across the eurozone, in obscure and opaque over-the-counter (OTC) derivative deals that traded directly between counterparties off exchanges between special purpose vehicles (SPV), and designed to help governments legally skirt EMU criteria, transnational banks provided Eurozone

governments with cash upfront in return for future payments by government. Such payments would reduce government fiscal revenue since the revenue from collateral assets has been pledged to investors of CDOs. The liabilities were taken off their national balance sheets to present a healthy picture of national finance, until the government is forced to make up the revenue shortfall in a recession. Thus it is hypocrisy of the extreme for Germany to hold Greece hostage with demand of severe fiscal austerity that will lead to socio-political instability, by asserting disingenuously that Germans work harder than Greeks, and that the German government is fiscally more responsible than the Greek government, and that Greece cannot expect German taxpayers to bail out Greece from a decade of poor public finance, made possible by German influence on diluting the criteria of the SPG. Goldman Doing Gods Work Again Wall Street is directly responsible for Greeces public finance predicament. In 2005, Goldman Sachs, doing what its chairman told Congress as Gods work, sold interest rate swaps it created to the National Bank of Greece (NBG), the countrys largest bank. In 2008, Goldman Sachs helped NGB put the swap denominated in euros into a legal special purpose vehicle (SPV) called Titlos. National then retained the bonds that Titlos issued as collateral to borrow even more euros from the European Central Bank (ECB) and in turn from international banks. The swap will be costly and unprofitable for the Greek government through its long contract term, while Goodman profited handsome in fees up front. Appropriately, in Greek manuscripts, the titlo was often used to mark the place where a scribe accidentally skipped the letter, if there was no space to draw the missed letter above. SPV Titlos performed the special purpose of skipping the sovereign liability Greece had assumed in order to get more loans from the ECB and international banks than was permitted under SPG criteria. Such SPV deals were not made public even though Titlos obligations are among the weak links in Greek public finance in 2010. Information on them finally trickled out only through government investigations and media investigative reporting. Der Spiegel reported in early January 2010 that Goldman Sachs two years earlier had helped the government of Greece cover up part of its huge fiscal deficit via a currency swap deal name Titlos, which used artificially high exchange rates. A report commissioned by the Greek Finance Ministry released on February 1, 2010, revealed that Greece had used swaps to defer interest repayments by several years. On February 15, 2010, Bloomberg reported a Greek government inquiry uncovered a series of swaps agreements with securities firms that allowed it to mask its growing public debts. The document did not identify the securities firms Greece used. But the former head of Greeces Public Debt Management Agency told Bloomberg that the government turned to Goldman Sachs in 2002 to obtain $1 billion through a swap agreement. (Please see my AToL series on GLOBAL POST-CRISIS ECONOMIC OUTLOOK: Part XII: Financial Globalization and Recurring Financial Crises Part XI: Comparing Eurozone Membership to Dollarization of Argentina Part X: The Trillion Dollar Failure Part IX: Effect of the Greek Crisis on German Domestic Politics Part VIII: Greek Tragedy Part VII: Global Sovereign Debt Crisis Part VI: Public Debt and Other Issues Part V: Public Debt, Fiscal Deficit and Sovereign Insolvency In these articles, I warned against the danger of SPVs that would eventual put Greece into a disastrous sovereign debt crisis.) Political Hurdles The fundamental decisions over the future of the European monetary union will be politically difficult, and they will be costly for the richer economies. The costs of not acting decisively now, however, are going to be even higher. The urgency in bailing out Greece is the contagion on Spain and Italy should Greece defaults, and through these economies to the US and Asia.

This fact is validated by the blunt warning from US Treasury Secretary Timothy Geithner on Friday, September 16 to eurozone finance ministers at a closed meeting of in Wroclaw, Poland. Geithner told the Europeans to stop political bickering and take control of the financial aspects of the debt crisis that has brought catastrophic risk to global financial markets. Geithner Warns Europe Mr. Geithner reportedly said on the sideline of the ministerial meeting: Whats very damaging is not just seeing the divisiveness in the debate over strategy in Europe but the ongoing conflict between countries and the [European] central bank, adding that governments and central banks need to take out the catastrophic risk to markets. Geithners presence at the meeting of EU financial ministers underlined the concerned of the US government about the danger of financial contagion from the eurozone sovereign debt and banking crisis and its negative effect on the fragile economic recovery in the US and other parts of the world, including Asia. In a blunt warning that reflected Washingtons growing concern, Secretary Geithner urged European leaders to halt a months-long clash with the European Central Bank and argued that the EUs growing reliance on foreign lenders would imperil the zones ability to control its own destiny. What is very damaging [in Europe] from the outside is not the divisiveness about the broader debate, about strategy, but about the ongoing conflict between governments and the central bank, and you need both to work together to do what is essential to the resolution of any crisis, Mr Geithner said on the sidelines of a meeting of eurozone finance ministers in Wroclaw, Poland on Friday, September 16. Governments and central banks have to take out the catastrophic risk from markets [and avoid] loose talk about dismantling the institutions of the euro, he added. Mr Geithners comments came as the Europes finance ministers agreed to withhold an 8 billion loan payment to Greece, a move that could leave Athens scrambling to satisfy its lenders before it runs out of cash. European Response George Osborns, UK chancellor, echoed Mr Geithners comments, telling Sky news on Saturday, September 18, that people know that time is running out, that the eurozone needs to show it can get a grip on the situation. However, some eurozone finance ministers hit back at Mr Geithners comments, questioning the usefulness of his visit. I found it peculiar that even though the Americans have significantly worse fundamental data than the eurozone, that they tell us what we should do and when we make a suggestion ... that they say no straight away, said Maria Fekter, Austrias finance minister. Swedens Anders Borg said: we need to make progress, but its quite clear the US has a big debt problem and the situation would be better if the US could show a sustainable way forward. The eurozones more fiscally prudent governments particularly Germany and the Netherlands - are keen to prove to their voters that they were forcing Greece to comply with the deep fiscal budget cuts and other reforms it promised when it accepted a 109 billion rescue package last year. Several eurozone ministers also dismissed a US suggestion to give additional flexibility to the eurozones 440 billion rescue fund, re-opening trans-Atlantic fissures over fiscal and economic policy. Markets Respond Negatively to EU Postponement on Decision Finance ministers of the EU extended the time frame to approve a revamp of the 440 billion rescue fund that was agreed by heads of member state in July. After predicting that all 17 governments of eurozone member states would ratify the changes by the end of this September, they are now expecting the process to drag on until mid-October.

Some eurozone ministers expressed unhappiness with Mr Geithners comments about Europe ending divisions as such comments actually opened up new divisions. Austria's Finance Minister Maria Fekter, one eurozone politician at the meeting who voiced her objection to Mr Geithner's comments, said: I found it peculiar that even though the Americans have significantly worse fundamental [economic] data than the eurozone, that they tell us what we should do. She was referring to US high national debt and the recurring trade and fiscal deficits, not mentioning the political standoff in Congress over the increase of the national debt ceiling. Joe Quinlan & Peter Sparding in Real Clear World gave the following analysis on Impact of a Eurozone Default on the Transatlantic Economy. Joe Quinlan is a Transatlantic Fellow at the German Marshall Fund. Peter Sparding is a Program Officer with the Economic Policy Program of the German Marshall Fund in Washington. Yet the September 17 weekend meeting of the 17 eurozone finance ministers in Poland, instead of calming markets, only increased market concerns. The meeting produced little in the way of concrete proposals to deal with Greeces acute funding issues and the risks of financial contagion. Too Little, Too Late Only two months after a second bailout was agreed to by European leaders, and amid new data indicating that the Greek economy is shrinking at a faster rate than expected, the size of rescue packages currency being discussed already seems to be inadequate. Furthermore, a number of indicators suggest the markets have already begun to discount a default yields on Greek bonds have soared to record highs, while the price for credit-default swaps to insure Greek debt has rocketed. Many hedge funds are poised to make a killing on a Greek sovereign default. Despite these punishing moves by investors who react with incomplete and unsubstantiated information, markets may still be under-pricing the total cost of a Greek default. A default on this scale is unprecedented, and its potentially widespread ramifications are unknown. Markets can limit some of their risk, but it is far from certain that an actual default would not lead to further panic and turmoil. Life After Default Scenarios for a Greek default could include a run on banks in Greece and in the rest of the world. Capital, people, goods, and other transportable assets would likely leave Greece and the eurozone. Hoarding of physical cash and delays in payments among international banks and multinational corporations could be expected. A Greek exit from the monetary zone might become an unavoidable next step. The risk of redenomination of government debt and currency depreciation would then result in higher borrowing costs or even being frozen out of debt and capital market. With the cost of capital very high over the medium term, or capital and credit unavailable at any price, the new/old currency likely being extremely weak and thus highly inflationary, a painful and prolonged period of no or negative economic growth for Greece and the eurozone seems unavoidable. The pain would also be felt elsewhere in the eurozone as suspicion and mistrust on credit worthiness among banks would curtail lending. Other perceived weak economies, such as Portugal, Ireland, or even Spain and Italy would swiftly be tested by financial markets. Despite what some in the creditor countries might hope for, Greeces default and/or exit from the common currency would thus not signal the end of the crisis, but instead would add even more pressure on stronger countries to come up with a Big Bang solution. Impact on the US For the US, developments in Europe should be reason for serious concern. While not as heavily invested in Greek debt, US banks are somewhat more exposed in Ireland and Spain. The US would have to try to insulate its financial system from shocks in Europe in order to protect its own already battered banking sector and its economy. To avoid a potential default-induced financial crisis, the Federal Reserve has already expanded its swap operations with the European Central Bank, and it may have to do more. (end of analysis)

On September 18, 2011, the Federal Open Market Committee (FOMC) authorized a $180 billion expansion of its temporary reciprocal currency arrangements (swap lines). According to the Feds press release, the changes allow for increases in the existing swap lines with the ECB and the Swiss National Bank and for new swap facilitieswith the Bank of Japan, the Bank of England, and the Bank of Canada. These measures are designed to improve the liquidity conditions in global financial markets, the release said. An underlying aspect of a currency swap is that banks (and businesses) around the world have assets and liabilities not only in their home currency, but also in dollars. Thus, banks in eurozone need funding in dollars as well as in euros. However, Europeans banks recently have been reluctant to lend to one another. Some observers believe this reluctance relates to uncertainty about the assets that other banks have on their balance sheets or because a bank might be uncertain about its own short-term cash needs. Whatever the cause, this reluctance in the interbank market has pushed up the premium for short-term dollar funding and has been evident in a sharp escalation in LIBOR rates. The currency swap lines were designed to inject liquidity, which can help bring rates down. The bottom line is that the Fed, by exchanging dollars for foreign currency, has helped to provide liquidity to banks around the world. This effort can help to bring interbank rates back down at a time when restrictively high rates can choke off access to financing that European banks and other businesses need to operate. The swap might also be needed to provide Federal Reserve dollars for US branches of European banks and jawbone US banks and money market funds to not withdraw their funds from Europe. However, even if the U.S. financial sector somehow managed to insulate itself from the risk of financial contagion, the impact on corporate America would be severe. Europe accounts for over onefifth of world GDP and one-quarter of global personal consumption. Just over half of corporate Americas non-US revenue comes from Europe. Geithner Warns Europe Against this backdrop, it is no wonder that U.S. Treasury Secretary Timothy Geithner warned this weekend of catastrophic risks if Europe failed to rise to this challenge. Indeed, the time to find a good outcome for Europes crisis has passed. It is time to acknowledge that any solution now will be costly. In the short term, this includes strengthening European banks and extending further support to distressed countries. Another failure to act decisively contains unforeseeable risk and is likely to come at a much higher price and not only for Europe. Secretary Geithner did not mince words. The fallout from a Greek default, the risks of the eurozone disintegrating, the systemic risks of a European banking crisis, the aftershocks to the U.S. economy any or all of these events could ultimately prove catastrophic for an already fragile transatlantic economy and transatlantic partnership. Turning EFSF into a Bank The Centre for European Policy Studies, a think tank in Brussels, proposed increasing EFSFs funding by is to turn it into a bank. This means the Luxembourg-based entity could lend money to financially distressed eurozone member with loans from the ECB to refinance such loans rather than having to rely solely on its limited capital base. As a bank, the EFSF could lend up to ten times its capital even in this difficult market, which would mean the 440 billion of capital in the facility could in theory be transformed into more than 4 trillion of bailout funds. But the reality is more complex. The EFSF would raise funds from the ECB relative to the quality of the collateral it puts up. Such collateral financial instruments are distressed government bonds that have low ratings because of high risk of default. This means that by definition, the EFSF can never raise sufficient bail out funds based on the distressed sovereign debts without a market discount plus a haircut imposed by the ECB. An under-funded EFSF that cannot buy distressed debt as face value cannot perform its role as a restorer of market confidence.

But it is political opposition rather than financial obstacles that poses the biggest and perhaps insurmountable difficulty. German Bundesbank chief Jens Weidmann has expressed his concern that the ECB itself may already be overextending. The eurozones central banks and the ECB have a combined capital base of 82 billion. It has already lent 535 billion to banks and bought a further 150 billion of government bonds to prop up the depressed market. Opposition from Germany and ECB So far, Germany, the euro zones deep pocket funding source, and the ECB, the lender of last resort, are both opposed to the idea of turning the EFSF into a bank, suggesting the idea has little chance of becoming reality. By Sunday, September 25, German finance minister Wolfgang Schaeuble said he was looking into alternatives to the EFSF-bank option. One alternative would be to use the EFSF to insure investors against losses from buying Italian or Spanish banks. The EFSF would issue credit enhancements for new bonds that could cover potential losses, cutting the risk for bondholders. EFSF as Insurer Such a scheme would not help Greece, said Sony Kapoor, a financial expert who advocated the model, but would set up a contagion firewall for Italy and Spain that would allow them tap money markets even if Greece were to default. This could take the form of the EFSF offering insurance against, say, the first 20 percent of any losses on these ... and would enable the EFSF to bring down the borrowing costs for Italy and Spain for the next 3 years or more, Kapoor, the managing director of think tank Re-Define told CNBC. Lowering the borrowing costs for Italy and Spain is a necessary step before any restructuring of Greek debt can be seriously contemplated, said Kapoor, The options being discussed are primarily about policymakers, who believe that Italy and Spain are fundamentally solvent, calling the markets bluff that they are not. Unlike the EFSF as it is currently constituted, the European Stability Mechanism (ESM) is permanent and has a pool of capital of 80 billion ($108.8 billion), paid in by countries in the same way as they do with the ECB. Starting the ESM in July 2012, rather than July 2013 as planned, could reassure investors because it provides a second lever to support markets alongside the ECB. However, German chancellor Angela Merkel and other leaders have to convince eurozone member state legislators to back their pledge to allow the EFSF to extend loans to eurozone member state whose sovereign bonds faces default or to buy sovereign bonds to prop up struggling eurozone member states. Merkels Domestic Political Problem German Chancellor Angela Merkel said on Sunday (September 18): Allowing Greece to default on its debt now would destroy investor confidence in the euro zone and might spark contagion like that experienced after the bankruptcy of Lehman Brothers in 2008. We need to take steps we can control, Merkel said, drawing a parallel between the Greek situation and that of Lehman, whose bankruptcy helped trigger the global financial crisis, What we cant do is destroy the confidence of all investors mid-course and get a situation where they say that if weve done it for Greece, we will also do it for Spain, for Belgium, or any other country. Then not a single person would put their money in Europe anymore. In a one-hour interview on the euro zone crisis with popular German talk show host Guenther Jauch, Merkel said she relied on the view of the International Monetary Fund when assessing how to handle Greece. As long as the IMF was convinced Greeces debt was sustainable, then she supported that position, she said.

Merkel also made clear that she did not view a parliamentary vote in Germany on Thursday (September 15) on the euro zones rescue mechanism as make-or-brake for her government. Because opposition parties support giving new powers to the European Financial Stability Facility (EFSF), passage is not in question. But some German politicians have suggested that if Merkel fails to win a majority with the conservative parties in her coalition known in Germany as a chancellor majority she should dissolve parliament and call new elections. "We are talking about a law here, a completely normal law. The government needs a majority. The chancellor majority is what you need when you are voted in as chancellor, or in other special personnel cases, Merkel said. "I want my own majority and I will fight for this. She also said she was appalled at a lack of progress from the Group of 20 countries in forging a consensus on regulating banks and dealing with the "too big to fail" problem. Christian Wulff, who owes his job as Germanys president to Mrs Merkel, complained that the financial markets are pushing governments around. Politics must regain its ability to act, he demanded. The euro crisis is Merkels trial by ordeal. She has tried to help indebted euro members states while refusing to write blank cheques on German tax money. But the markets have repeatedly tested that approach, requiring ever larger and more elaborate bail-outs. Now, Germanys increasingly skeptical Bundestag (lower house of parliament) is about to weigh in. This month (September) it will consider legislation to approve expanded powers for the European Financial Stability Facility (EFSF), a temporary fund for helping the indebted euro countries. After that it will vote on a second bail-out of Greece, worth about 109 billion ($157 billion), and then on a permanent successor to the EFSF. Resistance, much of it from Mrs Merkels coalition, is stiffening. Dissenters have two main worries. The first is that the Bundestag will be stripped of its right to determine how taxpayers money is spent. They expect encouragement on September 7th from a ruling by the constitutional court on the legality of the first Greek bail-out and the EFSF. The court is not expected to overturn the measures, but may reinforce the Bundestags authority over budgetary matters. The trick will be to do that without paralyzing the institutions being set up to deal with euro crises. The second fear is that Germany will end up pouring even more money into countries that are unwilling or unable to solve their own fiscal problems. The rescue measures will certainly buy time, says Wolfgang Bosbach, a CDU leader in the Bundestag who is normally loyal to Mrs Merkel. But I fear they wont solve the problem permanently, so there will have to be more aid. Greeces problem is not lack of credit; it is lack of competitiveness, he believes. There are enough pro-rescue votes in the Bundestag to pass the legislation (the main opposition parties favour even more generous measures, such as issuing Eurobonds jointly guaranteed by euro-zone governments). The question is whether the chancellor majority will suffice to enact the package without opposition votes. If the majority buckles, Mrs Merkel would be weakened, perhaps fatally. The government could collapse, two years before elections are scheduled. But this seems unlikely. None of the coalition parties is keen to face elections now. The FDP, which harbors some vocal skeptics, might not even re-enter the Bundestag. Mr Bosbach expects the chancellors majority to hold up, though he does not plan to join it. Belatedly, Mrs Merkel is starting to counter the threat. She will try to placate the CDUs base in a series of regional meetings and has set up a commission to fashion a party consensus on the euro. Her rhetoric now sometimes throbs with un-Merkel-like fervor. Europe is the most important thing we have, she says (though not in Schwerin). Other CDU leaders are sounding Europhile notes not heard for some time (without providing much detail or any timetable). Ursula von der Leyen, the labor minister, calls for a United States of Europe. Mrs Merkel may recover from her mid-term slump. Though CDU traditionalists grumble about her leadership, they have no one capable of challenging her. Rising stars like Mrs von der Leyen are modernisers like the chancellor herself. There is no alternative centre of power within the party, says Gerd Langguth of the University of Bonn. With luck, Mrs Merkel will have two years to persuade voters, also, to see the brighter side of things.

