Deepening global financial crisis

By S P SETH

It is quite daunting to get a handle on the worsening financial situation of Western economies, including the United States. Not long ago, the European Union of 27 countries, and its euro zone of 17 countries with a common currency, was the hallmark of regional consolidation, setting an example for many other regions. But it is having serious problems that might put the whole project at risk. The question is: what went wrong?

What has gone wrong is that the entire edifice of capitalism increasingly became like a pyramid structure based on sand dunes of flakey finances. It became an exercise, in most cases, of bundling up and bunching up several financial instruments of dubious/toxic value and to trade them as real products. And so long as the governments, banks, hedge funds, insurance agencies and the likes continued to paddle this illusion, everybody seemed happy. And to keep the merry go round, there was more credit available than ever and people were encouraged to borrow from banks and other credit institutions to buy houses and whatever they wanted. The new economy supposedly had got rid of inflation and the upward curve was there to say with more of the same.

While China was busy being the factory of the world producing cheap consumer goods and building up trade surpluses with the United States and Europe, the latter were wittingly or unwittingly running down their manufacturing base. China’s cheap goods helped to keep the inflation down in the United States, Europe and elsewhere in the world. And to keep up the momentum of its manufacturing exports, China happily invested significant amount of its trade surpluses in the US bonds and treasury notes, thus providing it with cheap credit.

And we know that when the economic bubble burst in 2008, Western economies were like the emperor with no clothes. The economic bubble first burst in the United States where, among other things, the housing market collapsed with people unable to repay their mortgages. The collapse of the US housing market sent shock waves into Europe because many of their banks had invested into US-origin toxic financial products, including mortgage stocks. Which meant that Europe too got involved into the huge pyramid credit scheme designed in the United States by its banks and other financial institutions.

The resultant global financial crisis was sought to be dealt with in two ways. First, the failing banks were bailed out by the state in both the United States and Europe. Which meant that the private losses of banks and other affected institutions were socialized and turned into sovereign debt at the cost of public finance. Second: The states undertook measures to stimulate their economies by borrowing more money on top of what they already owed so as to stem recession. But it hasn’t worked quite like that. The US economy, for instance, is in deep trouble with official unemployment at 9.2 per cent with 14 million unemployed. The anticipated recovery was supposed to create more employment and more revenue to kick start the economy that, in turn, will pay off the debt over a period of time. It was the usual formula of the boom and bust cycle, one following the other and so on.

Even as the US is stuck in economic rut, its politicians are trying to score political points in the fashion of Emperor Nero fiddling while Rome was burning. The US debt is about to reach its present limit of $14.3 trillion. And if by August 2, the debt limit is not raised, the country will not be able to pay many of its bills, like interest payments on its debt, salaries and welfare entitlements and so on. In the event, it will not only seriously dent the United States’ economic credibility but also worsen the global economic crisis. Two of the international rating agencies have threatened to downgrade US’ top level (AAA) credit rating.

The political controversy in the US centers on the need to rein in US debt through a mix of spending cuts and tax increases. The Republicans oppose any kind of tax increase, and advocate significant spending cuts to slash welfare entitlements. President Obama and Democrats in the Congress broadly favor a mix of the two. They are engaging in political brinkmanship, particularly the Republicans, waiting which side will blink first. And if it is not resolved by August 2, the US and the world, by most accounts, might be in even greater economic trouble.

Even if the immediate crisis is resolved and the debt ceiling raised, the US economy remains in serious trouble. The stimulation packages haven’t worked to revive the economy meaningfully, if at all. The Federal Reserve’s efforts by injecting more liquidity through printing money and buying bonds haven’t done the trick. Neither has keeping the official interest rate at around the lowest point revived the confidence. With millions of people unemployed and under-employed and many unable to repay their mortgages and other loans, the consumer confidence is at a low point. The morale in the United States is quite low because people can’t see much hope over the horizon.

At the same time, in Europe, Greece is teetering, Ireland and Portugal are already on drip with their respective rescue packages, with Spain and Italy not too far behind. The European Union, and its euro zone, is not sure if successive bailouts of sick economies are worthwhile if they will have to eventually default on their debts. If they default, it will affect the balance sheets of German, French and other banks exposed to the debts of these economies. Which, in turn, might require their governments to bail out their banks. It is a vicious circle, with no escape hatch.

Among the major world economies, China has weathered the crisis relatively better. But it has serious problems of its own---inflation, for one. But that is another story.

Note: This article was first published in Daily TimesDeepening global financial crisis

By S P SETH

It is quite daunting to get a handle on the worsening financial situation of Western economies, including the United States. Not long ago, the European Union of 27 countries, and its euro zone of 17 countries with a common currency, was the hallmark of regional consolidation, setting an example for many other regions. But it is having serious problems that might put the whole project at risk. The question is: what went wrong?

