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Global Economy is broke, Asia should take the lead to fix it


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Global  Economy is broke, Asia should take the lead to fix it


Financial system alone is not the problem, the problem is economic and political. by Source: Prof. Maurizio Tosi
Financial system alone is not the problem, the problem is economic and political.

Three fixes are offered: 
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(1) Promote public works, reduce unemployment
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(2) Promote savings
(3) Ban financial derivatives

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Just as European Community was formed in the wake of the depression of the 20th century, it is time to form Indian Ocean Community which links with the European Community and with US economy which largely depends on maritime time trade across the Indian Ocean.

The downgrade on August 5, 2011, of United States rating from AAA to AA+ by Standard & Poor, (S&P) a private rating agency is a symptom of the underlying economic crisis which is  global . 

The underlying problem is both economic and political - extending to the entire globe.

The downgrade complemented the turmoil in Europe with the debt problems faced by PIGS (Portugal, Ireland, Greece, Spain). PIGS have been joined by Italy, France and Germany who have their own Euro-dollar problems to cope with.

The crisis of 2011 is comparable to the economic crises after the two world wars (i.e. after 1919, 1940). Lessons can be learnt from these economic crises.

Keynesian economic model

 

Keynes was instrumental in introducing the current mainstream economic thought , in the wake of the First and Second World Wars.

 

He wrote two works:


The Economic Consequences of the Peace (1919)

How to Pay for the War: A radical plan for the Chancellor of the Exchequer  (1940)

 

Economic consequences of peace (1919)

 

Keynes wrote in 1919: "If we aim deliberately at the impoverishment of Central Europe, vengeance, I dare predict, will not limp. Nothing can then delay for very long that final war between the forces of Reaction and the despairing convulsions of Revolution, before which the horrors of the late German war will fade into nothing."

 

He attacked the post World War I deflation policies with A Tract on Monetary Reform in 1923  an argument that countries should ensure stability of domestic prices, avoiding deflation even at the cost of allowing their currency to depreciate.

 

Keynes's predictions of disaster were borne out when the German economy suffered the hyperinflation of 1923, and again by the collapse of the Weimar Republic and the outbreak of World War II. Only a fraction of reparations were ever paid.

 

How to pay for the war (1940)

 

At the height of the Great Depression, in 1933, Keynes published The Means to Prosperity, which contained specific policy recommendations for tackling unemployment in a  global  recession, chiefly counter cyclical public spending and contains one of the first mentions of the multiplier effect.

 

Keynes' General Theory of Employment, Interest and Money (1936) argues that demand, not supply, is the key variable governing the overall level of economic activity. Without government intervention to increase expenditure, an economy can remain trapped in a    low employment equilibrium.  Keynes advocated activist economic policy by government to stimulate demand in times of high unemployment for example by spending on public works.

 

One consequence was the US announcement of Marshall Plan.

 

Key argument was that war effort should be largely financed by higher taxation and especially by compulsory saving (essentially workers loaning money to the government), rather than deficit spending, in order to avoid inflation. Marshall Plan finally ended up in the formation of European Community with Euro dollar as their common currency. 


 
Double-dip recession of 2011 evokes the memories of history lessons.
 
26.5% decline in US GDP (from 1929 to 1933).
 
US Unemployment: 24.9% (1933), >20% (1932-35)
 
In US, 85% fall in stock prices; 47% fall in industrial production; 80% fall in home building (1929-33)
 
Today, any adverse impact on US economy impacts gobal finances - not merely in Europe but in Asia.  The consequence of US downgrade has been that all stockmarkets in the world recorded massive declines, in a cascading effect.
 
US $ dominates currency circulation in world economy.
 
US trade deficits and consequent increased supply of US $ to the world meant that over 66% of US $ (1980-2005) are held outside USA. Two-thirds of US $ (Over $1 trillion) are in circulation outside USA.
 
Causes for dominance of US$
 
After the formation of OPEC and Petroleum products cartel, petro-dollars were stated in US$ terms and recycled in the world.
 
Thanks to forex, trade, investment, financial derivatives (puts and calls, credit swaps, participatory notes), petro-dollars, US $  is the dominant currency.
 
Total Forex reserves: $9.7 trillion (i.e. 16.7% of World GDP 58.26 trillion). Of these reserves, 2/3 are in US $, held and transacted in financial markets.
 
How to overcome the present economic mess?
 
(1) Promote public works, reduce unemployment
 
US and developed economies of the world should pause and learn lessons from history of the last 20 centuries.
 
Impoverishment of colonies by the colonial loot should be recognized.
 
Developed economies owe reparations to the impoverishment developing world which has come out of colonial dominance.
 
One solution: Just as European Community and Eurodollar were formed, an Indian Ocean Community and Mudra as common currency of IOC should be instituted.
 
This will lead to employment generation in ALL economies of the globe.
 
Law of the Sea now expands territorial waters to 200 nautical miles, opening up new zone for economic exploitation. Projects are ready to link Vladivostok and Bangkok through Trans-Asian Highway and Trans-Asian Railway projects which will provide the multiplier effect made popular in economics by Keynes.
 
(2) Promote savings
 
Avoid the temptation to print US dollars. Slow down the US $ money circulation. Institute steps to reduce US and other Developed Countries' Current Account Deficit by incresing their exports of services for public works' financing in Developing countries, for e.g. IOC.
 
US current account deficit (1976 to 2009): $8.5 trillion which becomes forex reserves of nations outside USA.
 
Promote savings in USA and other Developed Countries.
 
Promote investment of $ held as cash by corporate.
 
(3) Ban financial derivatives
 
Financial instruments such as options, financial derivatives, participatory notes create a false sense of financial health.
 
They do not provide insurance cover, they only promote the development of excessive greed.
 
To promote greater corporate social responsibility, take lessons from millennia-old Dharma-dhamma institutions which promote social responsibility through sreni dharma (corporate responsibility) (e.g. making voluntary contributions as a percentage of turnover to social causes).

S. Kalyanaraman
Former Sr. Exec., Asian Development Bank. Director, Sarasvati Research Center.
Aug. 30, 2011

 

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Director, Sarasvati Research Center. Former Sr. Exec., Asian Development Bank. Ph.D. in Public Administration.

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