"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Friday, January 28, 2011

Egypt Crumbling Into Chaos



I am no expert on Egypt, but I know a client state when I see one.  Egypt is the second largest recipient of US Foreign aid - only Israel receives more.  And this is no accident, the two have been historic rivals, only to be at peace with each other under Carter's Administration with the Camp David Accords.  The US, more than any other nation, is extremely influential in the Middle East - a region, due to its oil reserves, that has been described by US policy planners as "history's greatest prize."

Oil, you see, goes hand in hand with money.  The two are strategic assets.  To have the world's reserve currency means you also control, or at least influence the most oil rich region in the world.  Dick Cheney once said at a 1999 speech at the Institute of Petroleum in London:
Oil is unique in that it is so strategic in nature. We are not talking about soapflakes or leisurewear here. Energy is truly fundamental to the world’s economy. The Gulf War was a reflection of that reality. The degree of government involvement also makes oil a unique commodity. This is true in both the overwhelming control of oil resources by national oil companies and governments as well as in the consuming nations where oil products are heavily taxed and regulated. 
Essentially, the petroleum industry deals with extreme risk and with billions of dollars on the line. Oil is produced in distant lands as a result of huge risk and enormous capital outlays, it is transported over vast distances, refined in expensive refineries with very heavy outlays required to protect the environment and to comply with strict and expensive regulations, distributed through a wide network of pipelines, trucks and wholesale outlets and sold at stations in prime locations and taxed heavily. 
It is the basic, fundamental building block of the world’s economy. It is unlike any other commodity. 
SOURCE

I was never a big fan of Cheney, but the man understands what makes the world work.  I know many bloggers have covered this Egyptian crisis.  But there are many aspects to it.  There is the political aspect, the human rights aspect, and there is also the aspect of contagion.  But as far as the focus of this blog, the global monetary system, this crisis represents a challenge to the US: a challenge of national security, energy, and as a result, the US Dollar.  Let us not forget that a large portion of the recent run up of the national debt has been due to the wars in Iraq and Afghanistan.  Thus, the Egyptian crisis falls at an extremely inconvenient moment.  It is so inconvenient, that Vice President Joseph Biden said when asked if he would characterize Mubarak as a dictator:
“Mubarak has been an ally of ours in a number of things. And he’s been very responsible on, relative to geopolitical interest in the region, the Middle East peace efforts; the actions Egypt has taken relative to normalizing relationship with – with Israel. … I would not refer to him as a dictator.” 
When it comes to foreign policy, there is little difference between Republicans and Democrats that inhabit the White House. Biden's answer is how the White House views client regimes - they are a necessary evil in order to effectuate US policy. The US needs Mubarak, just as it once needed these guys:

President Eisenhower with Cuba's Batista, later to be overthrown by Castro


Vice President Nixon, with King Idris of Libya, later to be overthrown by Khadaffi

President Carter and the Shah of Iran and his wife, during Ayatolla Khomeini's rise

All of the above "transitions in power," and there have been many more, were big setbacks for US foreign policy.  What is compounding the issue today with Egypt is the ongoing global financial crisis, as well as the ongoing wars in Afghanistan and Iraq.  The US, financially, is not in the same state as it was during the cold war, when it only had to face the USSR with little debt, or at least, had a greater ability to finance military operations and foreign governments.  I know that MMT'ers will say, the US is not debt-constrained technically, and that is true.  But the US nonetheless has financial limits that affect the execution of its foreign policy.

Thus, this crisis in Egypt is worrisome for the US, and by extension, the US global monetary system which also relies on the US maintaining influence in the Middle East.  

For the purposes of this blog, I am not viewing this crisis in a moral or patriotic context.  I am viewing this crisis in a geopolitical context, based on realpolitik, and how it can affect the current global order, and by extension, the current global monetary system.

13 comments:

OKL said...

it's the issue of rising inequality i am so concerned about.

while historically people have revolted because of ideology alone, more often than not that revolution was caused by hunger.. again, high food prices has been a major factor in one way or another, if not the trigger.

who cares if the stock market goes up or down? sure, people may go bankrupt, but if there's enough food to go around, it's not so bad... but when there isn't?

this is one very real danger of the USD policy and the prevailing monetary structure in place around the world.

while the Fed's policy now has been openly stated as "raising asset prices to improve balance sheets"- and it may very well do so for the banks- for us viewing the global situation as a whole, it is clearly absurd and ridiculous, the US is getting everything while the rest of the world who doesn't participate in their shenanigans don't.

the rest of the world exports to the US in exchange for dollars and those USD are now worth much less; however much value/tangible wealth they export, it doesn't seem to be enough to purchase more.

i can go on and on... but you get the idea; the rest of the world gets worthless USD while the US enjoys everything- up till they decided to bailout the bankers since LTCM in 1998- even the lower percentile of the US population is feeling the heat.

something's wrong and clearly, if our global leaders do not "wake up", view the data/info as it is instead of subscribing to some silly free market hypothesis- something which the economists were supposed to advice against- we will keep continuing down this path until it breaks, fulfilling Newton's first law, "Every body remains in a state of rest or uniform motion unless it is acted upon by an external unbalanced force."