Geithner Pushed Europe Again Treasury Secretary Timothy Geithner told European government officials bluntly on Saturday, September 24, 2011, to eliminate the threat of a catastrophic financial crisis by teaming up with the European Central bank to boost the continents bailout capacity. Geithner, in his most explicit language to date, said fiscal authorities should work more closely with the ECB to ensure that euro-area governments with sound policies have access to affordable financing and to ensure that European banks have adequate capital and liquidity to weather the crisis. "The threat of cascading default, bank runs, and catastrophic risk must be taken off the table, as otherwise it will undermine all other efforts, both within Europe and globally. Decisions as to how to conclusively address the region's problems cannot wait until the crisis gets more severe," Geithner said. Geithner has been lobbying for weeks for European officials to leverage their 440 billion ($603 billion) European Financial Stability Fund through the ECB to increase its capacity. His statement suggests that he wants Europe to employ the ECB's balance sheet in the same manner as the Federal Reserve did with Treasury capital during the 2008-09 financial crisis. The Treasury in 2008 pledged $20 billion in capital to allow the Federal Reserve to lend $200 billion to restart credit markets frozen by the financial crisis. Geithner said that because inflation risks were largely less acute, some central banks had room to further ease policy, keep rates lower longer and slow the pace of expected tightening. He and Federal Reserve Chairman Ben Bernanke met on Friday, September 16, in Washington with top officials from the European Central Bank and some national central banks from Europe, in part to discuss international financial regulatory reform. Geithner said US growth needed additional support from the Obama administration's $447 billion taxcut and spending package to boost jobs growth. Without this, fiscal policy would shrink too quickly and likely cause U.S. growth to be below potential in 2012. Fiscal policy everywhere has to be guided by the imperatives of growth," he said. Geithner also said that the IMF is still falling short in assessing exchange rate policies and should itself be subject to more scrutiny. The Fund's surveillance would benefit from the publication of an External Stability Report that provides a frank assessment of exchange rate misalignment and excessive reserves accumulation and progress being made in reducing global imbalances," Geithner said. "We call on the IMF to set forth a strong and comprehensive set of proposals to address these deficiencies. On September 29, 2011, the German Parliament approved the expansion of the bailout fund for heavily indebted European countries, the most important step in a tortuous process that has rattled markets and raised doubts about the ability of governments to react to the expanding debt crisis. September 29, 2011

Part III: Supranational Globalization vs Nation State Sovereignty As the eurozone sovereign debt crisis unfolds, an unspoken political undercurrent is turning a complex yet narrow restructuring negotiation between sovereign government debtors and transnational bank creditors in a regional sovereign debt crisis into a broad political confrontation of supranational globalization versus nation state sovereignty in the economic ecosystem and financial infrastructure of the existent neoliberal economic world order.

On a more fundamental level, the global credit crisis of 2008 that began in the US, followed by the European sovereign debt crisis of 2011 as a collateral development of it, are raising questions on the viability of neoliberal market capitalism that had ascended to universal status as the economic/financial system of choice since the end of the Cold War. After the dissolution of the USSR, Europe worked to correct its division between capitalistic democracy and socialist central planning since the end of WWII. Led by a reunited Germany at the end of the Cold War, many influential Europeans began to work for the integration of Europe to form a single common market with a common currency in the form of the euro introduced in 1999. The Flawed System of Globalized Low-Wage Market Capitalism Europe, similar to other participants in globalized neoliberal trade, fell into the trap of a cross-border financial regime propelled by debt capitalism, the initial phase of which appeared to be a new wonder express train to easy prosperity through financial manipulation. Low wages achieved through crossborder wage arbitrage provided extraordinary returns on capital. Low-wage workers were allowed to keep consuming beyond their wage income by easy consumer credit to absorb the overcapacity from overinvestment funded by high return on capital. All went swimmingly until the debt bubble burst in mid 2007 in New York, the world capital of a new game called structured finance. Structured finance involves the pooling of financial assets with long-term revue streams into a hierarchal structure of prioritized claims, known as tranches, of gradations of risk to issue structured securities for sale to investors of varying appetite for risk with compensatory returns. The unbundling of risk with structured securitization expanded the market for risk by allowing investors to selected tranches to fit their investment objectives and by wide redistribution of risk from particular investors to systemic market risk, under-pricing risk for any particular exposure, thus encouraging speculative investment. Structured finance can lead to increases in the aggregate value of a pool of financial assets by under-pricing unit risk through the shift of part of the risk to the global financial system. With the emergence of cross-border wage arbitrage, and the globalization of finance, the US financial sector gained control of the US economy, transforming finance from a sector that served the industrial economy to a dominant position of a profit center, replaced industrial capitalism in which full employment is a necessary objective, with finance capitalism in which structural unemployment is a necessary objective to prevent inflation. Money can actually be made by management decision to lay off employees. Increasingly, globalized market capitalism, with free trade and financial innovation as its partners in crime, is being exposed by unfolding events as the defective system that has produced unsustainable financial imbalances that resulted in recurring global crises of excessive debt and deficient demand. Monetarism as practiced by contemporary central banking has provided the theoretical anchor for growing dependence on debt as the necessary stimulant and facilitator of financial expansion, confusing unsustainable market expansion fueled by debt as economic growth that would produce sustainable prosperity. Deregulated market capitalism operating with loose accommodating central bank monetary policies has produced extreme disparity of income and wealth in the name of necessary capital formation both among competitive trading nations and among competitive market participants within nations that have adopted market economy as the only path to economic growth. The flawed theories of monetarism rely on persistent structural unemployment (above 6%) as the prime effective way to maintain price stability unnatural and elusive in business cycles. The excessive concentration of capital in a few hands has led to deregulated cross-border movement of predatory capital to maximize return by depressing workers wages world wide via cross-border wage arbitrage, generating investment gluts that produce industrial overcapacity out of balance with stagnant aggregate demand due to low wage levels in all trading economies. Neoliberal trade no longer operates according to Richardian comparative advantage, but is based on absolute advantage of capital over labor system wide. Low wages provide excess profit to yield destabilizing high return on capital that eventually leads to over-investment to cause industrial overcapacity which cannot be absorbed by low-wage consumer

demand. To complete the downward cycle of overblown financial market expansion that obstructs optimum economic growth because excessively high return on capital undercuts wages needed to support demand, central bank monetarism supplies massive liquidity to the financial market to fuel unsustainable consumer debt to mask the imbalance between high return on capital and low wage levels. This is the fundamental cause of the global debt crisis that imploded first in the US in mid 2007 and spread to the European sovereign debt crisis of 2011. Please see my April 2010 series GLOBAL POST-CRISIS ECONOMIC OUTLOOK: Part XII: Financial Globalization and Recurring Financial Crises Part XI: Comparing Eurozone Membership to Dollarization of Argentina Part X: The Trillion Dollar Failure Part IX: Effect of the Greek Crisis on German Domestic Politics Part VIII: Greek Tragedy Part VII: Global Sovereign Debt Crisis Part VI: Public Debt and Other Issues Part V: Public Debt, Fiscal Deficit and Sovereign Insolvency Part IV: Feds Extraordinary Section 13(3) Programs Part III: The Feds No-Exit Strategy Part II: Two Different Banking Crises - 1929 and 2007 Part I: Crisis of Wealth Destruction. Europe Integration Put at Risk by National Interest Calculations Governments of sovereign nation states both inside and outside the eruozone are now quietly but observably formulating protectionist financial strategies to respond to adverse impacts on their interlinked yet still separate individual national economies, banking systems and financial infrastructure from an inevitable collapse of the global financial system detonated by the European sovereign debt crisis of 2011, which has been festering in Greece and threatens to spread to Portugal, Spain and Italy and beyond as the sovereign debt crisis spins rapidly out of control. Behind the noble faade of the need and the willingness to sacrifice national interests for the common good lurks an economic realpolitik calculation in the deliberation taking place in high councils of sovereign governments. Individual governments are apprehensive about the ruinously high cost of being left as part of a dwindling group of eurozone supporting team players without ulterior motives. The task of bailing out heavily-indebted weak economies in the eurozone is turning out to be a bridge too far for the governments of the healthy, stronger economies. This is because domestic politics of the weaker economies makes it difficulty for political leaders to restore needed fiscal discipline to solve their sovereign debt problem to preserve the eurozone monetary union. The financial cost of regional solidarity may well be too high for all member states rich and poor alike. This high cost will cause serious socio-political instability across the entirely eurozone, the European Union and beyond. France and Germany have championed a new financial transaction tax in recent months, but European economies outside the eurozone reiterated their opposition at a finance minister meeting in early November, 2011. The US also declined to give the proposed tax a firm backing at the summit of the world's 20 leading and developing economies in France. Tensions between Germany and Britain over how to handle the crisis in the eurozone deepened after German chancellor Merkel was reported as not about to allow the UK to get away with its refusal to back a European financial transactions tax designed to curb derivative trading that causes instability in European financial markets. Merkel told the press: Britain had a responsibility to make Europe a success. Volker Kauder, Chairman of the CDU/CSU parliamentary group in the Bundestag after a short term as Secretary General of the CDU, said at the CDU conference in Leipzig: I can understand that the British don't want that [a transactions tax] when they generate almost 30% of their gross domestic product from financial-market business in the City of London. Only going after their own benefit and refusing to contribute is not the message were letting the British get away with. The transactions tax on has been proposed and discussed since the Asian Financial Crisis of 1997. The proposal receiving the most attention was the Tobin Tax, proposed by Nobel Laureate James Tobin in

1972 in his Janeway Lectures at Princeton, shortly after the Bretton Woods system of monetary management ended in 1971 with the dollar taken off by President Nixon from its linkage to gold, which created a situation whereby the US dollar as a fiat currency continuing to be the reserve currency for international trade, confirming the collapse of the Bretton Woods system of fixed exchange rates tied to a gold-back dollar. Tobin claims that a currency transaction tax on all spot conversions between currencies can act as a penalty to neutralize short-term financial round-trip excursions for profit from rapid exchange rate fluctuations, and to stabilize foreign exchange markets. The proposed tax is to be levied at each exchange of a currency into another at 0.5% of the volume of the transaction, to eliminate potential profit from currency speculation even as such transaction drastically increased interest rates for the currency under attack. Sharp increases in interest rates are disastrous for a national economy as shown in the financial crises in Mexico, East Asia and Russia in the late 1990s. The Tobin tax would return some margin of maneuver to currency issuing banks in small countries and would be a measure of opposition to the dictate of speculative forces in the financial markets. The Tobin tax has since been criticized as too mild to achieve the market stability that Tobin claimed, as the foreign exchange market routinely handles a daily volume of over $4 trillion. The Guardian reported on November 18, 2011 that hours after UK Prime Minister David Cameron failed to persuade German Chancellor Angela Merkel to drop the idea of a Tobin tax in the EU, former UK Prime Minister Sir John Major warned that a Franco-German plan to introduce a financial transaction tax across Europe was akin to directing a heat-seeking missile at the City of London. He also accused Paris and Berlin of fanning the flames of Euroscepticism. Major reportedly injected himself into the issue as he visited Brussels and Berlin to discuss German plans for a revision of the Lisbon treaty to provide a legal basis for tough new fiscal rules for the eurozone. Britain would accept the treaty changes, which would only apply to the 17 members of the eurozone, if it wins assurances that the City of London would not be harmed. Major said in an interview by Sir David Frost on Al-Jazeera English that the UK would fight hard to resist a Tobin tax. While this would be decided separately from the treaty negotiations, Britain could withhold support if its concerns about the tax are not met. Major said: The proposal at the moment for a financial transaction tax is a heat-seeking missile proposed in continental Europe aimed at the City of London. If there were such a tax, about 80%, 85% of the yield would come from the City of London. Now it is not surprising that the British are upset, if we were proposing [taxes] on luxuries like wine I dare say some of our continental partners would think we were being rather unfair to them. Well that's the position for us. We can't accept a financial transaction tax. I don't think we will have to, but the proposal adds to Euroscepticism and yet in many ways it's a paper tiger. Majors interview was broadcast after Merkel told Cameron in Berlin that France and Germany want to press ahead with a Tobin tax (inaccurately called the Robin Hood Tax in some press reports) as one way of helping to deal with the sovereign debt crisis in the EU. Britain would back such a tax in the unlikely event it applied globally, particularly in the US. But George Osborne warned fellow EU finance ministers that a unilateral move would drive business to Asia and the US. Britain would be able to veto the introduction of the tax in the EU because all taxation matters have to be agreed by all 27 members of the EU. But France and Germany would be able to use what are known as enhanced co-operation powers under the Lisbon treaty to introduce the tax in the 17 members of the eurozone. Britain objects to this because the tax 0.1% on stock and bond trades and 0.01% on derivatives could still apply in the City, the UKs Wall Street. The European Commission has proposed it should be levied on any bank registered where the tax applies. This means that any transactions of German-registered banks in the City would be subject to the tax. Merkel highlighted the differences with Cameron when she said in Berlin: We are at one saying that a global financial transaction tax would be implemented by both countries immediately. But just a European one, we did not make any progress. We have to both work on where we feel change is

needed. Cameron said: The danger, we have always believed, is driving transactions to a jurisdiction where it wouldn't be applied. So a global tax would be a good thing, but in Britain also we have put in place stamp duty on share transactions, a bank levy. We believe we are asking the financial services to make a fair and proper contribution to rebuilding our economy, to bring down our debts and our deficits. I think it is right in all countries to make sure that they do that. German and British sources stressed that Merkel and Cameron, who enjoy warm relations, held a constructive meeting. The UK prime minister is understood to have made clear to the German Chanellor that Britains concerns go beyond the Tobin tax amid fears greater fiscal co-ordination among the eurozone could change the single market. Downing Street is warning that it will oppose any moves towards caucusing among the 17 eurozone countries in which they agree a position on financial services and impose it on the rest of the EU. Merkel made clear in their discussions that she will give no ground on a key British recommendation that the European Central Bank should act as the lender of last resort for the eurozone. Germany underlined its impatience with Britain when Wolfgang Schuble, the finance minister, said that all EU members would eventually join the single currency. This may happen more quickly than some people in the British Isles believe, he said. Cameron received a mild boost on his first stop in Brussels when Herman Van Rompuy, the president of the European Council, told him that Germany has failed to persuade some members of the eurozone to agree to treaty change. Enda Kenny, the Irish prime minister, has told Merkel he would probably have to hold a referendum because German plans to give EU institutions, rather than member states, the final say over imposing penalties is seen as a major transfer of powers. The treaty change may be narrow but it will be deep for the 17 members of the eurozone, one British source said. If Angela Merkel wants to transfer significant sovereignty to Brussels she has to ask whether the technocratic governments in Italy and Greece will get that through their parliaments. French President Nicholas Sarkozy expressed support for a Robin hood Tax to make the rich for their fair share of taxes which current loopholes tax laws permitted high income individuals to avoid paying taxes. The idea originates from the US in a populist swelling, supported by superrich individuals such as Warren Buffet and Bill Gates. But Britains Conservative government has resisted its implementation of any form of financial transaction tax unless all financial centers agree on the same tax, to prevent cross-border tax arbitrage. . Popular Discontent and Populist Politics Vocal and violent mass demonstrations have been breaking out in the financially weak southern countries in the eurozone, particularly in Greece where the sovereign debt crisis is the most immediately critical. In the US where the Great Recession of 2008 is entering its third year, with unemployment expected to remain intolerably high for several more years, the Occupy Wall Street (OSW) protest movement of the victimized 99% of the population is picking up momentum and support beyond Wall Street and the US to many other countries around the world. The visible target is the financial sector known as Wall Street, but the real target is the structural unfairness of finance capitalism to the working class of the world. Popular discontent is ushering in a new age of populist politics. A Debt Crisis Cannot Be Cured by More Debt The European sovereign debt crisis, a financial disaster of excessive debt unsustainable by low wages, cannot be cured merely by financial bailouts from supranational institutions taking on more debt with sovereign guarantee to fund distressed sovereign debt, or by merely recapitalizing the distressed banking system with new money created ex nihilo (out of thin air) by expanded central bank balance sheets. The crisis has been caused by the dysfunctional monetary rules of finance capitalism and cannot be solved by rescue packages conceived under the same dysfunctional monetary rules merely to buy time until the same crisis explodes again at bigger scale.