What has gone wrong is that the entire edifice of capitalism increasingly became like a pyramid structure based on sand dunes of flakey finances. It became an exercise, in most cases, of bundling up and bunching up several financial instruments of dubious/toxic value and to trade them as real products. And so long as the governments, banks, hedge funds, insurance agencies and the likes continued to paddle this illusion, everybody seemed happy. And to keep the merry go round, there was more credit available than ever and people were encouraged to borrow from banks and other credit institutions to buy houses and whatever they wanted. The new economy supposedly had got rid of inflation and the upward curve was there to say with more of the same.

While China was busy being the factory of the world producing cheap consumer goods and building up trade surpluses with the United States and Europe, the latter were wittingly or unwittingly running down their manufacturing base. China’s cheap goods helped to keep the inflation down in the United States, Europe and elsewhere in the world. And to keep up the momentum of its manufacturing exports, China happily invested significant amount of its trade surpluses in the US bonds and treasury notes, thus providing it with cheap credit.

And we know that when the economic bubble burst in 2008, Western economies were like the emperor with no clothes. The economic bubble first burst in the United States where, among other things, the housing market collapsed with people unable to repay their mortgages. The collapse of the US housing market sent shock waves into Europe because many of their banks had invested into US-origin toxic financial products, including mortgage stocks. Which meant that Europe too got involved into the huge pyramid credit scheme designed in the United States by its banks and other financial institutions.

The resultant global financial crisis was sought to be dealt with in two ways. First, the failing banks were bailed out by the state in both the United States and Europe. Which meant that the private losses of banks and other affected institutions were socialized and turned into sovereign debt at the cost of public finance. Second: The states undertook measures to stimulate their economies by borrowing more money on top of what they already owed so as to stem recession. But it hasn’t worked quite like that. The US economy, for instance, is in deep trouble with official unemployment at 9.2 per cent with 14 million unemployed. The anticipated recovery was supposed to create more employment and more revenue to kick start the economy that, in turn, will pay off the debt over a period of time. It was the usual formula of the boom and bust cycle, one following the other and so on.

Even as the US is stuck in economic rut, its politicians are trying to score political points in the fashion of Emperor Nero fiddling while Rome was burning. The US debt is about to reach its present limit of $14.3 trillion. And if by August 2, the debt limit is not raised, the country will not be able to pay many of its bills, like interest payments on its debt, salaries and welfare entitlements and so on. In the event, it will not only seriously dent the United States’ economic credibility but also worsen the global economic crisis. Two of the international rating agencies have threatened to downgrade US’ top level (AAA) credit rating.

The political controversy in the US centers on the need to rein in US debt through a mix of spending cuts and tax increases. The Republicans oppose any kind of tax increase, and advocate significant spending cuts to slash welfare entitlements. President Obama and Democrats in the Congress broadly favor a mix of the two. They are engaging in political brinkmanship, particularly the Republicans, waiting which side will blink first. And if it is not resolved by August 2, the US and the world, by most accounts, might be in even greater economic trouble.

Even if the immediate crisis is resolved and the debt ceiling raised, the US economy remains in serious trouble. The stimulation packages haven’t worked to revive the economy meaningfully, if at all. The Federal Reserve’s efforts by injecting more liquidity through printing money and buying bonds haven’t done the trick. Neither has keeping the official interest rate at around the lowest point revived the confidence. With millions of people unemployed and under-employed and many unable to repay their mortgages and other loans, the consumer confidence is at a low point. The morale in the United States is quite low because people can’t see much hope over the horizon.

At the same time, in Europe, Greece is teetering, Ireland and Portugal are already on drip with their respective rescue packages, with Spain and Italy not too far behind. The European Union, and its euro zone, is not sure if successive bailouts of sick economies are worthwhile if they will have to eventually default on their debts. If they default, it will affect the balance sheets of German, French and other banks exposed to the debts of these economies. Which, in turn, might require their governments to bail out their banks. It is a vicious circle, with no escape hatch.

Among the major world economies, China has weathered the crisis relatively better. But it has serious problems of its own---inflation, for one. But that is another story.

Note: This article was first published in Daily Times

Australia’s China conundrum

By Sushil Seth

With Australia’s economic fortunes linked to China’s economic growth, Beijing presumes that it has earned the right to hector Canberra on the state of its economy. And to add insult to injury, a junior diplomat at the Chinese embassy did the hectoring by telling a business forum that Australia’s “dual speed and patchwork economy” needed fixing with Chinese help.

In a wide-ranging critique, Mr Ouyang Cheng reportedly advised Australia to deal with “infrastructure bottleneck and shortage of skilled labor”. He maintained that China’s strengths in these areas could be utilized to “help accelerate Australia’s economic development.”