Maybe until then we will realize that we are not that different from inanimate/lifeless things afterall; reminded of our own fallibility and begin to implement policies that keep our feet firmly grounded.

Misthos said...

OKL,

After I wrote this post, I got to thinking about QE and the subsequent dollar devaluation.

I agree with everything that you write above, and it is now dawning on me that QE and dollar devaluation will also have US national security implications. As you say, the dollar as reserve currency allows the US to export inflation and to consume the economic output of others.

But this inflation coupled with the recent global climate issues affecting agriculture is contributing to higher food costs, which contributes to political instability in the poorest countries.

The US can (so far) print away to feed its 40+ million US citizens getting food assistance, but other, poorer nations don't have this luxury.

The world's poor is bearing the brunt of the US's policy of dollar devaluation to manage its debts. This is creating circumstances that policy makers may have underestimated, or entirely overlooked.

The wealth inequality too, within the US and abroad, I fear, will create severe social and political upheaval.

I have said before, that we live in such a hyper-complex and interconnected world that it is difficult to foresee the unintended consequences of our policymakers' "solutions."

One way or the other, such wealth imbalances, historically, either self-correct thru grass roots political upheaval or the wealth imbalances are maintained by governments thru the violent political suppression of their people.

Most people in the Western world have no idea what is happening. We are watching a new world unfold. Wealth is being consolidated within countries and amongst countries with many losers being created in the process.

Misthos said...

Here's another thought:

Last summer, I was in Manhattan and I got to talking to the cab driver who was an Indian that used to live in Trinidad.

I asked him how things were in Trinidad, and he described to me the wealth inequality and the corrupt government. Things were so bad, he would have to hire security to escort his wife when she went shopping.

I don't remember all the details he gave me, but basically, there was a government supported by the US, and it's leader was a corrupt thug. There was political upheaval, and China, with its massive surplus, stepped in and invested in their oil production. Trinidad is an oil producing nation.

I'm not saying that China was being a "nice guy" compared to the US - it was acting in its self interest and tried a different tact. Such incidents, the cab driver told me, are rarely reported in the US.

I only casually researched this after I heard about it from the cab driver, but it seems to me that it was a setback in US energy security.

Thus, I also see a trend where the US may begin to lose influence abroad to China due to political instability in developing countries. This geopolitical re-alignment could really upset the current world order.

I'm not being pro US or pro China, I'm just making an observation here. Such geopolitical re-alignments, too, are rarely smooth transitions. Historian Niall Ferguson recently commented on this - and arrived at dire conclusions. My take on what he said was, yes the US can be brutal, but when a superpower is replaced or even challenged, the world becomes a dangerous place for everyone during the transition.

The post USA-USSR world which emerged in the early 1990s, with the US unchallenged, and a global debt splurge creating "wealth" for all, is over.

A new world is slowly emerging. This will have consequences for the world's current monetary system - and the US Dollar.

OKL said...

Misthos,

I agree with you. One of the things that really irks me to no end is when intelligent people, who get paid highly, shirks responsibility when the shit hits the fan and says, "We couldn't see it coming."

My response has always been, "So what are you paid for? Why couldn't you see it?"

Anyway, rants aside, China is recognized as the leader of the developing countries; they have been most generous with aid to African countries, whether in the direct form of healthcare, agriculture or industrial development.

in the UN general assembly, it is well known that because of those policies, China commands a great majority of the African votes; irregardless of which African govt is in power.

i guess what im saying is that China already has a great influence in the global scene.

the US also shoots itself in the foot of course, i don't think anyone in the world is convinced that US Foreign Policy is actually benefitting anyone; it seems to make more sense if we viewed the US Foreign Policy as one of "destabilizing".

"assist" the countries with oil, get them to export oil to US in return, they accumulate USD, get them to "open" their economy so US MNCs can go in and begin western influence... it all sounds gd until we realize that that is not what people signed up for.

and you are also right, the world's poor is paying the heaviest price for the "target inflation of 2-3%/annum"; there is nothing complicated about compounding. no wages can keep up with that... and that's besides companies trying to stay lean!