The Need for an Income Policy The fundamental long-term solution to the European sovereign debt crisis has to come from government commitment to a new income policy of rising wages to restore the balance between greatly expanded productive capacity from over investment and stagnant aggregate demand caused by low wages through global downward wage arbitrage. Yet all the proposed rescue packages thus far are based on a dead-end strategy of pushing already low wages even lower through austere fiscal policy to pay off high levels of sovereign debt that had come into existence to mask imbalances created by decades of insufficient wage income for the average worker, the bulk of the population that the OWS protest movement identified as the 99% who are deprive of their fair share of the fruit of their labor by cross-border wage arbitrage that led to a debtinfested economy. Fiscal Austerity that Pushes Down Wages Exacerbated the Debt Crisis Fiscal austerity by governments of the poorer countries as demanded by the governments of the richer economies in the eurozone will only deepen the debt crisis rather than solving it. What the richer economies fails to understand is that their export to the common market within the eurozone will shrink unless all the economies in the zone have robust purchasing power through an income policy of decent wages. The Need for a new Symbiotic Relationship between Capital and Labor This sovereign debt crisis in Europe has morphed into a political crisis that will require a political solution to reconstitute a symbiotic relationship between capital and labor, away from the current exploitative relationship of capital over labor. Income disparity and wealth concentration are the causes of the debt crisis Solution Cannot Come From One-Size-Fit-All Measures The crisis has already claimed the fall of two coalition governments in the eurozone: Greece and Italy. It is not clear if the replacement governments can deal more effectively with the domestic socioeconomic problems associated with rescue proposals hammered together by creditor governments in other capitals. For more than two years, the overall economy of the eurozone, which is really a composite of national economies of very different shapes, characters, history and culture, has been incapacitated by a fatal malaise an externally imposed one-size-fit-all supranational monetary policy and standardized fiscal criteria on the separate domestic economies in different constituent nation states linked by a monetary union without a fiscal union. The disparity between different national economies of member states in the eurozone and in the European Union is wide and structural. For example, national attitude toward inflation is diametrically opposite between Germans and Italians. The more advanced northern economies do not need, nor do they want the same expansionary monetary policy and fiscal permissiveness for optimum economic growth as the poorer economies of the southern countries. Yet these separate national economies are artificially linked to a common currency with a rigid unified monetary policy controlled by a supranational constitution that dictates rules of acceptable fiscal behavior for all eurozone member states. The European sovereign debt crisis manifests itself in distinctly different problems that overlaps and exacerbate each other. The PIIGS (Portugal, Ireland, Italy, Greece and Spain) are facing crises of excessive debt, both sovereign and private debt, brought about by an abrupt and sharp decline in economic growth rates caused by catastrophic external monetary events from across the Atlantic. This contraction in the PIIGS economies transmits a crisis of liquidity, possibly even solvency, to threaten the banking system in the European Union, regulated and supervised by a supranational European Central Bank (ECB). Leading the pack of deficits hawks, German Chancellor Angela Merkel unveiled plans in June 2010 for 80 billion ($107 billion) in budget cuts over the next four years -- a package she hoped would bring by

2013 Germanys structural fiscal deficit within the European Unions Stability and Growth Pact (SGP) limits of 3% of GDP. This tight fiscal policy in the midst of a sharp economic contraction caused by financial events in the US has the effect of dragging the entire eurozone into the abyss of debt deflation with an extended period of economic stagnation, not to mention social unrest and political instability. The economic impact of the proposed austerity program will neutralize the stimulus programs. The European Union is a Dysfunctional Family of Unruly members The cumbersome policy-making procedures and centrifugal political dynamics of the EU rival Byzantine politics in complexity, deviousness, and intrigue, depriving the union of strong effective political leadership. The EU as it is currently constituted is like a dysfunctional family with unruly independent members, making EU political leaders impotent to deal effectively with the on-coming crisis in a timely, decisive and effective manner before the problem became unmanageable. Behind every eurozone government declaration of unwavering commitment to the continuation of the economic union with the euro as its common currency, lays the fear of the commitment being overwhelmed by powerful centrifugal economic nationalism and political self-determination. Support for the euro is always qualified by reservation on the loss of independent monetary sovereignty. This dysfunctionality has forced vocal supporters of the monetary union, such as German Chancellor Merkel, to call for a new treaty to enforce closer co-ordination of economic policy-making, moving expeditiously towards a fiscal union. Ironically, the concern for disparate fiscal policies among member states of the eurozone had pushed Merkel to veto a eurozone-wide guarantee for banks in the eurozone to replace the national responsibility for banks operating in each national economy. Yet, the idea of a new treaty is not meaningful as a solution to a crisis that requires immediate solutions. The history of the European monetary union shows that treaties took years to negotiate and even more years for ratification by all the member states before entering into force. Besides, the Stability and Growth Pact (SGP), as set up in the Maastricht Treaty of 1992, already clearly defines monetary and fiscal criteria for eurozone member states. Still, it failed to keep member states from violating the clearly stated criteria of SGP. The financial history of Germany leaves the current federal republic with a garrison state apprehension against inflation to prevent a recurrence of socio-economic instability that bred political extremism in the 1930s. To German political leaders, peace in Europe requires European integration. European monetary union is viewed by Germans as an effective transition toward eventual European political union, The monetary instrument for bring about Europes new regional socio-political order is the euro, a common currency designed to entice national behavioral convergence towards economic and political union. The logic behind regional cohesion is that monetary and economic union in Europe would serve to bring about a high common standard of fiscal discipline set by the German model to move smoothly towards voluntary political integration through an economic structure in which what is good for the integrated constitution is also good for the constituents national units individually. Full Cohesion of Europe is Wishful Thinking The European sovereign debt crisis has exposed the principle of full cohesion as wishful thinking. The reality remains that supranationalism continues to be resisted by deep-rooted nationalist culture set by the Peace of Westphalia in 1648 even in the 21st century. There remains widespread suspicion that the common good in the eurozone is neither shared equitably nor paid proportionately by all constituent nations. Deep-rooted Westphalian national cultural fixations continue to infest separate national perspectives and national behavior to block full cohesion of the eurozone and of Europe. The hope that a common currency would ensure collective financial stability and fiscal union for the eurozone has been shattered by deregulated market forces in the first externally sourced recession in the eurozone as a unit in the neoliberal globalized economic system since the introduction of the euro in 1999. In the current European sovereign debt crisis, the prerequisites of common monetary credibility are testing regional political cohesion in a confrontation between eurozone member states of uneven economic strength and fiscal discipline and most significantly socio-political culture.

The Debate on German Responsibility Yet, in Germany, the strongest economy in the eurozone, the domestic political discourse on German responsibility for the monetary health of the eurozone is conditioned on German expectation of nonGermans in the eurozone to think, act and behave as Germans traditionally do, with a national government of fastidious fiscal discipline, and an socio-economic culture of domestic frugality and a competitive work ethic that yields persistent trade surplus, notwithstanding that within the euro trade zone, systemic equilibrium means that surplus in current account and capital account in some national economies can only come from deficit in current accounts and capital accounts of other profligate national economies. It is simply not possible for every trading nation in a trading system to have a trade surplus. The winwin myth of neoliberal trade conflicts with the zero sum reality of the accounting game of national surplus and deficits. Regional integration removes the fear of invasive foreign financial and economic imperialism independent sovereign states rely on to maintain national discipline. In a fully cohesive system, it is only equitable for fiscal deficits in the poorer units to be paid for by fiscal surplus in the richer units. In the US, New York and California consistently send more tax revenue to the federal government in Washington than these two rich states receive back in federal funding. Fiscal Deficits are the Symptom, not the Cause of the Sovereign Debt Crisis Further, it is not informative to blame the European sovereign debt crisis entirely on fiscal deficits incurred by some profligate national governments in the eurozone since these governments have voluntarily surrendered independent sovereign monetary policy authority to a supranational authority. Constituent governments of the eurozone are thus deprived of options of traditional monetary measures to defuse mounting sovereign debt problems with currency devaluation to restore balance of external trade. Fiscal deficit is the symptom, not the cause of the sovereign debt crisis. Solve the sovereign debt problem with economic growth will automatically eliminate the fiscal deficit. But arbitrarily cutting the fiscal deficit will only stifle economic growth to exacerbate the sovereign debt crisis. The idea that some countries are in financial difficulty because of poor fiscal management by their governments is only a convenient cop-out. Several of the distressed national economies in the eurozone have public and private debt levels not much worse than those of the US. The US Immune to Sovereign Debt Crisis Because of Dollar Hegemony But the US does not need to go to the International Monetary Fund (IMF) for emergency loans because the Federal Reserve can provide the US economy with all the dollars it needs by monetary measures such as interest rate policy and quantitative easing by expansion of central bank balance sheet, while the Treasury can sell as much sovereign bonds as its needs, subject only to national debt limit set by Congress. This is because the US, by having all its debts denominated in its own fiat currency, has no foreign debts, only domestic debts held by foreigners. Dollar hegemony also gives the US exceptional privileges to run current account deficits perpetually. (Please see my April 11, 2002 AToL article on Dollar Hegemony) This is fundamentally different from eurozone economies the sovereign debt of which is denominated in euro, a common currency over which each individual sovereign state in the eurozone does not enjoy sovereign monetary authority. This is of significant political importance because resentment against fiscal austerity needed to deal with sovereign debt problems is more acute when viewed by the public as being imposed by foreigners rather by self government. Greek and German Attitude on IMF not Identical Even for Greece, the most egregious sovereign debtor in the eurozone, the IMF would normally offer temporary liquidity support in return for currency devaluation with fiscal conditionalities. Even IMF has recognized that it severe conditionalities requirements for last resort lending has often been counterproductive.

The people of Greece have the choice of accepting IFM conditionalies which can be oppressive, or to withdraw from the world trading system temporarily. The IMF then acts as a bank of last resort, and while the Greek people may not feel grateful amity toward a supranational bank, the decision to seek help remains voluntary and the penalties are accepted the result of a voluntary decision by the borrowing nation. With the proposed rescue terms of the supranational European Central Bank and its supranational affiliate such as the European Investment Bank (EIB) and the EFSF, the bailout special purpose vehicle of the EIB, the people of Greece understandably feel victimized by a supranational regime over which they have little control and from which they cannot withdraw honorably and equitably. German Preference for a European Monetary Fund On the other side, the German government rejects the idea that an outside body such as the IMF should dictate economic policy to a country that shares with Germany a common currency. Instead, Germany proposed a European Monetary Fund (EMF) to provide conditional temporary liquidity support to the European banks in debt crisis. Under the exclusive direction of member states of the eurozone, the EMF would set conditions on fiscal policy to the government requesting financial aid. In my July 12, 2002 AToL article, I proposed an Asian Monetary Fund (AMF) for similar reasons after the Asia financial crisis of 1997. Lack of Transparency Makes Greek Sovereign Debt Impact Disproportionate to its Small Size The turmoil over Greeces public finances has shown Europes monetary union, which today has 17 member states, with Estonia joining in 2011, to be ill equipped to manage a sovereign debt crises denominated in euro. The debt problems of Greece, one of the eurozones smallest economies, with a GDP of 230 billion, has threatened the stability of the entire eurozone and the EU with a GDP of 12.3 trillion, the largest in the world, because the complex and opaque exposure to liability in special purpose vehicles leave unclear the amount of liability exposure for each and every sovereign market participant in a worst case eventuality. Proposal for European Monetary Fund Behind the rapidly mutating crisis, eurozone politicians have been considering the lessons of past crises in which the rapidity of financial market collapse was beyond the ability of slow process of organizing effective response. Establishing a European Monetary Fund is expected to help limit market uncertainty with prepackaged bailout procedures that are triggered by predetermined levels of crisis, acting as circuit breakers to prevent crises of market failure from spinning out of control. The intention behind the EMF is to set up the rules and tools to prevent cumulative recurring market instability in the eurozone stemming from the indebtedness of even one single profligate member state government, such as Greeces, or a group of unruly governments such as those of PIIGS nations. The first details of the plan, including support for an EMF modeled on the IMF, but more specifically designed for the more advanced economies of Europe, were revealed by German Finance Minister Wolfgang Schuble. The EMF fund would have resources to lend to eurozone member states in financial difficulty, but only subject to very strict conditions to curb excessive budget deficits and government borrowing. The idea was proposed by Germany and German officials are now trying to get France on board. Few details on how the proposed European Monetary Fund will be organized and how it would work have been provided by the German Finance Ministry. Some semi-official ideas were developed in a working paper published in February 2010 by Daniel Gros, director of the Brussels-based Centre for European Policy Studies (CEPS), and Thomas Mayer, chief economist at Deutsche Bank. Gros and Mayer argues in their paper in favor of a European Monetary Fund, saying that German leaders wanted to make sure that the Greek people understood what deep sacrifices would be necessary to get the countrys budget deficit under control. They cannot get out of this without a very deep recession under the best of circumstances, Mr. Gros told the press. If they just start screaming when

they see the dentists drill, they are lost. Events since have shown that the Greek people did much more than merely scream, with violent protests that declared if their leaders accept the austerity demands by EU leaders, they will really be lost. The CEPS paper proposes funding the EMF out of levies on countries that incur debt above European Union rules on debt (60% of GDP) and fiscal deficit (3% of GDP) as spelled out in the SGP, thus increasing the incentive of undisciplined governments to comply. But this levy would also exacerbate the debt and deficit problems by taking money from those governments who need it most. EMF funding would be supplemented by borrowing in the markets on the credit or guarantees of the European Union. The paper argues that if such a fund had been launched with the introduction of the euro in 1999, it would have accumulated 120 billion ($163billion) by now enough to rescue a smallto-medium-sized eurozone member government from its sovereign debt difficulties. It is an inconclusive argument since with the backing of the EMF, a member state will be able to accumulate higher levels of debt before triggering any reliable distress alarm signal. Much of the problem of the current debt crisis can be attributed to the use of special purpose vehicles by borrowing governments to secure funds from shadow banking financial institutions by hiding the excess debt from the balance sheets of government finance. Furthermore, unregulated structured finance would enable governments to leverage their reserve accounts in the EMF to take out more debt, defeating the function of such accounts as a raining-day reserve. The European sovereign debt crisis is not the outcome of not having safety rules; it was the result of purposeful violation of safety rules. The CEPS paper spells out that in a crisis, a country could call on funds up to the amount it had paid in, providing its fiscal policies were approved by other eurozone members. Help beyond that amount would entail a supervised adjustment program. When a government falls into imminent danger of default, the fund would have the power to issue replacement debt. But it would impose a so-called haircut on investors of the old debt who would receive only a fraction of the government bonds face value. French officials appeared to be caught surprised by the speed of the EMF proposal from Germany. In principle, Paris backed proposals but is waiting for details on how it works. An unnamed spokesman said the proposed EMF will help us avoid a repeat of the Greek situation. But he emphasized that the plans were sketchy so far and the imitative is from Germany. French economist and public policy expert, Universit Paris-Dauphine Economics Professor PisaniFerry, Director of Bruegel, the Brussels-based economic think tank, said that though the approval hurdles are significant, the proposal was a positive development that the leading EU members were discussing ways to prevent future Greek-style meltdowns, adding that Its a sign they are learning from the crisis, which I think is good. Germany Wants Penalties for Fiscal Violations German officials also want penalties to be imposed for fiscal violations. Among the proposed ideas are: suspension of European Union subsidies, the cohesion funds, to countries that fail to observe fiscal discipline; suspension of voting rights in ministerial meetings; and even suspension from the eurozone. A less controversial idea is to enforce fines already permitted under the EUs Stability and Growth Pact (SGP). Impetus for a European Monetary Fund initially came from the German finance minister, Wolfgang Schuble, who told the German newspaper Welt am Sonntag in an interview that the countries that use the euro needed an institution with similar powers to intervene as the International Monetary Fund. Mr. Schuble did not provide details of how the fund would work, saying he would present a plan soon. The European Commission, the executive arm of the European Union, immediately endorsed the EMF proposal while officials in some European capitals complained that they had not been briefed on the plan. There was no explicit endorsement from German Chancellor Angela Merkel. The proposed EMF

would represent a shift for known Germany position which resists providing financial assistance to countries that get in fiscal trouble because of bad policy decisions, even though those policy decisions were not considered bad by most risk analysts until after the global debt market crashed. The problem was that creative structured finance of fiscal needs was deemed prudent by risk managers when marked to model in a normal market. Such structured finance only became risky when the normal market fails and normal hedges against risk lose their protective function. And the market failure was not caused by anything the governments of the eurozone member states did, but from the financial implosion of the burst of the global debt securitization bubble created in the US that caused a paradigm shift in the market that demolished the risk dynamics of all the structured finance models. German Reservation on IMF German leaders are known to feel that more in-group cooperation is preferable to accepting external intervention from the IMF. The use of IMF emergency funds has been held up as a bargaining chip to lower the cost of bailout from within the eurozone by George A. Papandreou, the Greek prime minister who had been forced to withdraw from government by the threat of a no confidence vote in parliament over domestic political criticism of his handling of the sovereign debt negotiations. A move to bypass IMF involvement would also be sensitive for President Nicolas Sarkozy of France, as his most potent domestic political rival at the time, Dominique Strauss-Kahn, was then the head of the IMF, before falling from grace in a bizarre sexual scandal in a New York hotel owned and operated by a French hotel chain, in an episode of life imitating the movies. German leaders also saw a European Monetary Fund as a vehicle to impose tougher sanctions on eurozone member countries that had defied with impunity SGP limits on fiscal deficit and national debt which all eurozone member states had voluntarily pledged to observe. Creative use of structured finance in sovereign debt securitization had allowed Greece to run up a real budget deficit equivalent to 12.7% of GDP tripling the SGP limit of 3%, and a real national debt level of 120% of GDP, doubling the SGP limit of 60%, without triggering automatic SGP sanctions, provoking a sovereign debt crisis in triggering a sharp rise in interest rate on rollovers of its short-term sovereign debt that the Greek government had no money to meet. A Greek default on its sovereign debt threatened to spread to Spain, Portugal, Italy and other eurozone countries, causing borrowing costs for their sovereign debt rollover to skyrocket. The fiscal crisis in Greece was not caused by excessively high wages and benefits of Greek public servants, as the German politicians assert; it was caused by a sudden and sharp rise of borrowing cost on its sovereign debt dispersed in a net of opaque structured finance instruments that in a normal market would have been quite manageable. Accepting help from the IMF would be an admission that the euro countries dont have the strength to solve their own problems, Mr. Schuble told Welt am Sonntag. Failed Campaign to Ban Credit default Swaps (CDS) For a brief moment, European leaders put their fingers on a key cause of the sovereign debt crisis. French President Sarkozy called for a crack down on credit default swaps a way for investors to hedge against the danger that a debt issuer will default. The swaps have been criticized because they allow speculators to in effect buy insurance on assets they do not own, destabilizing bond markets. Through a spokesman, German Chancellor endorsed the French campaign against structured finance. (Please see my article on Credit Default Swaps (CDS) in the series: 2009 The Year Monetarism Enters Bankruptcy: Part I: Bankrupt Monetarism Part II: Central Banking Practices Monetarism at the Expense of the Economy Part III: Stress Tests for Banks which appeared in AToL on May 13, 2009 as Credulity Caught in Stress Test) In Part III of the series, I wrote: CDS contracts are generally subject to mark-to-market accounting that introduces regular periodic

income statements to show balance sheet volatility that would not be present in a regulated insurance contract. Further, the buyer of a CDS does not even need to own the underlying security or other form of credit exposure. In fact, the buyer does not even have to suffer an actual loss from the default event, only a virtual loss would suffice for collection of the insured notional amount. So, at 0.02 cents to a dollar (1 to 10,000 odd), speculators could place bets to collect astronomical payouts in billions with affordable losses. A $10, 000 bet on a CDS default could stand to win $100,000,000 within a year. That was exactly what many hedge funds did because they could recoup all their lost bets even if they only won once in 10,000 years. Almost a year later, on March 9, 2010, Greek Prime Minister Papandreou, encouraged by France and Germany, meeting with President Barack Obama in Washington, complained to the US president that Greeces problems stemmed in part from a lack of transparency in the trading of complex financial instruments such as credit default swaps (CDS). If we were to have transparency, I would say immediately we would have had much more possibility to prevent the crisis as it unfolded, Papandreou told the press afterwards. Papandreou argued that investor manipulation of CDS was pushing Greece to the brink of financial ruin and dragging down the euro. European officials then said they might ban some credit default swaps in European markets, while German Chancellor Angela Merkel called on Washington to help curb trading in the financial instruments. In response, President Barack Obama said Europe should deal with its own debt problems, resisting pressure from Greek Prime Minister George Papandreou and other European leaders on the US to join a coordinated crackdown on market speculators, in keeping with the US own effort of financial regulatory reform since 2008. White House officials said Greece should focus on righting its economy and lowering its crushing sovereign debt, as if skyrocketed borrowing cost from credit rating downgrade had nothing to do with the Greek sovereign debt crisis. Yet the sovereign debt crisis in Greece could be traced to a paradigm shift in the debt securitization market that began in the US. The White Houses cool response to Greeces call for regulatory crackdown of CDS showed there was still no trans-Atlantic consensus on what - if anything - to do about the problem of destabilizing speculation in financial markets. Some commentators questioned whether Germanys proposal for a European Monetary Fund was designed to help Greece or to signal to Greek officials that they could not expect bailout aid from Europe soon and that Greece must solve its own problems by accepting austere fiscal reform. The Futility of Beefing up the European Financial Stability Facility (EFSF) The promise of more generous financial support from Germany and France for the sovereign debt crisis in Greece can buy time for the euro, but it is questionable if it can save the euro in the long run, not to mention the serious issue of moral hazard. The EUs existing bailout special purpose vehicle, the European Financial Stability Facility (EFSF) own by the European Investment Bank (EIB), has 440 billion at its disposal. On September 29, 2011, the German parliament voted to give the fund expanded authority to raise more funds to enlarge its bailout purse to 1 trillion. The EFSF is already providing liquidity support to Greece, Ireland and Portugal. It could, if necessary, give limited support to Spain but would have no spare financial capacity to help Italy which has sovereign debt at 120% of its $2.05 trillion GDP or $2.45 trillion outstanding. In late October, 2011, a joint report by the EU and the International Monetary Fund (IMF) warned that, without a haircut by the creditor banks, the Greek sovereign debt crisis alone could swallow the entire 440 billion available to the EFSF, the bailout special purpose vehicle owned by the EIB leaving nothing in spare to help the affected banks of Italy, Spain, France and Germany. The IMF added a condition of a 50% or higher haircut for the banks to IMF commitment to help Greece. The rescue deal finally agreed to has the banks taking a 60% haircut on the Greek debt they hold. The Financial Cancer Spreads As the European sovereign debt crisis dragged on like a growing financial cancer that metastasizes over