He cautioned that “Australia’s dual speed [basically the growing mining sector, and the depressed manufacturing and other economic activities) and patchwork economy would not only hurt its own economic development but also influence China and Australia’s long-term economic co-operation.”

These problems are “… also limiting China’s investment in Australia.” And he sought a new mechanism to engage Australia on economic and trade issues to “solve the difficulties of the Chinese enterprises in Australia during their projects application and operation.”

China feels that Australia discriminates when it comes to Chinese investment proposals.

Basically, China’s wants a bigger, if not decisive, say in the way it would like to deploy its capital and labor (if and when needed) in Australia. This will enable it to coordinate demand and supply of the commodities it imports from Australia, and curb their price hikes.

In a larger sense, China would very much like to integrate Australia’s economy in a supportive role to China’s economic requirements.

The flexing of China’s economic muscles is on par with Beijing’s approach to international relations evident in Asia-Pacific region and as far away as Africa and Latin America.

It is using its economic leverage to corner resources for China’s economic development by linking the resources sector of these countries to its economic growth and creating their dependence on China. And once tied in, these economies have very little leeway to chart an independent course.

With Australia, these are early stages but the trend is quite clear. Indeed, there is enough disquiet in Australia to warrant a Senate inquiry into the question of foreign investments, particularly in agricultural land where China has made some forays to mine in farm lands.

Australia’s relations with China are rather tricky. At one level, China is its largest trading partner, with two-way trade topping $100 billion last year, much of it in Australia’s favor.

At another level, Canberra regards China as a strategic threat. Which is leading it to further expand its defense ties with the United States.

It is also moving much of its navy and air force to the north and west of the country where its minerals and energy resources are concentrated and it is more vulnerable. Without naming the potential threat from China, it is taking necessary steps to secure its northern approaches.

Australia has committed to a major program of modernizing and updating its military hardware.

Obviously, Canberra wouldn’t expect to face this threat on its own but by being part of a joint and/or coordinated force with the United States and, possibly, Japan.

As Greg Sheridan, foreign editor of The Australian, writes, “Moving more of our navy and air force to the north and north-west, and inviting a much bigger US military presence there, makes eminent strategic sense.”

But the question is: how will Canberra strike a balance between its primary economic relationship with Beijing and its security partnership with the United States? This is Australia’s China conundrum.

Professor Hugh White of the Australian National University favors Australia playing a bridging role by persuading both US and China to a shared and cooperative leadership in the region. In which case, Australia will not need to choose between them and might live happily thereafter.

He has argued that, “China needs to be persuaded that it, too, should settle for a shared leadership in Asia, a continued strong role for the US and growing roles for Japan and India.”

He apparently seems to realize the odds against this. Because, alternatively, he suggests that Australia might “like New Zealand, simply rely on neutrality and remoteness to keep us clear of Asia’s turmoil, and hope they keep away from us.”

But Professor White’s neutrality option doesn’t have many takers in Australia.

The US, of course, is pretty confident that Australia will be on its side. Australia is US’s military ally, and is taking steps to further expand strategic cooperation with the United States against the backdrop of a rising threat from China.

In other words, China will have to reckon with the reality of Australia not only siding with the US in case of a military confrontation between US and China but also actively contributing to meet all eventualities.

Australia is, of course, not being explicit about this, and hoping that the necessity to choose might not arise. But it is like an ostrich burying its head in sand.

Apart from the general contest for leadership between China and the US, there are regional flashpoints like Taiwan, Korea, and the one now emerging over the South China Sea. China is seeking to edge out its regional neighbors, like Vietnam and the Philippines, from competing sovereignty claims to island chains.

The Philippines has even invoked its alliance with the US to deal with Chinese encroachments into waters and islands claimed by it.

China knows that Australia is a US ally. But Beijing hopes to use its economic leverage through trade and investment to dent its alliance with the United States. However, if Australia were to opt for neutrality, China would be unlikely to take its claim seriously considering its vast network of strategic links with the United States.

China’s growing economic interests in Australia will give it a convenient handle to interfere in Australia’s affairs. Ouyang Cheng’s stern lecture to Australia requiring it to fix its economic malaise is a precursor of things to come..

In this sense, Australia’s economic fortune through its China connection might not be a blessing in the medium and long term. But, in the meantime, let us make the most of it.

Rethinking India-Pakistan relations

By S P SETH

Even as Pakistan’s establishment weighs up the country’s situation in the midst of its multiple woes a certain perspective of contemporary history might help. Ever since India’s partition and the creation of Pakistan as a sovereign state, the relationship between the two countries has been, in so many ways, a continuation of the pre-partition politics. But with independence and separation the stakes rose by externalizing and accentuating, what was once, the internal politics of an undivided people. The Hindu-Muslim divide, fostered by the British during their long rule, is continuing to characterize India-Pakistan relations. As a smaller state with its perceived insecurity, Pakistan sought powerful friends and allies to strengthen it.