(not that its wrong of course, but i'm looking at the overall effect from 40,000ft in the air)

again, you are also correct in pointing out the food/energy "crisis"; i put that in inverted commas because so far, new production and drilling methods are still maintaining a decent yield... but it's the climate that is really worrying me; it doesn't take a genius to see that record high/low temperatures, increasing frequency of natural disasters are signs that the planet is regulating itself.

mother nature gives little care to human affairs.

well, these are interesting times we live in... lots to observe and learn from... the US is falling in global reputation, but the military is still "officially" recognized as decades ahead of the next competitor and that's what's important; reserve currency is ultimately backed by guns, not pens or dollars... there's plenty of room for the US to push back.

to sum it up;

- food/energy/climate crisis; rising resource prices, 'environmental refugees' etc

- demographics; West is aging, Middle East and East is 'maturing'

- power shift; West population ~15% of world population, but they control 85% of the world; will they let the East take charge without a fight?

- increasing global debt requires more constant/more inflation; how long can this last?

- financialization; in the past, capital flows followed trade flows, now its in reverse; bankers hold power and influence

- rising global income inequality; if elites view this situation as people being incapable/lazy, dissent will follow... imho, more and more people are sensing that the system is broken

- conventional warfare vs modern warfare; application of "crisis-war-resolution-peace" does not apply as well anymore; opponent increasingly difficult to identify, which gives meaning to "there is no strategy without an opponent"


i've sort of lost my appetite to be honest... lol

yet, at the end of the day, we do what we can/want to the best of our abilities as we know it and hope that one good thing leads to another... because hope.. well, springs eternal.

sorry about the comment being a little disjointed...

Jim Slip said...

I don't really see what's the problem. Like Martin Wolf (of the Financial Times) said about countries that want to free themselves from the tyranny of the dollar, all they have to do is stop buying dollars. Then their currency appreciates, dollar depreciates. Problem solved. Also, float your currency (no need for reserves) and finance USEFUL infrastructure for your citizens.

Reading a lot from Bill Mitchell's blog recently, so it seems obvious that neither Western or Eastern governments are doing REMOTELY what they can within the operational aspects of the current system to actually help their citizens.

Misthos said...

OKL,

Looks like we share the same world view.

But as for those that say "we couldn't see it coming" well, I truly believe they are being sincere when they say it. To admit otherwise, would be to blame themselves; an intellectual hurdle they can never overcome due to their arrogance. After all, they are the same people that created the mess, and profited from it.

But these same people have an arrogance bordering on some sort of personality disorder. That's the best way I can describe it.

These are not your average people. They step on a lot of people on their path to success. Few of them take the financial risks that say, a small businessperson takes. Most like Bank CEOs don't even have skin in the game. I know small businessmen that have taken mortgages out on their homes, risking everything to succeed. You think Lloyd Blankfein of Goldman Sachs takes that kind of risk? Hell no - it's always others people money, he gets bailed out, and he always has an information edge that 99% of investors do not have.

When one of these sociopaths like Stanley O'Neil of Merrill Lynch or Dick Fuld of Lehman Bros. fails, they walk away with millions. The small businessperson? They get wiped out. And I mean a homeless type of wipe out. That's real capitalism, not what these banksters practice.

But it's not even about money to them. They are immune to the type of financial catastrophe that the average person may face. To them, it's all power, and they believe, in their world, that they are demi-gods. As Lloyd Blankfein said, they are doing god's work. They really believe it.

Misthos said...

Jim,

Actually, China and others are increasingly entering into bilateral trade arrangements that do not involve the US Dollar. Thus in a way, the process is transpiring right now.

An immediate, world-wide change in reserve currency usage would be catastrophic, in my view. No one wins when a global system is upended so quickly.

The question is, can a transition out of the dollar be smooth thru-out the entire process? I don't think so. Eventually, there is a breaking point. The US reacts.

See my post:

http://fiatcollapse.blogspot.com/2010/11/michael-hudson-on-impending-dollar.html

See the last three minutes of the Hudson interview.

OKL said...

Jim,

I didn't read the Wolf piece and I don't subscribe to FT either, so you might have to copy and paste it somewhere for me...

However, I think that is simplifying the problem far too much by telling countries like Egypt not to accumulate USD.

imho, all the economic progress has been made under a political agreement; there has never been a situation where progress was made without it.

That said, Egypt's progress after Sadat occupied the Sinai to take control of the Suez Canal in 1973 was only possible because of the implicit agreement in the Middle East.

So, what was the agreement? Be pro-Western, keep the Suez Canal open and maintain the status quo in the Middle East. Bear in mind that Egypt is the largest Arab country in the Middle East and they can challenge the Israelis, Saudis and Iranians if they choose to.