the entire euro financial sector and the economy, eurozone government leaders played games with rescue proposals under the conventional rules of finance capitalism and at a scale that could only buy time to postpone a catastrophic collapse of financial markets in the eurozone. Yet similar to delays in treatment for cancer, time was actually working against the sovereign debt crisis to make the bailout more costly with each day of delay. Europe was playing for time when time was actually making the crisis more difficult to solve. As Greece fell into the terminal stage of the debt cancer, financial markets started to doubt the availability of domestic political consensus and financial resources needed by EU political leaders to rescue Italy and Spain, two large economies with mountainous debt and insufficient economic growth under the current economic order and policy framework to sustain the rapidly escalating cost of servicing the debt which the market began to view as heading nearer to default. The cost of borrowing for these two debtor governments has risen sharply in both the primary and secondary debt markets, further exacerbating market skepticism in the ability of the debtor governments to meet even the increased interest payments due at the end of each passing month, let alone the prospect of ever paying off the debt. German Refusal to be the White Knight to Save the Euro To calm market volatility and to bring down borrowing costs for sovereign debt with credit rating downgrades, Germany needs to commit firm and timely support for a credible bailout plan designed to bring quick recovery toward growth to the distressed eurozone economies. But the financial options are limited and none are politically appealing. Without a strategy of boosting high growth, all the temporary life-support rescue deals only make the final collapse more painful. Following US example, the European Central Bank (ECB) toyed with the strategy of stepping up purchases of eurozone distressed government bonds through central bank quantitative easing, to shift the distressed debt onto the balance sheet of the ECB and to interject desperately needed liquidity into the critically impaired eurozone financial system. But while the ECB is already buying small amounts of some southern European government bonds, the practice is of questionable legality. Further, Germany is not enthusiastic about further ECB quantitative easing, certainly not at a scale that would be helpful to the eurozone sovereign debt crisis. The idea of introducing Eurobonds with collective eurozone government guarantee has been proposed, with eurozone member state governments raising money collectively as a single unit to ease the rising cost of separate borrowing for those member states with rapidly declining credit ratings. But the idea failed to attract much support, particularly from Germany, the strongest and highest rated economy in the eurozone, except as a post crisis long-term consideration, and only after fiscal discipline is solidly guaranteed by the governments of the southern economies. There is logic in the Germany resistance as its may encourage the southern member states to exploit the good credit ratings of the strong northern economies to delay necessary fiscal reform in their own economies. This leaves the option of strengthening of resources of the EFSF, a special purpose vehicle of the European Investment Bank (EIB), possibly through credit mechanisms that would link it to the ECB, as the only feasible solution as an immediate measure. A bailout purse of 2 trillion was discussed in July, 2011. By the time the plan to boost the financial power of the EFSF was adopted by all member states at the end of September, after a precarious political struggle by Chancellor Merkel in the German parliament, the amount needed had gone up to 6 trillion. The Centre for European Policy Studies, a think tank in Brussels, calculated that as a bank instead of just a special purpose vehicle owned by the EIB, the EFSF could lend up to ten times its capital even in this difficult market, which would mean the 440 billion of capital in the facility could in theory be transformable into more than 4 trillion of bailout funds. Bailing Out a Debt Crisis with More Debt But bailing out distressed debt with more debt is an addicts folly, not a viable solution in finance. The European sovereign debt crisis and the dysfunctionality of the euro as a common currency without a common fiscal union is a fundamentally inoperative arrangement.

To cure the sovereign debt malaise under crisis conditions, much of the sovereign debt owed by Greece, Portugal and even Italy will have to be written down if not written off entirely, and the debt must be extinguished, rather than merely shifted into a gigantic supranational special purpose vehicle from many mini national special purpose vehicles facing imminent default. The huge amount of distressed European sovereign debt with rising interest payments will exacerbate fiscal deficits for the national issuers, causing the cost of new borrowing to skyrocket in a vicious debt circle. But debt writeoff will in turn require a massive recapitalization of European banks. The amount of capital needed ranges from by 200-300 billion as estimated by the IMF, to 6 trillion by some conservative market analysts. Fiscal Austerity Counterproductive Many neoliberal economists have suggested that the heavily-indebted governments in the eurozone need to adopt austere fiscal policies to keep government spending under control to keep it in line with projected revenue, and to introduce structural economic reforms that will facilitate economic growth through national competitiveness in cross-border trade. Fiscal austerity can help only as a gradual longterm cure. As a measure in the midst of a financial/economic crisis, fiscal austerity is equivalent to pouring oil on fire, both economically and politically Trade Competitiveness a False Cure But the entire world cannot expect to pay off sovereign debt with current account surplus from export to other economies. Within the eurozone, the trade surplus for one member state must be a deficit for a counterparty member state in intra-zone trade. Thus within the eurozone, trade competitiveness cannot be a solution to a systemic sovereign debt problem. If trade competitiveness is achieved by lowering domestic wages, it would in fact exacerbate the debt crisis further by further reducing aggregate demand as capital seeking higher return must push wages down with cross-border wage arbitrage. A case in point is Greece. Similar to Portugal, Italy, Ireland and Spain, Greece suffers from low labor productivity and low wages, economic practices restrictive of competition, low-tech industry and a persistent state fiscal deficit financed by growing foreign loans denominated in the euro, a common currency over which national governments in the eurozone have voluntarily surrendered monetary policy authority to the supranational European Central Bank. Greece Cannot Push Already Low-Wages Lower Greeces unit labor costs have diverged from those in Germany for doing the same work by around 3040% since the launch of the euro as a common accounting currency on January 1, 1999. In order to restore cross-border trade competitiveness, Greece would have to cut already low wages by 50% from present levels. Not only will that lead to unacceptable levels of social and political instability, it actually will further reduce aggregate demand in the Greek national economy and force it to seek trade surplus from more export to a eurozone market in which every other constituent national government is also trying to pay for its fiscal deficit with a trade surplus earned with low-wage competitiveness. It is a beggar thy own workers game of no winners, just more destructive than its opposite strategy of beggar thy neighbors through protective trade tariffs. Law of One Price Needs to Also Apply to Wages While the law of one price applies to the value of the common currency within the eurozone, wages are not subject to the law of one price in the eurozone. As a result, fiscal union cannot be introduced along with currency union because the only way the low-wage southern economies in the eurozone can match the high living standard of the high-wage northern economies is to take on rising national debt. While the laws of capitalistic public finance can be adjusted to compensate for national socio-economic differences, they cannot be ignored totally. There-in lays the conceptual weakness of the idea of European integration via a common currency. Export Trade Dancing After the Music Has Stopped Export trade is now a game in which the music, namely profitability in cross-border trade, has stopped while the players had no choice but keep doing the export dance. Looking to earn trade surplus through

low domestic wages to pay for fiscal deficit necessary to compensate for low domestic wages is equivalent to a family renting out its children at slave wages to work for money to buy imported food at high cost, instead of the family growing its own food to feed all its members. Greece Already in Default Under current public finance accounting rules, Greece will officially default on its sovereign debt eventually. It is only a matter of time even if some form of bailout can be organized for Greece before the Greek government runs of out money. But the expected size of any realistically available bailout will not be sufficient to service and extinguish the amount of Greek debt outstanding. Default is postponed only by taking on more debt, a process that is unsustainable. Greece is already in technical default through haircuts negotiated and accepted by its creditors and rescuers. After the haircut, any creditor willing to extend more credit to Greece needs to have his head examined. Bailouts Designed to Buy Time When Time Makes the Solution More Difficult All the proposals to bailout Greece from its sovereign debt crisis so far can only postpone the final day of reckoning. And at the end of the day, Greece may realize that the best option is to abandon the euro and withdraw from the EU and accept the consequences of default. Staying in the eurozone would mean year after year of unremitting austerity for generations, an economic scenario looking worse by the week than a one-off sovereign debt default. Leaving the euro and the eurozone, though financially traumatic in the near-term, would allow the debtor government to devalue a new national currency managed by a new national bank system that can adopt a monetary policy to support domestic development as the best prospect for domestic growth from a new base. Greece needs to abandon central banking which manages a supranational one-sizefits-all monetary policy to support the value of the euro as a common currency of the eurozone at the expense of the constituent economies by holding down demand. Instead, Greece needs to adopt national banking with a sovereign monetary policy that supports the monetary and financial needs of Greek economic development, and let the market set the exchange value of the new Greek national currency. November 16, 2011

Part IV: Need for an Orderly Withdrawal Mechanism from the Euro and the Eurozone In the face of imminent breakup, eurozone and EU governments will do well for their common good to create an orderly exit mechanism for Greece and any other country in financial distress that may wish to leave the monetary union to regain sovereign authority to preserve independent, unilateral monetary operational space. Hang Together or Hang Separately Benjamin Franklins famous forewarning at the signing of the US Constitution that We must all hang together, or surely we will all hang separately, does not seem to apply to the situation facing the eurozone governments. There does not seem to be any compelling reason to preserve the eurozone as it is currently constituted. In fact, it seems that to save the euro as a common currency, it is necessary to restructure the eurozone to rid it of profligate sovereign member states or to adopt fiscal union that would dilute national sovereignty. Hanging together in defiance of structural centrifugal forces of economic nationalism acting on the eurozone may drag the whole zone into the abyss of bottomless sovereign debt. Need for Supranational Authority

To keep the eurozone in good economic health, there is a need for a supranational institution with a clear mandate and authority to coordinate a zone-wide fiscal regulatory regime with two hands, one with monetary policy authority and the other with commensurate fiscal policy authority. Yet forcing eurozone member governments to adjust their separate fiscal policies to accommodate monetary rigidity of a common currency is to ask their political leaders to commit domestic electoral suicide. Without the availability of both monetary and fiscal supranational authority, the effect of supranational policy dealing with the sovereign debt crisis caused by a common currency is merely the same as sounds of one hand clapping. Pre-Arranged Exit A pre-arranged exit door for voluntary withdraw for member states may provide a better chance to restore the monetary credibility and financial strength of the eurozone by ridding it of the unsustainable burden of hopeless fiscal liability of profligate member states while allowing the member states in sovereign debt and fiscal distress the monetary option of using sovereign credit denominated in their own national currencies to work out their public finance difficulties independent of the rigid centralized monetary policy of the eurozone. This is particularly true when current eurozone monetary policy appears to be designed only for the needs of the zones stronger economies, with such rigid unified monetary policy inevitably landing the weaker economies in unsolvable sovereign debt crises that need to be paid for with socio-politically de-stabilizing fiscal auterity down the road. Conceptually, voluntary monetary union membership is not truly voluntary without an operative mechanism for voluntary withdrawal. A clear legal framework with standardized financial terms for member states wanting or needing to withdraw voluntarily from the euro as a common currency will be less disruptive to the European Union than would otherwise be with involuntary sovereign debt defaults inflicted by market forces or with the uncontrolled consequences of ad hoc expulsion of hapless member states in the midst of a severe financial crisis. German and French Deliberation on Eurozong Restructuring Unconfirmed reports from Brussels in early November 2011 gave hints that the leaders of Germany and France, the two biggest and strongest economies in the eurozone, had begun preliminary deliberation on a restructuring of the eurozone to create a New Europe of more solid credit worthiness, in view of the fact that Italy, the third largest economy in eurozone after Germany and France, and the government with the biggest sovereign debt exposure, while being too big to fail, is also too big to rescue. Should Italy default, the vulnerability of sovereign debt of Spain to market pressure would be heightened, as would those of France and even Germany. Political Turmoil in Italy By November 2011, Italian Prime Minister Silvio Berlusconi had lost control of the political situation at home as a result of his failing leadership in dealing effectively with relentless market pressure on Italian sovereign debt, and had to resign voluntarily his prime minister position to avoid the indignity of a no confidence vote in parliament, with a consolation prize of being allowed to tender his resignation officially only after his austerity fiscal program designed to calm creditor concern was adopted by parliament. Concurrently, a new national unity coalition government was experiencing weeks of birth pains as the sovereign debt crisis in Italy was left to deteriorate further in the market by an open-ended political vacuum. Equity Market Sell-Offs Equity markets were hit with deep sell-offs in the weeks after November 16 following news from Brussels that the leaders of France and Germany were discussing the need for a formalized expulsion process for fiscally unruly member states from the eurozone, despite quick denial by French government spokesmen that such talk was mere baseless rumor. The leaders of France and Germany were reported as holding discussions on possible treaty changes to create tighter coordinated economic governance for governments whose economies use the euro, including the idea of more central surveillance of national budgets and fiscal estimates and projections,

with clearer operational rules and stricter sanctions for those governments that persistently violate criteria set by the Stability and Growth Pact (SGP) in the Maastricht Treaty, namely fiscal deficit not over 3% of GDP, public debt not over 60% of GDP and inflation rate of not more than 1.5 percentage points higher than the average of the three best performing (lowest inflation) member states of the EU. SGP Criteria Depress Growth The fact is that no economy in the world today meets the SGP criteria, and should a government impose such criteria, its economy might not be better off because of the resultant anemic growth rate from the tight fiscal criteria. The Achilles heel of the SGP is that stability, both monetary and fiscal, in high growth situations yields wonderful economic results, but stability in anemic growth situations is hell, particularly for politicians in democratic countries whose governments are more vulnerable to short-term voter sentiment. This is an economic truth insightfully observed by John Maynard Keynes. Whether this truth is labeled as a Keyensian Perspective or not does not distract from its validity. France and Germany Debate via Public Speeches On Thursday, December 1, 2011, days before a potential market implosion on eurozone sovereign debt when several large tranches of sovereign debt from eurozone governments would face market challenges of rolling over on their maturing sovereign debts, French President Nicolas Sarkozy used a major hour-long speech in the southern port of Toulon to sketch out the French vision of Europes future by setting out initiatives that appear to be at odds with Germanys proposal for more rigorous monetary union by treaty reform to save the single currency and to restore a stronger European Union able to ward off fragmentation from its most serious economic and political crisis since its existence. France Calls for Suprantionalism by Another Name Firing off an official blast in the high-stake political debate among top EU political leaders that will decide on the fate of the euro as a common currency, Sarkozy delivered an high-profile speech calling for a new deal that would enable political leaders of the 17 eurozone member states to strike political bargains among themselves, while conceding that Europes sovereign debt crisis and collapsing market confidence in the common currency have left France with the realization that it must surrender some sovereignty to a new supranational supervisory regime of fiscal discipline. Along with France, all other eurozone governments would need to forfeit their constituent rights of veto in eurozone central fiscal policy-making under a new system of majority vote. Sarkozy left the details of his proposal vague in his otherwise carefully crafted speech. Still, the main thrust of his proposal appears to run counter to Berlins call for a much more rigorous monetary union in which participating governments would surrender ultimate control of the their sovereign fiscal policy prerogative to a centralized supranational EU entity with intrusive powers of scrutiny on national fiscal conditions and enforcement of prescribed penalties for fiscal violations. Denying the obvious, Sarkozy declared adamantly: The reform of Europe is not a march towards supranationality. The integration of Europe will go the inter-governmental way because Europe needs to make [unified] strategic political choices. Germany Insists on Treaty Reform German Chancellor Angela Merkel, before going to Paris on Monday, December 4, to try to work out details of the new eurozone treaty change with her French counterpart, would unveil her own proposals and priorities in a speech to the Bundestag in Berlin on Friday, December 2, one day after Sarkozys policy speech. British Prime Minister David Cameron would also to go to Paris Friday, December 2 for discussions on the crisis the French President. Addressing parliament in Berlin amid warnings that time is running out for the euro, Merkel repeated her view that the eurozone should establish a fiscal union in order to safeguard the single currency, urging that the Lisbon Treaty be renegotiated to create a regime of controls and penalties which would ensure that European sovereign debt crisis will not be a recurring affair.