This is where the United States came in with its own national and strategic interests. During the Cold War, the US was inclined to regard India with suspicion for its close ties with the Soviet Union. Which created convergence of political and strategic interests between the US and Pakistan, though they didn’t have quite the same agenda. Pakistan wanted to create leverage against India, while the US was more interested in Pakistan’s strategic location not far from the then Soviet Union. The point is that Pakistan’s insecurity against a larger India (a carry over of the pre-partition politics) militated against a fresh start between the two countries. And this has continued to this day, with added complications.

Indeed, with both India and Pakistan as sovereign nations, it was possible, after initial hiccups, to build upon their shared history and culture. But it wasn’t done and both are paying the price for it. For instance, the economic imperative of lifting the standards of their majority populations living in poverty would have created regional stability. There would have been greater cultural interaction to explore a common past and build on it. The vast amount of monies spent on defense budgets could have been used in more productive ways to fund infrastructure thus creating employment opportunities, and to fund literacy and education, to extend and improve health facilities and outcomes and the list would go on. The stakes thus created in common good would have acted as a curb on extremism and terrorist activities.

A shared peace between India and Pakistan is imperative for their common prosperity, now torn by artificial barriers built on prejudice and fear. While India is weighed down by Pakistan’s lurch toward militancy and terrorism mounted by Taliban and associated extremist groups, for Pakistan it is an existential crisis. Therefore, it is time for a rethink in Pakistan to confront the new reality when the state has become a hostage to militant groups dictating the country’s contours in a direction that is alien to majority of its population, if their voting record is anything to go by. In other words, the country’s leadership across the political spectrum requires strategic clarity. That is to decide: which is the biggest danger to Pakistan? Is it a perceived threat from India or a possible internal collapse?

When the Taliban came to power in Afghanistan after a bloody civil war and with Pakistan’s support, it was regarded as a great strategic victory. Under a friendly Taliban regime beholden to Pakistan, Afghanistan was said to provide “strategic depth” in a potential war with India. But what happened was that the Taliban’s nexus with al Qaeda chief, Osama bin Laden, and the 9/11 attack on the US, believed to have been orchestrated by him and his close lieutenants, eventually ended up embroiling Pakistan in the US war in Afghanistan. Which is still causing serious problems in the country, including rolling attacks in parts of Pakistan by the Taliban’s offshoot, Pakistani Taliban. And these attacks have de-stabilized Pakistan to the point of creating an existential threat to the state.

The concept of “defense in depth” turned into a nightmare created by the Afghan Taliban because of its dalliance with the al Qaeda. But the concept still finds favor with Pakistan’s political and military establishment. As the US proceeds with withdrawal of its troops from Afghanistan by the end of 2014, the prospect of Taliban once again capturing power in Afghanistan and beholden to Pakistan for sheltering its top leadership, the idea of “strategic depth” in Afghanistan might once again become attractive.

But it might turn out to be as deceptive as before. Islamabad might find again that a Taliban regime would like to pursue its own agenda. As Tariq Ali has recently commented in the London Review of Books, as part of a review of two books on Afghanistan: “…Gradually, Mullah Omar’s government gained autonomy from its patrons in Islamabad and even engaged in friendly negotiations with US oil companies. But its Wahhabi connections proved fatal. The rest we know.” This time, it might take the form of supporting the Pakistani Taliban against the state. Their ideological affinity to promote and impose a Wahhabi version of Islam on both Afghanistan and Pakistan is a dreadful prospect.

Pakistan, therefore, needs to rethink the country’s ethos and identity. It is true that Pakistan was created to ensure a secure future for the subcontinent’s Muslim population from a Hindu-majority India. But it hasn’t worked like that. It has simply externalized that sense of insecurity. True, the younger generations of people on both sides have very little or no experience of the violence and forced migration of communities that followed partition. But the narrative of that experience by elders and school/university textbooks has, in some ways, deepened the chasm.

Pakistan’s Taliban insurgency is not only widening the gulf, but also threatening the state. Pakistan’s establishment might re-think its founding ideology as a counter to a Hindu-majority India. Its negative formulation tends to cast it into a state of permanent insecurity and threat from India to the point that it can’t even see the serious danger it is facing from within. For sure, it will be controversial after so many years. But there is need to think outside the box of permanent hostility between India and Pakistan, because it hasn’t served the people’s interest. Besides, there is need for a new vision and a new direction in its national affairs.

Note: This article was first published in the Daily Times.