Merckel refused to be rushed into trying to resolve the crisis with temporary, expedient measures, declaring that staying power rather than speed was the answer. This position held by Germany is understandable since Germany is the only country whose economy has staying power. Thus Merkel's declaration of the importance of staying power is a message of Germany holding all the cards in the quest for solution to the European sovereign debt crisis. Merkel Rejects Proposal for Eurobonds but Shows Flexibility on ECB Ahead of talks in Paris on Monday, December 5, 2011 with her French counterpart to work out a unified strategy before taking it to an EU summit in Brussels on Thursday, December 8, 2011, Merkel ruled out any pooling of eurozone debt in the form of Eurobonds as non-starter. She did hint some flexibility on her position on the European Central Bank. This was viewed by the market as a concession by Germany, as Merkel had been adamantly opposed to both the issuing of Eurobonds and allowing the ECB an expanded market intervention role as the eurozones lender of last resort. A discussion about Eurobonds is pointless, Merkel declared. Anyone who has not grasped that Eurobonds are no remedy has not understood the nature of the crisis. To German thinking, it would be a move towards uncontrolled moral hazard for the profligate government whose lack of fiscal discipline had caused the sovereign debt crisis. On the ECB issue, Merkel appeared to be less uncompromising than before. The role of the ECB is different from that of the US Federal Reserve or the Bank of England, she pointed out. She would leave it to the German Central Bank in Frankfurt to act as it sees fit, since a central bank is supposed to be politically independent. Ill not comment on what national central banks, or the European Central Bank, do or don't do, expressing a correct political posture that would also put the burden of monetary decision on the German Central Bank where it belongs. Merkel Buying Time with Demand for Long-Term Solution Some in the market think that Merkel is merely buying time to institute a new longer-term euro regime with short-term action to ward off market pressure on the euro. The ECB would be encouraged to expand its bond-buying similar to the Feds TARP program, while the International Monetary Fund (IMF) could take a bigger role; eurozone countries could post more bilateral loans with the IMF to enlarge bailout capacities, effectively setting up a prototype European Monetary Fund. Enlarging the IMF would face the question of where the new funds would come from and the question could be expected to intensify discussion on IMF reform, as the emerging economies have been demanding a bigger voice in IMF policy formulation if they are asked to increase their contribution to the IMF. ECB Sets Tight Fiscal Regime as Condition for Market Intervention Mario Draghi, new head of the ECB, signaled on Thursday, December 1. 2001 that once the stiffer fiscal regime was agreed, ECB could become more proactive in helping to solve the crisis. However, the condition of fiscal union is not expected to become reality anytime soon as the debate on the balance of national sovereignty and supranational authority rages on regarding federalism in the European Union. Germany Warns Britain Merkel repeated her view that the Lisbon Treaty had to be re-opened for systemic reform to be possible. In a clear warning to British Prime Minister David Cameron, the German Chancellor pointed out should the 27-member EU block treaty reform, the 17-member eurozone within the EU can forge their own sub-pact within the Lisbon Treaty, which could leave Britain out of decision-making completely. The implication is that, if Cameron makes too many problems (tabling additional demands unacceptable elsewhere) eurozone leaders will sidestep the stalemate. Merkel Calls for Tobin Tax and Ban on Short Selling

Earlier in May 2011, Merkel launched a barrage of rhetoric against financial markets, throwing Germanys weight behind a demand for a global tax on bank transactions (known as the Tobin Tax from the days of the Asian Financial Crisis of 1997) and proposing a radical shift in the rules governing the single currency by insisting struggling eurozone countries be allowed to restructure their debt with government protection from market speculation. The idea, when floated by Greece to Washington with German encouragement, did not receive support form President Obama. Following Greeces debt emergency and with the euro in the throes of its worst crisis of confidence, Merkel proposed a nine-point plan rewriting the euro regime to include legally enshrined budget deficit ceilings in all 16 member countries. The German demands, in a finance ministry paper, could require the EU's Lisbon Treaty to be renegotiated, presenting British Prime Minister David Cameron with a dilemma over whether this would trigger an EU referendum in Britain. Markets Fell by German Response to Sovereign Debt Crisis German reponse to the sovereign crisis in the eurozone and Germanys shocking decision to impose a ban on naked shorts a strategy designed to profit from falling markets drove the FTSE 100 down below 5,000 for the first time since November 2010 and to its biggest two-day fall since March 2008. Wall Street was also rattled after a rise in jobless claims added to the euro tension. With the blue-chip Dow Jones industrial average down almost 3% by the middle of the session. The broader S&P 500 index reached official "correction" territory as it sank 10% below its recent high point, set in late April. Britains Financial Sector Under Pressure from German Call Regulatory Reform Camerons coalition government feared pressure on the UK banking sector by Germanys call for a Tobin Tax and promising to rewrite the fundamentally flawed system of financial regulation. The British prime minister also pledged to study the complex issue of separating retail and investment banking and giving regulators greater powers, as an echo of financial regulatory reform in the US. Merkel, unrepentant about her controversial unilateral ban on short selling, told a Berlin conference on market regulation that governments the world over were failing to come good on their pledges made two years earlier to strengthen regulation of financial markets. In a concession to her centre-left opposition before a crucial vote in Berlin on the 750bn for the EFSF rescue funding for the fragile euro, Merkel said she would fight for a global financial transactions tax at the G20 meeting in Canada in June. German Finance Minister Schuble argued that if the G20 effort failed there should be a European tax and if that ran into resistance not least with the British he would recommend it for the 16 countries of the eurozone. In Brussels, Germany has consistently demanded for the eurozone heightened budgetary rigor, coupled with draconian penalties for profligate eurozone member governments, without which the euro cannot survive as a common currency. The crisis in Greece has brutally exposed weaknesses in European monetary union, the paper by Schuble reads. Monetary union is ill-equipped to deal with the extreme scenario of sovereign liquidity and solvency crises. Sarkozy Calls for Debt Guillotine President Nicolas Sarkozy of France, in a gesture of support to Merkel, said he was looking at changing the French Constitution to introduce a debt guillotine, with no mention of figures or deadlines, invoking horrifying images of the French Revolution. A coolapse of the euro will cause significant financial problems for France, having to revert back to a national currency whose value will fall even lower than what it was before the adoption of the euro. Frances debt of the 800million owed to the European Central Bank will consequently double in exchange value, and would have to be paid by Metroplitan France (l'Hexagone - as the French refer to Metroplitan France, the part of France in Europe, as opposed to l'Outre-mer, or colloquially les DOMTOM - Overseas France, which together form what is officially called the French Repulbic of which Metropolitan France accounts for 81.8% of the territory and 95.9% of the population.).

Sarkozy, or his successor, would have to play the Tropical card: a devaluation of the CFA franc could allow France to owe to African countries of the CFA zone only half of their assets deposited at the French Treasury and to use more than 40% of African resources to keep France solvent. Sarkozy has commissioned two African heads of states, Alassane Dramane Ouattara of Cote dIvoire and Sassou Nguesso of Congo-Brazzaville, to prepare the West African populations to receiving the merciless blade of the debt guillotine. The franc CFA is the name of two currencies used in former French colonies in Africa which are guaranteed by the French treasury. They are the West Africa franc CFA and the Central African franc CFA. Although theoretically separate, the two franc CFA currencies are effectively interchangeable, currently at a fixed exchange rate to the euro: 100 franc CFA = 1 former French (nouveau) franc = 0.152449 euro; or 1 euro = 655.957 franc CFA. Although Central African franc CFA and West African franc CFA have always been at parity and have therefore always had the same exchange value to other currencies, they are in principle separate currencies that could theoretically have different exchange values at any time that one of the two CFA monetary authorities, or France, so decide. Therefore West African franc CFA coins and banknotes are theoretically not accepted in countries using Central African franc CFA, and vice versa. However in practice the permanent parity of the two CFA franc currencies is widely assumed. Franc CFA currencies are used in fourteen countries: twelve former French colonies in Africa, as well as in former Portugese colony Guinea-Bssau and in former Spanish colony Equatorial Guinea. The ISO currency codes for the Central African franc CFA is XAF and for the Wesr African franc CFA is XOF. ISO 4217 is a standard published by the Inrernational Standards Organization (ISO) which delineates currency designators, country codes (alpha and numeric), and references to minor units in three tables: 1 - Current currency & funds code list; 2 - Current funds codes and 3 - List of codes for historical denominations of currencies & funds. The tables, history and ongoing discussion is maintained by SIX Interbank Clearing, Ltd which acts as the ISO 4217 Maintenance Agency on behalf of the International Organization for Standardization (ISO) and its Swiss member SNV (Swiss Association for Standardization). The ISO 4217 code list is used in banking and business globally. In many countries the ISO codes for the more common currencies are so well known publicly that exchange rates published in newspapers or posted in banks use only these to delineate the different currencies, instead of translated currency names or ambiguous currency symbols . ISO 4217 codes are used on airline tickets and international train tickets to remove any ambiguity about price. In 1973, the ISO Technical Committee 68 decided to develop codes for the representation of currencies and funds for use in any application of trade, commerce or banking. At the 17th session (February 1978) of the related UN/ECE Group of Experts agreed that the three-letter alphabetic codes for International Standard ISO 4217, Codes for the representation of currencies and funds, would be suitable for use in international trade. Over time, new currencies are created and old currencies are discontinued. Frequently, these changes are due to new governments (through war or a new constitution), treaties between countries standardizing on a currency, or revaluation of the currency due to excessive inflation. As a result, the list of codes must be updated from time to time. Germany Calls for Allowing Governments to Default in Managed Way In May 2010, Schuble eased up on Germanys initial proposals that debt-ridden delinquents without fiscal reform be kicked out of the common currency. Still, the German finance minister argued that countries in dire sovereign debt straits must be allowed to restructure their sovereign debt or default in a managed way, without making clear whether such a country would need to quit the euro, or how contagion can been limited by a firewall. Schuble also suggest that national budgets of eurozone governments be peer-reviewed by specialists at the European Central Bank or independent experts to ensure budgetary rigor and adhesion to a revamped Stability and Growth Pact. In May 2010, German officials seemed not to understand that fiscal problems in many eurozone countries are not economic problems, but political problems with economic implication. Some of these changes on further surrender of sovereignty to supranational authority would need the Lisbon Treaty to be reopened, requiring the assent of all 27 members, whether

in the eurozone or not. Germany Insists on Log-Term Solution Despite pressure in Washington, in London, and elsewhere for prompt spectacular action to halt a potential disaster spilling over to the US and UK, Merkel in May 2011 pleaded for time, emphasizing that a crisis which had taken years to build would require years to resolve. A European diplomat was reported to have said: We want this fixed as soon as possible. But Merkel and others say that misses the point, that these are really big issues. Were now realistic about how long itll take. It will be sufficient [meantime] to muddle through. Muddling through was exactly the Europeans did in the 18 months since the sovereign debt crisis broke out. The US press called it kicking the can down the road, without a plan. Merkozy Team not a Partnership of Equals The Merkozy team is clearly not a partnership of equals, a fact clear from the separate speeches in Toulon and Berlin on the difference between the French and German views on The Future of Europe. Charles Grant, director of the Centre for European Reform, wrote: For the first time in the history of the EU, Germany is the unquestioned leader, and France is number two. Since the financial crisis struck in 2008, the economic inequality between France and Germany has grown. While both Germany and France agree on the need for fiscal union for the eurozone, pooling or surrendering some national sovereignty over budgets to keep debt within fiscal capacity and to punish those who violate the SGP criteria. The key difference lays the process of constitutional reform. Rewriting the Lisbon Treaty will required negotiation by all 27 EU governments and ratification by all 27 EU parliaments. Experience shows this to be time consuming, politically hazardous, diplomatically acrimonious and government positions held hostage by referendums. Germany under Merkel insists on it due to domestic political sentiments while France under Sarkozy would prefer to avoid it also for domestic political reasons. There are bigger differences. Assuming Merkel prevails, who is the enforcer of fiscal union? Sarkozy wants powers to stay with national leaders. Merkel wants them vested in a "European institution". The Lesson of Thatchers Hostility to a Federal Europe Lest one forget Margaret Thatchers famous NO,NO,NO! speech in the House of Commons on the European Council meeting in Rome held on October 27/28 1990 on the final stage in the European Council, her hostility to a federal Europe led to Geoffrey Howe resigning on November 1 and to his fellow federalist Michael Haseltines bid for the Tory leadership which brought down Thatcher on November 22, 1990. Germany Calls for Using European Commission and European Court as Referees On Friday December 2, 2011, Merkel suggested the European Commission and the European Court of Justice referee fiscal conduct of eurozone governments, and issue automatic penalties to offenders. You couldn't [then be able as a sovereign state] legislate your own budget. You need to seek agreement from someone else on how to spend your taxpayers' money, commented an EU diplomat. Sakozy Denies France Supports Supranationality On Thursday, December 1, 2011, Sarkozy denied he was proposing supranational authorities, but was only stressing tightly coordinated decision-taking between governments and their leaders. Forfeiting sovereign power over Frances budget could be politically costly for Sarkozy, facing election May 2012. For both the right and the left in France, the notion is contested. Gaullists among Sarkozys own ranks are also against any such idea. Euro Faces Critical Week

Merkel demanded more strict control over fiscal policies of eurozone member governments at the beginning of a critical week for the euro. Hopping to forestall the imminent collapse of the common currency, the German chancellor decided to give the impression of finally taking decisive action to calm the financial markets when she said it was time to stop talking about a fiscal union and start creating one. Merkel acknowledged, however, that negotiations to secure for the 17-member eurozone greater central fiscal control could not be rushed and would involve a risky renegotiation of the Lisbon Treaty and risky ratification on the negotiated changes. Still, interest rates on Italian and Spanish government borrowing fell sharply and markets rose on hopes that European politicians are finally taking the euro crisis seriously and have woken up to the potential damage that a breakup might inflict, despite the fact that the process could take years to bear fruit, and could still be torpedoed by politicians from any of the 17 eurozone countries subject to domestic political pressure on the loss of sovereignty. Britain and France Gave Support to German Call for Treaty Reform British Prime Minister David Cameron, for whom the talks over closer fiscal union threaten to be politically perilous, and concerned about the negative impact of a chaotic breakup of the euro on an already fragile UK economy hurt by uncertainty on the euro, was in Paris on Friday, December 2 for a 90-minutes working lunch at the Elysee Palace with French President Nicolas Sarkozy, before heading back to London where, appearing resigned to Merkels plan for treaty reform, declared he was not categorically opposed to it. If there is treaty change, then I will make sure that we further protect and enhance Britains interests, he said. A statement No.10 Downing Street said Britain accepts that the eurozone needs a new set of rules and, with a treaty negotiation looking increasing imminent, Britains priorities in those talks would include protecting the single European market and the City of London [as an international finance center] and preventing the 17 countries in the eurozone ganging up against the interests of the 10 noneuro EU countries who are outside it. France and Germany would try to draw up a more detailed blueprint at a summit on the following Monday, December 5 after Merkel presented her proposal to the Bundestag, while the US Treasury Secretary Tim Geithner is expected to stress Washingtons concern over the risk to the global economy posed by the monetary crisis when he makes his fourth visit to Europe in six months. A final battle between national sovereignty and supranationalism is on the horizon. Merkel is pushing for a new enforceable European fiscal regime under which countries using the euro would ultimately need to sacrifice sovereign fiscal powers to a European supranational authority that would monitor and subsequently either endorse or veto national budgets. It would punish those whose debt levels are deemed to be destabilizing the euro as a common currency. She pointed again that there was no quick fix to a crisis that had taken years to develop, and stressed there was no danger for German budgetary sovereignty presumably because Germany has a good record of fiscal discipline and therefore no supranational authority would challenge German sovereignty on fiscal issues. In other words, national sovereignty is save for countries that do not violate SGP criteria. Merkel Sets Eyes of Long-Term Preventive Cure The thrust of Merkel's argument is not so much about settling the immediate sovereign debt crisis, but installing a longer-term regime to ensure such crisis can never happen again. The Lisbon Treaty would need to be revised to make that possible. But if that proved too difficult, she added in remarks that will resonate in No.10 Downing Street, the eurozone leaders could take matters into their own hands outside the EU treaty, and leave trouble makers such as Britain out of the decision-making circle. EU Treaty Reform Problematic For British Political Leaders An EU treaty negotiation would present Cameron with the perilous task of trying to prevent a rupture between his pro-European Liberal Democrat coalition partners and the increasingly impatient Eurosceptic wing of the Conservative party.

But some Tory Members of Parliament want to use any renegotiation to demand a wholesale repatriation of sovereign powers from the EU a position that is unacceptable to the Liberal Democrats. Camerons response has been to stress his commitment to the repatriation of sovereign powers in the long term while arguing that, with the euro in crisis, now is not the time for the time for a full-scale renegotiation. The British position of short-term surrender of sovereign powers with repatriation in the long-term is based on reverse logic from that of Germany, which wants long-term surrender of sovereign powers with short-term compromise until the sovereign debt crisis is solved with long-term solutions. Merkel Insists Only Long-Term Solutions Will Appease Markets Merkel sought to turn the tide on two years of a collapsing euro by demanding a permanent fiscal union among the 17 common currency countries through a risky re-negotiation of the Lisbon Treaty. Amid apocalyptic warnings that the decade-old common currency was on its last legs, with only days left, before sovereign default by Italy and Spain failing to roll over their maturing bonds, for European leaders to concoct an effective response to the sovereign debt crisis that would appease the bond markets, Merkel, however, emphasized that she would not be rushed and that there was no quick fix to a crisis that had taken years to develop. In her speech to the Bundestag in Berlin on Friday December 4, Merkel said the time had come to stop talking about a fiscal union and start creating one. She is to draw up a more detailed blueprint with President Nicolas Sarkozy in Paris on Monday and deliver the new scheme to a crucial EU summit in Brussels next Thursday. A Franco-German Duet Coming a day after Sarkozys speech in Toulon on the future of Europe, Merkel's statement was a signal of Franco-German resolve to deal with the sovereign debt crisis after 18 months of persistent ineffectiveness. The question remains that even with a show of German leadership and French support, can the sovereign debt crisis be resolved to everybodys satisfaction, including the voting public in different countries? The key reason Germany is adamently opposed to the issuance of Eurobonds is simple Germany will be the party paying for all the cost of the bad debts of other euro nations while other eurozone governments continue on a painless joy ride on Germanys good credit as they have done since the introduction of the euro. Without fundamental fiscal reform, the good credit rating of Germany will be sacrificed for no good purpose, as the unconditional backing of German credit on Eurobonds would only give the profligate eurozone governments less incentive to introduce politically unpopular but operationally necessary fiscal reform. Germany under Chancellor Merkel also opposes any expansion of the market interventionist role of the European Central Bank even though no other institution is available or financially qualified to save the euro from market pressure, without fundamental constitutional reform on fiscal union, because it would turn the ECB into a dope pusher instead of being a detoxification agent of ruinous debt. It appeared, however, that Merkel has been forced by internation pressure to moderate her resistance to an expanded if limited ECB role, only if just to buy time and to clear the way for national central banks in the eurozone and International Monetary Fund to intervene in bond markets to relieve the time pressure so as to provide the breathing space needed for working out a more fundamental systemic response. France Protective of National Sovereignty France is uncomfortable with the approach of formal permanent dilution of sovereign powers by a supranational institution. Loss of sovereign power is historically a long-held Gaullist phobia. Accrodingly, it is understandable that Sarkozy leans towards a less formal arrangement on a case-bycase basis on the kind of punitive sanction to be decided by heads of government in the eurozone, taking into consideration the socio-political dynamics of each nation facing imminent default, so the penalty will lead to positive policy effects rather than painful punishment on the population for no redeeming purpose.

Sarkozy also favors immediate measures such as the floating of Eurobonds or a proactive market intervention role for the ECB, despite Merkels strong opposition on both in public. On Friday, December 2, 2011, Merkel in her speech in the Bundestag acknowledged that treaty reform can pave the way towards Eurobonds issuance. She appeared to be softening her stance on the ECBs interventionist role, not to cure the crisis but to buy time for long-term cures to take hold. Market expectations ahead of the European summit schedule for Friday December 9, 2011 include visible progress on agreements on long-term reform on fiscal integration and that agreement on longterm solutions may help close gaps in short-term disagreements among EU member states. Britain Will Defend its National Interests from Supranationalism British Prime Minister David Cameron, who had a lunch meeting with Sarkozy in Paris during the last week of November, indicated upon returning to London that he would support Merkels plan of treaty reform, although stressing that he would vigorously defend Britains national interests in any EU treaty changes. Disappointed by the outcome of the EU summit meeting on Tuesday, November 29, which saw eurozone finance ministers admit to having failed to boost the EFSF bailout fund to the promised 1 trillion, markets rallied the following day when the worlds major central banks stepped in under urging from the US Federal Reserve to lower the cost of US dollar funding for banks in Europe and elsewhere to offset capital flight from the euro. The market rally carried right through to Friday, further supported by expectations of a cut in the ECBs key policy rate on the coming Thursday and the EU summit on the coming Friday, which will hopefully deliver plans to transform the currency union into a closer fiscal union. Shuttle Diplomacy and Public Dialogues All the shuttle diplomacy and public dialogue though official speeches were designed as political theater for setting up national positions for negotiation at the EU summit the week after. The oncoming summit has been described as another of Europes last chance to secure the survival of the euro as a common currency, among many previous last chances warnings that had passed without a solution. France and Germany now appear united on the need to keep the euro as a common currency even by shrinking the eurozone, yet the two nations remain divided over the proper ways to achieving that objective. Together we will make proposals to guarantee Europes future, said Sarkozy, ignoring that the fact that proposals by France are diametrically opposite to those by Germany. France wants the European Central Bank (ECB) to intervene in the market to stabilize the euro as a common currency of government with difference fiscal policies and conditions. This role for the ECB has been persistently rejected by Germany. In his speech in Toulon, while acknowledging the independence of the ECB, as a central bank, from national political pressures, something that all central banks insist on, Sarkozy also said that the ECB should act if conditions require as a matter of fulfilling its institutional mandate. The ECB is independent and will remain so. I am convinced that facing the risk of deflation that threatens Europe, the ECB will act, he said. Its up to it [ECB] to decide when and in what way. The implication is that the ECB will act according to macro-economic conditions and not from poltical pressure. Merkel also wants to reform the treaty conditions governing the euro by rewriting the Lisbon Treaty, to be negotiated by all 27 EU member states that would also involve the European parliament and the European Commission. While he did not provide details, Sarkozy emphasized the autonomy of the eurozone from the EU, suggesting that the 17 member states in the eurozone could form a separate sub-pact without reopening the Lisbon Treaty that governs the EU. Merkel in Berlin insists there should be automatic punishments for countries in violation of the treaty terms, with the European Court acting as referee. Sarkozy said only that sanctions should be more automatic, leaving room for member state leaders to strike deals. The use of the term punishment rather than penalty suggests that Merkel is thinking of inflicting

pain on the population as an effective leverage, rather than imposing disadvantages on government to government interaction. ECB Supports Eurozone Fsical Union Mario Draghi, the new head of the ECB, supports the German view on constitutional reform while hinting that the European central bank could become more proactive in supporting the European bond market once the new regime of fiscal coordination is operational. Fundamental questions are being raised and they call for an answer, Draghi told the European Parliament in Brussels on December 1, 2011. A new fiscal compact is definitely the most important element to start restoring credibility. Other elements might follow, but the sequencing matters. It is first and foremost important to get a commonly shared fiscal compact right. Draghi did not specify what more the ECB could do and said the central banks bond purchases can only be limited. Our economic and monetary union needs a new fiscal compact a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made. Coordinated Central Bank Action A day earlier, the ECB joined forces with the Federal Reserve to cut the cost of emergency dollar loans to banks outside the US. While the coordinated action fuelled a global stock market rally, the yield on Italys 10-year bond remained close to 7% as contagion spreads to the euro regions core. The euro initially fell on Draghis remarks before rebounding to trade at $1.3486 at 1:25 pm in Frankfurt. The Stoxx Europe 600 Index also recouped its losses. The market viewed Draghi as trying to manage market expectations to make people understand while the ECB would not behave as the Bank of England or the Federal Reserve do, it does not mean it is unable to supportive of the market. ECB Cuts Interst Rate and Faces a Classic Liquidity Trap The ECB unexpectedly cut its benchmark interest rate by a quarter point to 1.25% earlier in November, and the market expects another quarter-point reduction when policy makers meet on December 8. Draghi said the central banks bond purchases aim solely to ensure its rates are transmitted on markets, as the Fed normally does in it open market operation, and not to create new money or subsidize governments as in quantitative easing. The ECB is already lending banks as much money as they ask for, in an attempt to stimulate the flow of credit to households and businesses. But Draghi pointed out: The ECB has created an enormous amount of liquidity, and we see now that this liquidity is being redeposited with the ECB deposit facility. Which means it is not so much the amount of liquidity that is the matter, but its the fact that this liquidity is not actually circulating. Draghi thinks the most important thing for the ECB to do is restore the flow of credit to the economy. We have observed serious credit tightening in the most recent period, which combined with the weakening of the business cycle doesnt bode at all well for the months to come, Draghi said. The head of the ECB is describing a classic Keynesain Liquidity Trap in which fear of capital losses on assets besides money creates a liquidity trap setting a floor under which interest rates cannot fall. While in this trap, interest rates are so low that any increase in money supply will cause bond-holders (fearing rises in interest rates and hence capital losses on their bonds) to sell their bonds to attain money (liquidity). European leaders are scheduled to meet in the week December 5 to discuss the next steps in winging down a sovereign debt crisis that will soon enter a third year. Draghis approach is backed by German Chancellor Angela Merkel, who says politicians must drive the euro region toward a fiscal union rather than rely on the ECBs bond purchases. Governments must restore their credibility vis--vis financial markets, Draghi said. December 4, 2011

China and a New World Economic Order By Henry C.K. Liu This article appeared in AToL on January 12, 2010 Merely two years before the end of the first decade of the 21st century, the post-Cold-War world economic order found itself facing its most serious crisis under the weight of unsustainable deregulated debt capitalism created by dollar hegemony. There are clear signs that out of this current crisis a new world economic order will emerge. China is in a promising position to influence this development toward a sustainable, balanced and cooperative world order of global fairness and universal justice. The root cause of the current crisis can be traced to the dismantlement of the Bretton Woods international finance architecture by the US in 1971 when President Richard Nixon suspended the dollars link to gold, and the subsequent deregulation of globalized financial markets that has allowed free cross-border movement of funds. Toward the end of the World War II, the United States, through its dominance in the Bretton Woods Conference of 1944, constructed a post-war international finance architecture based on a gold-back dollar as a reserve currency to revive world trade. The Bretton Woods monetary regime allowed the US, which at that time was in possession of most of the world gold, to take over the role of financial and economic hegemon in a new age of neo-imperialism under finance capitalism previously played by Britain in the age of imperialism under industrial capitalism. Economics thinking prevalent immediately after WWII, drawing lessons from the 1930s Great Depression, had deemed international capital flow undesirable and unnecessary for national economic development. Trade, a relatively small aspect of most national economies at the time, was to be mediated through fixed exchange rates pegged to a gold-backed dollar. These fixed exchange rates were to be adjusted only gradually and periodically to reflect the relative strength of the economies participating in international trade, which was expected to augment, but not overwhelm, the national economies. The impact of exchange rates was limited to the settlement of international trade. Exchange rate considerations were not expected to dictate domestic monetary and fiscal policies, the chief function of which was to support domestic development and regarded as the inviolable province of national sovereignty. During the Cold War, there was no global trade. The economies of the two contending ideology blocks were completely disconnected and did not trade outside of their own blocks. Within each block, allied economies interact through foreign aid from and memorandum trade with their respective superpowers. The competition was not for profit but for the hearts and minds of the people in the two opposing blocks, as well as those in the non-aligned nations in the Third World. The competition between the two superpowers was to give rather than to take from their separate fraternal economies. The population of the superpowers worked hard to help the poor within their separate blocks. Convergence toward equality was the policy aim even if not always the practice. The Cold War era of foreign aid and memorandum trade had a better record of poverty reduction within either of the two camps than post-Cold War globalized neo-liberal trade dominated by one single superpower. The aim was not only to raise income and increase wealth, but also to reduce income and wealth disparity between and within economies. In the world economic order that emerged after the Cold War, income and wealth disparity has been rationalized as a necessity for capital formation even in the rich economies. From 1980 to 2007, the total after tax income earned by the top 0.1% of earners in the US more than quadrupled, while the share earned by everyone else in the top 10% rose far less and the share of the bottom 90% actually declined in purchasing power. In China, privatization of state-owned-enterprises since 1978 has pushed a large segment of the

working population outside of socialist sphere of free social benefits in health care, education and retirement entitlements. Unemployment is now a serious structural problem everywhere including the Chinese socialist market economy. Excessive reliance on export financed by foreign capital has also left developmental imbalances between the exporting coastal regions and the isolated interior. Despite recurring big trade surpluses denominated in dollars, China has been prevented by dollar hegemony from using sovereign credit to finance domestic development. China is now the worlds biggest creditor nation, yet the Chinese economy continues to require foreign capital that demands rates of return higher than such capital could get in their home economies. Ironically, much of this foreign capital comes from the US which is deeply indebted to China. The US is investing in China with money it borrows from China. The US is able to do this because the debt and capital are both denominated in dollars that the US can print at will. Todays post-industrial financial market economies are all plagued by overcapacity created by insufficient consumer purchasing power. The Chinese market economy is a glaring example of this structural contradiction which arises from the need of companies to keep down wages to maximize corporate profit. Workers everywhere are not able to afford all the products they produce, thus causing overcapacity that has to be absorbed by export. American entrepreneur Henry Ford (1867-1943) understood this structural contradiction in industrial market economies and identified rising wages as a solution to overcapacity caused by rising labor productivity. But foreign capital denominated in foreign currency (dollars) rejects the need for high local wages because it earns its dollar profits from export to foreign markets. This is the main reason why emerging economies must avoid excess dependence on export for dollars financed by foreign capital in dollars. China needs to accelerate its domestic development with sovereign credit denominated in Chinese currency to proportionally reduce its excessive dependence on export for dollars financed by foreign capital in dollars. China needs to denominate its export trade in Chinese currency to break free from dollar hegemony. This is the key strategy for positively influencing a new world economic order of universal justice to replace current predatory terms of international trade under dollar hegemony. Since the Cold War, which officially ended with the dissolution of the USSR in 1991, world economic growth has distorted by a shift from aggregate domestic development with sovereign credit within sovereign nations to excessive reliance on globalized neo-liberal trade engineered and led by the US as the sole remaining superpower. International trade has since been denominated in the US dollar, a fiat currency after 1971, as the main reserve currency. International trade has been driven by the huge US consumer market made possible by the high wages of US workers backed not by rising productivity, but by US dollars that the US, and only the US, can print at will through its central bank. In China, rising worker productivity has not resulted in higher wages, but only in lower export prices. This is the main reason why the Chinese domestic market lags behind in consumer demand despite enormous rise in Chinese worker productivity. Many Western critics erroneously pressure China to revalue its currency to address the persistently large trade imbalance. The only effective measure to deal with this trade imbalance is for China to raise wages rather than to revalue the exchange rate of its currency. For the past two decades before the global financial crisis that first broke out in mid 2007, economic growth in the dysfunctional world economic order has been, and still is, based primarily on free crossborder flow of capital and speculative funds driven by cross-border wage and regulatory arbitrage. This growth has been sustained by knocking down national tariffs worldwide through the authority of supranational institutions such as the World Trade Organization (WTO), and financed by a deregulated foreign exchange market working in concert with a global central banking regime independent of national political pressure, lorded over by the supranational Bank of International Settlement (BIS) and the International Monetary Fund (IMF). Ever since the end of the Cold War in 1991, which actually began winding down in the early 1970s with US policy of Dtente, trade has increasingly overwhelmed domestic development in the global economy, as superpower competition to win the hearts and minds of the world in the form of aid subsided. Persistent fiscal and trade deficits forced the US to suspend in 1971 the peg of the dollar to

gold at $35 per ounce, in effect abandoning the Bretton Woods regime of fixed exchange rates linked to a gold-back dollar. The flawed international finance architecture that resulted has since limited the global growth engine to operating with only the one cylinder of international trade, leaving all other cylinders of domestic development in a state of permanent stagnation. The venue of sovereign credit for national development has been foreclosed permanently. China needs to free itself from dollar hegemony to use sovereign credit to develop her domestic economy. Since 1978, China has exposed itself to the disadvantages of export trade denominated in dollars. Much of the wealth created in China during the last 30 years has ended up in the US, leaving China in an extended state of capital shortage despite being the largest holder of foreign reserves in the world. When it comes to consumer power and environmental pollution, China is only the kitchen; the dinning room is in the US. In a new world economic order, China should move the dinning room back inside China. The global economy is a comprehensive and complex system of which trade is only one sector. Yet economists and policy-makers promoting neoliberal globalization tend to view trade as the entire global economy itself, downplaying the importance of non-trade-related domestic development. Neoliberals promote market fundamentalism as the sole, indispensable path for national economic growth, despite ample evidence in the past three decades that trade globalization tends to distort balanced domestic development in ways that hurt not only the less developed, but also the developed economies. This is why a new world economic order must restore domestic development with sovereign credit as the driving force and reduce world trade as an auxiliary force in which export should be denominated in the exporting countrys currency. The distributional consequences of predatory terms of global trade liberalization under dollar hegemony work against the developing economies in the world. Such predatory terms of trade also work against the poor and the financially weak in all economies, including the advance economies, putting the less educated and the less skilled in a downward spiral of chronic unemployment and persistent hopelessness. Reductions in tariffs reduce tax revenues for public spending that can help poor people and weaken needed protection for endangered domestic industries. While distributional consequences of trade liberalization are complex and country-specific, the general trend has been to exacerbate income disparity everywhere, which in turn leads to economic underperformance and political instability in all countries. In the United States, the Mecca of free-market entrepreneurship, spending by the statist sectors government operations, public finance, defense, health care, social security and public education have kept the economy afloat in recurring protracted recessions, while entrepreneurial ventures in corporate finance, insurance, high-tech manufacturing, airlines and communication languish in extended doldrums needing government bailout. Unregulated markets lead naturally to monopolistic consolidation and abuses in corporate governance and finance through the concentration of market power. It has become clear and undeniable that free markets are inherently self-destructive of their own freedom. Free markets depend on enlightened government regulations to remain free and to prevent them from turning into failed markets. Government, from monarchy to democracy, within capitalist market economies or socialist economies, exists to protect the weak from the strong and to maintain socio-political stability with a just socioeconomic order. A new world economic order will have to be based on this principle of universal justice between and within sovereign nations. For China to exert influence on the formation of this new world economic order, it must construct its domestic economic order on the same principle of equality and fairness. World trade is now a game in which the US produces fiat dollars of uncertain exchange value and zero intrinsic value, and the rest of the world produces goods and services that fiat dollars can buy. The worlds interlinked economies no longer trade to capture Ricardian comparative advantage; they compete in exports to capture needed dollars to service dollar-denominated foreign capital and debts and to accumulate dollar reserves to stabilize the value of their currencies in world currency markets. To prevent speculative and manipulative attacks on their currencies, central banks of all trading governments must acquire and hold dollar reserves in amounts that can withstand market pressure on

their currencies in circulation. The higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold. Only the Federal Reserve is exempt from this pressure, because the US Treasury can print dollars at will with relative immunity. This creates a built-in support for a strong dollar that in turn forces the worlds central banks to acquire and hold more dollar reserves, making the dollar even stronger. This phenomenon is known as dollar hegemony, which is created by a geopolitically-constructed peculiarity through which critical commodities, among the most notable being oil, are denominated in dollars. Everyone accepts dollars because dollars can buy oil. The recycling of petro-dollars into other dollar assets is the price the US has extracted from oil-producing countries for US tolerance for the oilexporting cartel since 1973. The trade value of a currency is no longer tied to the productivity of its issuing economy, but to the size of dollar reserves held by its central bank. By definition, dollar reserves must be invested in dollar assets, creating an automatic capital-accounts surplus for the dollar economy. Even though the US has been a net debtor since 1986, its net income on the international investment position has remained positive, as the rate of return on US investments abroad continues to exceed that on foreign investments in the US. This reflects the overall strength of the US economy, and that strength is derived from the US being the only nation that can enjoy the benefits of sovereign credit utilization while amassing external debt denominated in dollars, largely due to dollar hegemony. Unlike other economies, the USS economy incurs no foreign debt, only domestic debt denominated in dollars held by foreigners. These debts can always be repaid by the Federal Reserve, the US central bank, printing more dollars. Since such a move will devalue the exchange rate of the dollar, foreign holders of the US dollar sovereign or private debt are prevented from demanding payment. Further, when basic commodities are denominated in dollars, the US essentially owns all such commodities. Foreign owners of dollar assets are merely unwitting temporary agents of the US dollar hegemony. Under the Westphalian world order of sovereign nation states, which has framed international relations since 1648, only coordinated economic nationalism that focuses on domestic development can pull the world economy out of its current downward spiral. Economic nationalism should not be confused with trade protectionism. Decades of predatory crossborder neo-liberal finance and trade have generated strong anti-globalization sentiments in every country around the world. It has become a class struggle between the financial elite and the working poor in rich and poor countries alike. Before the end of the first decade of the 21st century, in a world where market fundamentalism has become the operative norm, misguided trade protectionism appears to be fast re-emerging and developing into a new global trade war with complex dimensions. The irony is that this new trade war is being launched not by the abused poor economies that have been receiving the short end of the trade stick, but by the U.S., as leader of rich nations which have been winning more than they have been losing in the current economic order and trade system. Much of this protectionism is designed to protect industries that the rich nations have voluntarily moved offshore for financial and environmental advantage. Such protectionism aims to protect non-existent economic activities by imposing tariffs on goods that the importing nations chose not to produce. The biggest battles of this new trade war are being fought on the currency exchange rate front under dollar hegemony, a global monetary regime in which export nation ship real wealth produced with low wages and high environmental abuse in exchange to fiat paper money of uncertain exchange value and zero intrinsic worth. . Rich nations need to recognize that their efforts to squeeze every last drop of advantage at all levels from already unfair finance and trade will only plunge the world into deeper depression. History has shown that while the poor suffer more in economic collapse, the rich, even as they are financially cushioned by their ill-gained wealth and structural advantage, are hurt by the sociopolitical repercussions of such a collapse, in the form of war, revolution or both. The structural problem of the Chinese economy can be described in one sentence: China produces from plants on its soil financed by foreign investment that operate with low domestic wages for foreign markets that pay with dollars that cannot be used in the Chinese domestic economy.

The solution to this structural problem can also be summed up in one sentence: China must finance Chinese plants with sovereign credit to produce for the domestic market where consumer purchasing power will come from high wages, with sovereign credit repaid by increased tax revenue from a vibrant domestic economy. The adverse impact from the current global financial crisis on the Chinese economy originates from the bloated export sector financed in large part by foreign capital denominated in dollars. Foreign markets have abruptly contracted since mid 2007 to cause massive closure of ten of thousands of foreign jointventures or wholly-owned enterprises, big, medium and small, in the Chinese export sector located along the coastal regions that has caused serious unemployment. Economic recovery through the shifting from export dependency to domestic development requires coordinated actions by both the state and the private sectors. The governments role is to guide stateowned-enterprises and private sector incentives toward a national full employment program through tax incentives and regulatory regimes. Government fiscal spending should be limited to funding infrastructure, both physical and social, that cannot be efficiently financed by private or even collective capital. Consumer demand should be enhanced as a priority in a national income policy to quickly raise wage levels in parallel with a well-funded social security program to eliminate the need for compulsory over-saving out of concern for emergency health expenses and provision for old-age security. In conclusion, China can exert positive influence on a new world economic order by setting an example with its own national development policy. To achieve this goal, China needs to adopt the following policy initiatives: 1) China must recognize that a deregulated market economy is counterproductive to national development. The clear evidence of this is what deregulated markets have done to the US economy, destroying US superpower status within three decades. China must revitalize central planning to guide national development and to use the market mechanism only to augment central planning targets. National destiny and national interest cannot be subjected to the dictation of market profit incentives. 2) China must place full employment with rising wages as a national economic priority and shift from the current market fundamentalist macro management on GDP growth with unemployment as a natural outcome of a monetary policy of price stability. Economic equality and justice must be the guiding developmental principle within the context of merit-based compensation. 3) China must break free from dollar hegemony to use sovereign credit to finance balance domestic development and to reduce excessive dependence on export for dollars and reliance on foreign capital denominated in dollars. A first step in this direction is to require all Chinese export be settled in RMB, not in dollars. 4) China should conduct its foreign trade on principle of mutual development for both trading partners rather than as a financial profit center for Chinese capital. China must reject the predatory terms of international trade developed during the age of imperialism. Unlike 19th century England and Japan, the huge size of the Chinese economy and its domestic market does not require imperialist terms of trade to survive. The US model failed because it aped the British model of empire after World War II. China must avoid making the same error. 5) China must guard against the fallacy of hoping to use green-tech investment as a stimulus to recover from the current global financial crisis. The global environment needs protection. But the time scale difference between the needs of the environment is not congruent with that of the current global financial crisis. The environmental protection problem cannot be solved without first solving the global financial crisis. Attempting to use green-tech investment to jumpstart the current economic crisis is putting the cart before the horse. Such an approach will only end up falling short on both environmental and economic aims.

Why China must buy US Treasuries with her Trade Surplus Dollars By Henry C.K. Liu Many have suggested China is not compelled to buy US Treasuries with her trade surplus dollars. They point out that China does so voluntarily because US sovereign debt is the safest insturment as a storer of value. This is now obviously no longer true. So why doess China continue to buy US sovereign debt? The answer is China has no other options but became a creditor to the US due to US-China trade imbalance. The following explains why. A debt is not an independent thing. It is a designation of financial relationship between parties. For a debt to exist between parties, one party, or parties, must be the debtor, or debtors, and a counterparty or counterparties must be the creditor, or creditors. A debt cannot exist without a counterbalancing credit position. 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. In the language of finance 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 former Federal Reserve Board Chairman Alan Greenspan calls "irrational exuberance", the economic man gone mad. 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 can claim on demand a prescribed amount of gold or other specie of intrinsic value. But fiat money issued by a sovereign government is not a sovereign debt but a sovereign credit instrument. Sovereign government bonds are sovereign debt while local government bonds are agency debt but not sovereign debt, because local governments, while they possess limited power to tax, cannot print money, which is the exclusive authority of the Federal government or a central government. When money buys bonds, the transaction represents sovereign credit canceling public or corporate debt. This relationship is rather straightforward but is of fundamental importance. Money issued by government fiat is now exclusive legal tender in all modern national economies. The State Theory of Money (Chartalism) holds that the general acceptance of government-issued fiat currency rests fundamentally on government's authority to tax. Government's willingness to accept the fiat currency it issues for payment of taxes gives such issuance currency within a national economy. That currency is sovereign credit for tax liabilities, which are dischargeable by credit instruments issued by government in the form of fiat money. When issuing fiat money, the government owes no one anything except to make good a promise to accept its money for tax payment. A central banking regime operates on the notion of government-issued fiat money as sovereign credit. A central bank operates essentially as a lender of last resort to a nations banking system, drawing on sovereign credit. A lender's position is a creditor position. Thomas Jefferson famouslly prophesied: "If the American people allow the banks to control the issuance of their currency, first by inflation, and then by deflation, the banks and corporations that will grow up around them will deprive people of all property until their children will wake up homeless on the continent their fathers occupied ... The issuing power of money should be taken from the banks and restored to Congress and the people to whom it belongs." This warning applies to all other peoples in

the world as well. Government levies taxes not to finance its operations, but to give value to its fiat money as sovereign credit instruments. If it chooses to, government can finance its operation entirely through user fees, as some fiscal conservatives suggest. Government needs never be indebted to the public. It creates a government debt component to provide a benchmark interest rate to anchor the private debt market, not because it needs money. Technically, a sovereign government needs never borrow. It can issue tax credit in the form of fiat money to meet all its liabilities. And only a sovereign government can issue fiat money as sovereign credit. If fiat money is not sovereign debt, then the entire conceptual structure of finance capitalism is subject to reordering, just as physics was subject to reordering when man's worldview changed with the realization that the earth is not stationary nor is it the center of the universe. The need for capital formation to finance socially-useful development will be exposed as a cruel hoax, as sovereign credit can finance all socially-useful development without problem. Private savings are not necessary to finance public socio-economic development, since private savings are not required for the supply of sovereign credit. Thus the relationship between national private savings rate and public finance is at best indirect. Sovereign credit can finance an economy in which unemployment is unknown, with wages constantly rising to provide consumer buying power to prevent production overcapacity. A vibrant economy is one in which there is persistent labor shortages that push up wages to reduce overcapacity. Private savings are needed only for private investment that has no intrinsic social purpose or value. Savings without full employment are deflationary, as savings reduces current consumption to provide investment to increase future supply, which is not needed in an economy with overcapacity created by lack of demand, which in turn has been created by low wages and unemployment. Say's Law of supply creating its own demand is a very special situation that is operative only under full employment with high wages. Say's Law ignores a critical time lag between supply and demand that can be fatally problematic to the cash-flow needs in a fast-moving modern economy. Savings require interest payments, the compounding of which will regressively make any financial scheme unsustainable. The religions forbade usury for very practical reasons. The relationship between assets and liabilities is expressed as credit and debt, with the designation determined by the flow of obligation. A flow from asset to liability is known as credit, the reverse is known as debt. A creditor is one who reduces his liability to increase his assets, which include the right of collection on the liabilities of his debtors. Sovereign debt is a pretend game to make private monetary debts denominated in fiat money tradable. The sovereign state, representing the people, owns all assets of a nation not assigned to the private sector. This is true regardless whether the state operates on socialist or capitalist principles. Thus the state's assets is the national wealth less that portion of private sector wealth after tax liabilities, plus all other claims on the private sector by sovereign right. High wages are the key determinant of national wealth. Privatization generally reduces state assets while it may increase tax revenue. As long as a sovereign state exists, its credit is limited only by the national wealth. If sovereign credit is used to increase national wealth, then sovereign credit is limitless as long as the growth of national wealth keeps pace with the growth of sovereign credit. When a sovereign state issues money as legal tender, it issues a monetary instrument backed by its sovereign rights, which includes taxation. A sovereign state never owes domestic debts except by design voluntarily. When a sovereign state borrows in order to avoid levying or raising taxes, it is a political expedience, not a financial necessity. When a sovereign state borrows, through the selling of sovereign bonds denominated in its own currency, it is withdrawing previously-issued sovereign credit from the financial system. When a sovereign state borrows foreign currency, it forfeits its sovereign credit privilege and reduces itself to an ordinary debtor because no sovereign state can issue foreign currency. Dollar hegemony prevents all states beside to US to finance their domestic development with sovereign credit. Government bonds act as absorbers of sovereign credit from the private sector. US Government bonds, through dollar hegemony, enjoy the highest credit rating, topping a credit risk pyramid in international sovereign and institutional debt markets. Dollar hegemony is a geopolitical phenomenon in which the

US dollar, a fiat currency, assumes the status of primary reserve currency in the international finance architecture. Architecture is an art the aesthetics of which is based on moral goodness, of which the current international finance architecture is visibly deficient. Thus dollar hegemony is objectionable not only because the dollar, as a fiat currency, usurps a role it does not deserve, but also because its effect on the world community is devoid of moral goodness, because it destroys the ability of sovereign governments beside the US to use sovereign credit to finance the development their domestic economies, and forces them to export to earn dollar reserves to maintain the exchange value of their own currencies. Money issued by sovereign government fiat is a sovereign monopoly while debt is not. Anyone with acceptable credit rating can borrow or lend, but only sovereign government can issue fiat money as legal tender. When a sovereign government issues fiat money, it issues certificates of its sovereign credit good for discharging tax liabilities imposed by the sovereign government on its citizens. Privately-issued money can exist only with the grace and permission of the sovereign, and is different from sovereign government-issued money in that privately issued money is an IOU from the issuer, with the issuer owing the holder the content of the money's backing. But sovereign government-issued fiat money is not a debt from the government because the money is backed by a potential debt from the holder in the form of tax liabilities. Money issued by a sovereign government by fiat as legal tender is good by law for settling all debts, private and public. Anyone refusing to accept dollars in the US for payment of debt is in violation of US law. Instruments used for settling debts are credit instruments. Buying up sovereign bonds with government-issued fiat money is one of the ways government releases more sovereign credit into the economy. By logic, the money supply in an economy is not government debt because, if increasing the money supply means increasing the national debt, then monetary easing would contract credit from the economy. But empirical evidence suggests otherwise: monetary ease increases the supply of credit. Thus if fiat money creation by sovereign government increases credit, money issued by sovereign government fiat is a credit instrument. Economist Hyman Minsky rightly noted that whenever credit is issued, money is created. The issuing of credit creates debt on the part of the counterparty; but debt is not money, credit is. Debt is negative money, a form of financial antimatter. Physicists understand the relationship between matter and antimatter. Einstein theorized that matter results from concentration of energy and Paul Dirac conceptualized the by-product creation of antimatter through the creation of matter out of energy. The collision of matter and antimatter produces annihilation that returns matter and antimatter to pure energy. The same is true with credit and debt, which are related but opposite. They are created in separate forms out of financial energy to produce matter (credit) and antimatter (debt). The collision of credit and debt will produce annihilation and return the resultant union to pure financial energy unharnessed for human benefit. The paying off of debt terminates financial interaction. Monetary debt is repayable with money. Sovereign government does not become a debtor by issuing fiat money, which, in the US, takes the form of a Federal Reserve note, not an ordinary bank note. The word "bank" does not appear on US dollars. Zero maturity money (ZMM) in the dollar economy, is equal M2 plus all money market funds, minus time deposits. It measures the supply of financial assets redeemable at par on demand. ZMM grew from $550 billion in 1971 when President Nixon took the dollar off a gold standard, to $9.6 trillion as of December 2009, is not a federal debt. It amounts to about 67.3% of US GDP of $14.26 trillion, slightly over the national debt of $12.33 trillion at the same point in time. Sovereign credit is what gives the US economy its inherent strength. A holder of fiat money is a holder of sovereign credit. The holder of fiat money is not a creditor to the state, as some monetary economists mistakenly claim. Fiat money only entitles its holder a replacement of the same money from government, nothing more. The dollar, being a Federal Reserve note, entitles the holder to exchange the note to another identical note at a Federal Reserve Bank, and nothing else. The holder of fiat money is acting as a state agent, with the full faith and credit of the state behind the instrument, which is good for paying taxes and is legal tender for all debt public and private. Fiat money, like a passport, entitles the holder to the protection of the state in enforcing sovereign credit. It is a certificate of state financial power inherent in sovereignty. The Chartalist theory of money claims that government, by virtual of its power to levy taxes payable with government-designated legal tender, does not need external financing. Accordingly, sovereign credit enables the government to finance a full-employment economy even in a regulated market

economy. The logic of Chartalism reasons that an excessively low tax rate will result in a low demand for currency and that a chronic government fiscal surplus is economically counterproductive and unsustainable because it drains credit from the economy continuously. The colonial administration in British Africa used land taxes to induce the carefree natives to use its currency and engage in financial productivity. Thus, according to Chartalist theory, an economy can finance with sovereign credit its domestic developmental needs, to achieve full employment and maximize balanced growth with prosperity without any need for sovereign debt or foreign loans or investment, and without the penalty of hyperinflation. But Chartalist theory is operative only in predominantly closed domestic monetary regimes. Countries participating in neo-liberal international free trade under the aegis of unregulated global financial and currency markets cannot operate on Chartalist principles because of the foreignexchange dilemma. Any government printing its own currency to finance legitimate domestic needs beyond the size of its foreign-exchange reserves will soon find its convertible currency under attack in the foreign-exchange markets, regardless of whether the currency is pegged at a fixed exchanged rate to another currency, or is free-floating. Thus all non-dollar economies are forced to attract foreign capital denominated in dollars even to meet domestic needs. But non-dollar economies must accumulate dollars reserves before they can attract foreign capital. Even with capital control, foreign capital will only invest in the export sector where dollar revenue can be earned. But the dollars that exporting economies accumulate from trade surpluses can only be invested in dollar assets, depriving the non-dollar economies of needed capital in domestic sectors. The only protection from such attacks on domestic currency is to suspend full convertibility, which then will keep foreign investment away. Thus dollar hegemony, the subjugation of all other fiat currencies to the dollar as the key reserve currency, starves non-dollar economies of needed capital by depriving their governments of the power to issue sovereign credit for domestic development. Under principles of Chartalism, foreign capital serves no useful domestic purpose outside of an imperialistic agenda. Dollar hegemony essentially taxes away the ability of the trading partners of the US to finance their own domestic development in their own currencies, and forces them to seek foreign loans and investment denominated in dollars, which the US, and only the US, can print at will with relative immunity. The Mundell-Fleming thesis, for which Robert Mundell won the 1999 Nobel Prize, states that in international finance, a government has the choice among (1) stable exchange rates, (2) international capital mobility and (3) domestic policy autonomy (full employment, interest rate policies, countercyclical fiscal spending, etc). With unregulated global financial markets, a government can have only two of the three options. Through dollar hegemony, the United States is the only country that can defy the Mundell-Fleming thesis. For more than a decade since the end of the Cold War, the US has kept the fiat dollar significantly above its real economic value, attracted capital account surpluses and exercised unilateral policy autonomy within a globalized financial system dictated by dollar hegemony. The reasons for this are complex but the single most important reason is that all major commodities, most notably oil, are denominated in dollars, mostly as an extension of superpower geopolitics. This fact is the anchor for dollar hegemony which makes possible US finance hegemony, which makes possible US exceptionism and unilateralism. When China exports real wealth to the US for fiat dollars, it is receiving US sovereing credit in exchange of material wealth in the form of goods. Thus the US trade deficit denominated in dollars is in fact US lending to China through buying Chinese goods on soveriegn credit. China now is a holder of US fiat money and as such is acting as a state agent of the US, with the full faith and credit of the USe behind the US sovereign credit instrument (dollar), which is good for paying US taxes and is legal tender for all debt public and private in the US. Fiat money, like a passport, entitles the holder to the protection of the state in enforcing sovereign credit. It is a certificate of state financial power inherent in sovereignty. Since China does not pay US taxes, the dollars that China recieves can only be used to buy US sovereign debt (Treasuries) through extingusishing the US sovereign creidt instruents (dollars). Through this transaction, China changes its position from that of an agent of US sovereign credit to that of a creditor to the US. This is why China must buy Tresuries with its surplus dollar - to change it s poistion from that of a US agent to that of a US creditor.

The only way for China to become free of this dilemma is to require all Chinese exports to be paid in Chinese currency.

Part V: G2 and SCO As Zbigniew Brzezinskis G2 concept of a US-China convergence in geopolitical interests is not yet official US policy, China is likely to merely keep monitoring signs of its evolution in US policymaking

without direct formal official response, while exploiting the concepts diplomatic possibilities for improving bilateral relations. Although China desires well-deserved recognition of it as a world power by the sole remaining superpower, albeit one that is fading, a G2 in the context of hawkish realpolitik generally associated with Brzezinskis world view would go against Chinas long-standing preference for multilateralism that would allow it to form bilateral partnerships and special relations around the globe and to participate as an independent power in regional organizations. China Rejects Concept of G2 On May 20, 2009, at the end of the 11th China-EU summit held in Prague, attended by European Commission President Jose Manuel Barroso, Czech President Vaclav Klaus, whose country held the rotating EU presidency, and EU foreign policy chief Javier Solana, Chinese Premier Wen Jiabao took the opportunity to assuage European concerns by dismissing as groundless the view that China and the United States - through the framework of a Group of Two (G2) - will monopolize world affairs in the future. Some say that world affairs will be managed solely by ChinaUnited States. I think that view is baseless and wrong, Wen told the press. It is impossible for a couple of countries or a group of big powers to resolve all global issues. Multipolarization and multilateralism represent the larger trend and the will of the people. The statement, while dismissing the prospect of G2 hegemonic condominium, does not specifically deny the usefulness on strong bilateral relations between China and the US, nor the beneficial possibilities of close China-US cooperation on global issues. China has always been committed to an independent foreign policy of peace and has continued to pursue a win-win strategy of opening up, said Wen. It stands ready to develop friendly relations and cooperation with all countries and it will never seek hegemony. Wen said China remains a developing country despite remarkable recent socio-economic achievements and that its modernization will continue for a long time with the unceasing efforts of many more generations. Shanghai Cooperation Organization (SCO) Even if the idea of a US-China G2 should become official US policy, China still will have to ensure that a formal G2 framework does not affect the strategic intent of the Shanghai Cooperation Organization (SCO), an interstate mutual-security organization originally founded in 1996 by the governments of China, Kazakhstan, Kyrgyzstan, Russia and Tajikistan. Initially known as the Shanghai Five and organized as a multilateral confidence-building mechanism to peacefully resolve legacy border disputes and to demilitarize the long border between China and the new independent states of the former Soviet Union, the Shanghai Five was joined by Uzbekistan in 2001 after which the members renamed the organization as SCO. A permanent organ of the SCO is the Regional Anti-Terrorist Structure (RA-TS), established in 2004 and headquartered in Tashkent, Uzbekistan. The RA-TS promotes cooperation between SCO member states against cross-border security threats from terrorism, separatism and extremism. The US, by its past actions, while being a selective opponent to terrorism and extremism after the 9/11, 2001 terrorist attacks, had been a covert and sometimes overt supporter of separatism in other countries around the world during and after the Cold War. The problems related to Al Qeuda, the Taliban and Afghanistan are classic examples of blowback from CIA handiwork. Mongolia, an independent state created in early 20th century by goreign imperialist supported separatism from a China then beset with internalpolitical upheaval, won SCO observer status in 2004. Iran, Pakistan, and India became observers in 2005. SCO Supports Uzbek Demand for US Withdrawal In 2005, with SCO support, Uzbekistan called for a fixed time schedule for the withdrawal of US forces from the Karshi-Khanabad Air Base (KKAB) located in southern Uzbekistan. After the 9/11 terrorist attacks on the US, Uzbekistan had been solicited to become a strategic partner of the US, cooperating with US forces on counterterrorism activities and allowing US use of the KKAB for antiterrorist purposes in return for US security guarantees and supply of military equipment. The Uzbek government subsequently grew apprehensive of US instigation of pro-democracy color revolutions in

other post-Soviet states such as Georgia, Ukraine, and Kyrgyzstan. SCO declaration of support for Uzbek decision to end its military cooperation with the US added geopolitical weight and accelerated US withdrawal which was completed by the end of 2005. The Soros Foundation, along with the CIA, was accused of supporting and even planning the color revolutions in order to serve western interests. After the Orange Revolution in Ukraine, several Central Asian nations took action against the George Soros Open Society Institute (OSI). Uzbekistan closed the OSI regional offices, while Tajik state media accused OSI-Tajikistan of corruption. The Guardian claimed that USAID, National Endowment for Democracy, the International Republican Institute, the National Democratic Institute for International Affairs and Freedom House are directly involved in the color revolutions. Both the Washington Post and the New York Times also reported substantial US involvement in these political events. SCO 2009 Summit The SCO has now moved into a new era of pragmatic cooperation that will benefit its member states and the international community. The SCO will hold its 9th annual summit June 15, 2009 in Yekaterinburg, a major city in the central part of Russia and the administrative center of Sverdlovsky Oblast (federal subject) on the eastern side of the Ural Mountian range. It is the most populous oblast within Asian Russia. Soon after the Russian Revolution, on July 17, 1918, Tsar Nicholas II and all members of the imperial family were executed by Soviet revolutionaries at the Ipatiev House in Yekaterinburg. US spy plane U2 pilot Gary Powers was shot down in 1960 over Yekaterinburg. In 1977, the Ipatiev House was demolished by order of Boris Yeltsin who later became the first President of the Russian Federation. The 2009 summit will be held on the eighth anniversary of the establishment of SCO. Under the guidance of the Shanghai Spirit, which enshrines mutual trust and benefits, equality, negotiation and respect for cultural diversity, the SCO has evolved into an efficient mechanism for maintaining common benefits for and promoting cooperation among member states. It has also grown into a major force in facilitating the realization of lasting peace and common development. The SCO also has made crucial contributions to the establishment of a just and rational international order. As SCO members have strengthened mutual trust and coordinated their stances on international issues, political collaboration within the SCO is expected to become a potent mechanism in setting up a new global political order. In terms of security, a major priority within the SCO, all member states have made achievements in fighting terrorism, drug trafficking and other problems. In particular, several meetings this year have outlined a more tangible roadmap for further cooperation in this sphere. SCO Conference on Afghanistan Member states at the first SCO conference on Afghanistan held March 27, 2009 in Moscow reached consensus on comprehensive cooperation against terrorism, drug trafficking and organized crime. The defense ministers of SCO member states also endorsed a cooperation plan for 2010-2011 after an April 29, 2009 meeting in Moscow. A series of cooperation documents concerning transborder organized crime, money laundering and oil and gas pipeline security were signed after the first meeting of the SCO interior and public security ministers in Yekaterinburg on May 18, 2009. SCO Economic and Trade Cooperation Economic and trade cooperation has also been undergoing smooth development among SCO members. A series of trade and investment projects are being implemented, including transportation projects involving China, Kyrgyzstan and Uzbekistan. A new outline for multilateral economic and trade cooperation among member states signed by SCO prime ministers at the 2008 October summit has marked key points for future initiatives. Moreover, SCO members have also started to discuss a joint mechanism against the ongoing global financial crisis. Relevant issues are expected to top the agenda at the Yekaterinburg summit. China has been playing an active role in SCO trade and economic cooperation. Trade volumes between China and the other member states have increased at an average annual growth rate of 30% - from US$12.1

billion in 2001 to US$67.5 billion in 2008. By the end of 2007, China has provided the other SCO members with investments worth US$13 billion. SCO member states also emphasize the enhancement of cooperation in culture, education, healthcare, disaster management and relief. SCO has become a platform for setting up collective measures, said SCO Secretary General Bolat Nurgaliyev. In compliance with an increasing need for foreign exchanges and cooperation, the SCO in recent years has accepted Mongolia, Pakistan, Iran and India as observers. It also has established contact group relations with Afghanistan and obtained observer status in the United Nations General Assembly. The SCO has also begun to study the procedural mechanism of accepting new member states. The reason SCO will thrive and prosper is that its tenets and formation are congruous with the multipolar and globalizing trend, the political and economic development of the Eurasia region and the fundamental interests of their peoples. Amidst the current financial crisis, strengthening economic and financial cooperation among SCO member states helps to enrich cooperation within the organizations framework. SCO member states China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan - adopted a program of multilateral trade and economic cooperation in 2003. Since then, cooperation in security and economic matters has been gradually evolved, with economic cooperation gaining an increasingly important influence. In October 2005, the SCO banks consortium was established, indicating the start of financial cooperation among the member states. Since then, the members have been actively cooperating by offering financial support to key projects, making the consortium an important platform to push for regional cooperation within the SCO. In the financial sector, Chinas Banking Regulatory Commission signed a memorandum of understanding on bilateral supervision cooperation with Central Asian member states. The central banks of the SCO members also signed financial cooperation treaties. Beijing and Moscow held several financial cooperation forum, the two central banks signed multiple bilateral agreements, and the commercial banks of the two countries established broader business ties. To further develop trade among member states, the SCO also established professional work teams to ensure the research and coordination of SCO members in the areas of quality supervision, E-commerce and investment promotion. Strengthening economic and financial cooperation is an inevitable choice for SCO members in order to meet the challenges of regional integration and globalization. It also is an important measure to cope with impacts from the global financial crisis. Through economic and financial cooperation, SCO members can increase cohesion, broaden cooperation, heighten vitality, and strengthen interdependence. SCO and the International Financial Order China and Russia are emerging economies and the other SCO members are developing countries. As such, their importance and interests have not been properly represented separately in the existing international financial order. SCO members as a block can cope with the global crisis more effectively, by raising the regions visibility and status to strengthen their collective voice by enhancing economic and financial cooperation. China had provided a preferential credit of more than US$900 million for the SCO. China had made and will continue to make contributions in promoting economic and financial cooperation in the organization. SCO will be an effective venue for restructuring the existing international fianc architecture. SCO different from NATO The SCO is not a mutual defense pact, unlike the North Atlantic Treaty Organization (NATO) which is a military alliance that has since expanded its original defensive mandate way beyond the North Atlantic region to carry on offensive operations in the Balkans, Afghanistan and Iraq. On April 16,

2003, NATO agreed to take command of the International Security Assistance Force (ISAF) in Afghanistan. The decision came at the request of Germany and the Netherlands, the two nations leading ISAF at the time of the agreement, with unanimous support of all nineteen NATO governments. The handover of control to NATO took place on August 11, and marked the first time in NATOs history that it took direct charge of an offensive mission outside the North Atlantic theatre. Since its establishment, SCO member states have held joint military exercises, most recently in 2007 near Russias Ural Mountains. Still, the SCO serves more as a forum to discuss multilateral issues of trade and security than a fully-developed counterpart of NATO, which has expanded its sphear of operation way beyond the North Atlantic region. On October 27, 2007, the SCO signed an agreement with the Collective Security Treaty Organization (CSTO) whose members are Armenia, Belarus, Kazakhstan, Russia and Tajikistan, in the Tajik capital Dushanbe, to broaden cooperation on issues such as security, crime, and drug trafficking. Joint action plans between the two organisations were signed in early 2008 in Beijing. Uzbekistan became a full member in 2008. CSTO is an observer member of the UN General Asembly. The CSTO charter reaffirmed the desire of all participating states to abstain from the use or threat of force. Signatories would not join other military alliances or other groups of states, while aggression against one signatory would be perceived as an aggression against all. To this end, the CSTO holds yearly military command exercises for the CSTO nations to have an opportunity to improve interorganization cooperation. The largest-scale CSTO military exercise held to date were the "Rubezh 2008" exercises hosted in Armenia where a combined total of 4,000 troops from all 7 constituent CSTO member countries conducted operative, strategic, and tactical training with an emphasis towards furthering efficiency of the collective security element of the CSTO partnership The CSTO grew out of the Commonwealth of Independent States (CIS), a regional organization whise members are former Soviet Republics. CIS first began as the CIS Collective Security Treaty (CST) which was signed on May 15, 1992, by Ameenia, Kyrgyzstan, Russian Federation, Tajikistan and Uzbekistan in the city of Tashkent. In 1993 Azerbajian signed the treaty on Septemeber 24, Georgia on December 9 and Belarus on December 31. The treaty came into effect on April 20, 1994. SCO and the Eurasian Economic Community (EurAsEC) The CIS is similar to the original European Community. Although the CIS has few supranational powers, it is more than a purely symbolic organization, possessing coordinating powers in the realm of trade, finance, lawmaking, and security. It has also promoted cooperation on democratization and transborder crime prevention. As a regional organization, CIS participates in UN peacekeeping forces. Some members of the CIS have established the Eurasian Economic Community (EurAsEC) with the aim of creating a full-fledged common market. EurAsEC, created on October 10, 2000 in Kazakhstans capital Astana by Presidents Alexander Lukashenko of Belarus, Nursultan Nazarbayev of Kazakhstan, Askas Akayev of Kyrgyzstan, Vladimir Putin of Russia, and Emomalia Rakhmonov of Tajikistan, originated from the Commonwealth of Independent States custom union between Belarus, Russia and Kazakhstan created on March 29, 1996. The Treaty on the establishment of the EurAsEC was subsequently signed on October 7, 2005 with Uzbekistan joining. Common Economic Space is expected to be launched on January 1, 2010. The Organization of Central Asian Cooperation (OCAC) was an international organization composed of Kazakhstan, Kyrgyzstan, Tajikistan, Uzbekistan and Russia. Georgia, Turkey and Ukraine had observer status. Kazakhstan, Kyrgyzstan, Tajikistan, Turkmanistan and Uzbekistan formed the OCAC in 1991 as Central Asian Commonwealth (CAC). The organization continued after 1994 as Central Asian Economic Union (CAEU), in which Tajikistan and Turkmenistan did not participate. In 1998 it became Central Asian Economic Cooperation (CAEC), which marked the return of Tajikistan. On February 28, 2002 it was renamed to its current name OCAC. Russia joined OCAC on May 28, 2004 on the initiative of Uzbekistan. In October, 2005 Uzbekistan applied for membership in EurAsEC. OCAC de facto dissolved on January 25, 2006, when Uzbekistan joined EurAsEC. On November 12, 2008, Uzbekistan temporarily suspended its membership in EurAsEC.

The creation of a common economic space between the CIS countries of Russia, Ukraine, Belarus, and Kazakhstan, was agreed in principle after a meeting in Moscow on February 23, 2003. The Common Economic Space would involve a supranational commission on trade and tariffs that would be based in Kiev, would initially be headed by a representative of Kazakhstan, and would not be subordinate to the governments of the four nations. The ultimate goal would be a regional organization that would be open for other countries to join as well, and could eventually lead even to a single currency. On May 22, 2003, the Ukrainian Parliament voted 266 to 51 in favor of the joint economic space. However, the Orange revolution of 2004 that brought to power Viktor Yushchenko dealt a significant blow against the project. Yushchenko has shown renewed interest in Ukrainian membership in the European Union, and such membership would be incompatible with the envisioned common economic space. The Paris summit of September 2008 hosted by Nicolas Sarkozy, President of France and president-inoffice of the European Council, attended by Javier Solana, High Representative of the EU for common foreign and security policy and other high ranking officials from Brussels, was a major event in the EU-Ukraine bilateral relations. Russian President Dmotry Medvedev has indicated that the creation of a common economic space for Russia, Kazakhstan, and Belarus may be launched on January 1, 2010. Russian Foreign Minister Sergei Lavrov said on December 10, 2008 that Moscow is ready to build a common economic space with both Europe and the United States on a basis of equality. Kazakh President Nursultan Nazarbayev has proposed the creation of a common noncash currency called yevrav for the community. This would help insulate the countries from the dollar global economic crisis. In May 2007 the CSTO secretary-general Nikolai Bordyyuzha suggested Iran could join the CSTO saying, "The CSTO is an open organization. If Iran applies in accordance with our charter, we will consider the application." [27] If Iran joined it would be the first state outside the former Soviet Union to become a member of the organization. On October 6, 2007, CSTO members agreed to a major expansion of the organization that would create a CSTO peacekeeping force that could deploy under a UN mandate or without one in its member states. The expansion would also allow all members to purchase Russian weapons at the same price as Russia. CSTO signed an agreement with the SCO, in the Tajik capital Dushanbe, to broaden cooperation on issues such as security, crime, and drug trafficking. On August 29, 2008, Russia announced it would seek CSTO recognition of the independence of Abkhazia and South Ossetia, which touched off a war between Russia and Georgia. Three days before, on August 26, Russia recognized the independence of Georgias breakaway regions of Abkhazia and South Ossetia. The CST was set to last for a 5-year period unless extended. On April 2, 1999, only six members of the CST signed a protocol renewing the treaty for another five year period Azerbaijan, Georgia and Uzbekstan refused to sign and withdrew from the treaty instead. At the same time Uzbekistan joined the GUAM group, established in 1997 by Georgia, Ukraine, Azerbijian and Moldova, changing the name to GUUAM group and largely seen as intending to counter Russian influence in the region. In the years following the signing of its charter the GUAM grouping was generally considered to have stagnated. During 2005, the CSTO partners conducted some common military exercises. In 2005, Uzbekistan withdrew from GUAM and joined the CSTO in 2006 in order to seek closer ties with Russia. In June 2007, Kyrgyzstan assumed the rotating CSTO presidency and in October 2007, the CSTO signed an agreement with the SCO, in the Tajik capital Dushanbe, to broaden cooperation on issues such as security, crime, and drug trafficking. On October 6, 2007, CSTO members agreed to a major expansion of the organization that would create a CSTO peacekeeping force that could deploy under a UN mandate or without one in its member

states. The expansion would also allow all members to purchase Russian weapons at the same price as Russia. On August 29, 2008, Russia announced it would seek CSTO recognition of the independence of Abkhazia and South Ossetia. Three days before, on August 26, Russia recognized the independence of Georgias breakaway regions of Abkhazia and South Ossetia. On February 4, 2009, Russian President Dmitry Medvedev announced that the rapid military reactionforce that would be deployed during a military aggression against a CSTO member would be just as good as comparable NATO forces. He added that Russia would be ready to contribute a division and a brigade. SCO Economic Cooperation All SCO members except China are also members of the EurAsEC. A Framework Agreement to enhance economic cooperation was signed by the SCO member states on 23 September 2003. At the same meeting Chinese Premier Wen Jaibao proposed a long-term objective to establish a free trade area in the SCO, while other more immediate measures would be taken to improve the flow of goods in the region. A follow up plan with 100 specific actions was signed one year later, on September 23, 2004. On 26 October 2005, the Moscow Summit of the SCO, the Secretary General of the Organisation said that the SCO will prioritise joint energy projects; such will include the oil and gas sector, the exploration of new hydrocarbon reserves, and joint use of water resources. The creation of an Interbank SCO Council was also agreed upon at that summit in order to fund future joint projects. The first meeting of the SCO Interbank Association was held in Beijing on 21-22 February 2006. On 30 November 2006, at an international conference: The SCO: Results and Perspectives, held in Almaty, the representative of the Russian Foreign Ministry announced that Russia is developing plans for an SCO Energy Club. The need for this club was reiterated by Moscow at an SCO summit in November 2007. Other SCO members, however, have not committed themselves to the idea. The August 28, 2008 summit issued a statement that read: Against the backdrop of a slowdown in the growth of world economy pursuing a responsible currency and financial policy, control over the capital flowing, ensuring food and energy security have been gaining special significance. In the St. Petersburg International Economic Forum held on June 5-6, 2009, the joint response of SCO members to the ongoing financial crisis, and the potential restructuring of the global financial and economic system, were the key topics of discussion. Panel members also noted the importance of development cooperation within the SCO, and interbank links between SCO member countries to finance key joint projects. Specifically: SCO countries have not escaped the consequences of the global financial crisis. Member countries need to consider the development and implementation of new economic and financial market regulations that differ from the principals established at Bretton Woods. It was noted that SCO members should implement joint efforts to handle the global financial crisis, and coordinate efforts to maintain trade relations at pre-crisis levels. Representatives of SCO member countries confirmed that they plan to transform the SCO into a new economic structure with management bodies on top of regional governments. The SCO, it was acknowledged, remains a forum for discussion and the development of joint projects in various areas including medicine, education, logistics and insurance. SCO members plan to accelerate cooperation with observer countries in the organization, including India and Iran. SCO members are considering establishing an energy club to intensify dialogue in the spheres of energy and water reserves. Several SCO members have significant energy reserves, while a growing number of member countries particularly in Central Asia face potential water and energy deficits. The development of a modern logistics network is vitally important for SCO member countries. The members are currently focused on creating a multinational logistics system (project E40), which envisages the establishment of several logistics centres on the territory of SCO members. Notably,

several SCO countries have no access to seaport infrastructure. The key task is to maintain stability in the SCO region, but this cannot be achieved without an adequate financial and economic base. The SCO interbank association plans to become more closely involved in financing projects oriented towards all six SCO members. It was confirmed that the SCOs upcoming summit in Yekaterinburg will include a detailed presentation on progress in this regard. Participants noted significant progress on various projects in the financial sphere among SCO members. EuroAsia Development Bank, created by Russia and Kazakhstan to invest in infrastructure projects, with $1billion under management, is being funded by Russian (Renaissance Capital), Kazakh (Samruk-Kazyna) and international (Macquarie Capital) financial institutions. Representatives of SCO member countries highlighted the important role of public-private partnerships several times during the discussion. China is a key SCO member. It was acknowledged that the Chinese economy has demonstrated its ability to absorb crisis threats, and the role of the Chinese economy is strengthening within the global framework. SCO member countries, it was acknowledged, may benefit from the Chinese experience, and Chinese officials confirmed their willingness to share this experience and support SCO member countries. SCO and BRICs At the invitation of Russian President Dmitry Medvedev, Chinese President Hu Jintao will pay a state visit to Russia in Moscow followed by state visits to Slovakia and Croatia from June 18 to June 20, after attending the 9th annual summit of the SCO June 14-18, 2009 in Yekaterinburg, a major city situated on the eastern side of the Ural mountain range in Asian Russia. SCO leaders are expected to discuss counter-measures for tackling the financial crisis as well as expanding inter-member economic cooperation. During the visit to Yekaterinburg, President Hu will also attend the first meeting of BRIC (Brazil, Russia, India and China) leaders.The term, BRIC, was coined by Goldman Sachs economist Jim O'Neill in 2003. BRICs account for 42% of the worlds population, 14.6% of global Gross Domestic Product (GDP) and 12.8% of the global trade volume in 2008. The first meeting of BRIC leaders, scheduled for June 16, 2009 will cover a wide range of issues including the world situation, a new global financial system, the current financial crisis, energy cooperation and environmental protection.