So what was the deal?

Egypt exports its commodities to the West and gets USD and EUR in return, together with military support, MNC investment/transferal of technology, acceptance into the international circle etc.

(i guess returning Egyptian archaelogical finds are one of them as well)

So under this political agreement, there is no choice for Egypt to accumulate anything other than USD or EURs and when it comes to oil, it is ultimately transacted in USD; so they are not really buying USD, but just accumulating them as a matter of fact.

So what do they do with all the USD they receive? They buy imports from the US or they buy US Treasuries.

Yes, they can convert USD to other currencies and thereby import from those countries- but that is not part of the political agreement. It might not matter much for smaller countries, but if Egypt starts converting USD to RMB, then the entire Middle East political balance shifts = bigger problems.

Under a free market, you're right- the Egyptian pound (EGP) would appreciate = USD depreciate- and correct the trade imbalance... but who accepts EGPs? Very few, since commodites are priced in USD and no one really has confidence when it comes to EGP. Furthermore, USD is the reserve currency, all transactions are done with it.

Which also means that countries would want to hold USD reserves in case some crisis occurs in their countries; who would want to go hat in hand to the Fed/IMF asking them to accept EGP based collateral in exchange for USD to import stuff? After seeing how the IMF used the 1997/8 Asian Financial Crisis to crush Suharto's regime in Indonesia, no one would be willing do so.

Besides, if the EGP strengthens, it means that their domestic industries suffer from a lack of foreign investment, which countries like Egypt needs to improve their economy and living standards- that will always be a drag on the economy no matter how much the Egyptian govt spends on infrastructure to provide employment for its people.... and that's if they even know what to spend on! and no corruption!

If they want to strengthen their domestic manufacturing capability through foreign direct investments and thereby exports, they would have to buy even more USD to keep the exchange rate low, stoking inflation, which would be made worse since Egypt imports ~40% of its resources... and that's assuming the US would allow them to do so (which is what is happening now).

All in all, it means that developing countries must accumulate USD reserves for emergency usage, international transactions and subject to the political agreements.

To cirumvent this problem, countries can opt to create bilateral agreements to transact in each other's currencies. For example, the Europeans will buy Chinese goods with the EUR and vice versa with RMB; no transacting in USD. This of course takes a great deal of political dealings and trust in each other not to devalue the currency or use it as a destabilizing tool on each other; which takes time to build, but could be accelerated by the idiocy of the Fed, which we are seeing now or the perceived weakening of the US, which is popular now.

OKL said...

cont'd


But there's a catch; since these economies export mostly to the US and the US is 25% of world GDP and runs the biggest account deficit, by definition other countries would have to hold USD.

So if the USD depreciates because other countries are not using it, it means that if the right policies are in place, the US will begin to export more... and when that happens, it means that USD is flowing back into the US, depleting the USD accounts in other countries; USD demand increases, USD supply decreases = foreign currencies depreciate = US MNCs start investing in foreign countries. of course, if the US govt starts running surpluses, then heheheh...

there's a much shorter way to discourage others from using other currencies to transact; undermine confidence in that country/s with foreign policy... in today's context, we would have to keep a close eye on how US deals with Iran/Middle East; if they do it well and fast enough, then they will either focus their attention on Russia or China.

bleagh, i've gone on long enough; but i guess you see the point, the US holds all the aces, simply because reserve currency status is backed by guns, not pens or currencies.

as for the free market? well, that was just a hypothesis, never reality. economic policy must always serve its political masters, just like the military.

to sum it up;
- USD accumulation is not a choice, but a must

- countries can spend wisely; if their people trust them to do so, if they know what to spend on, if they do spend it properly... too many ifs

- US holds the aces; especially cultural influence and military power; they are just over-focused on the Middle East at the moment


cheers

Jim Slip said...

OKL, sadly the Financial Times website only allows you to view 9 articles per month if you're not a subscriber, so I've lost access to the Martin Wolf editorial.

Anyway, my preferred choice for economy-related stuff is Bill Mitchell's excellent blog, because not only he explains the operational realities of the current system in a simple and coherent manner, but also because he explains why governments (pretty much worldwide) have done a terrible job at promoting conditions for prosperity.

The blog can be found at:

http://bilbo.economicoutlook.net

Anyway, there is clearly a bias in your views in favour of the export orientated model, whereas the exporting (virtuous) countries should get a store of value in exchange for their exports. Clearly the gold-standard is the appropriate monetary system if you choose to pursue such an export growth model, because it "punishes" deficit countries by imposing clear restrictions on them immediately (lose their gold supplies, devalue, limit spending etc).

However, since we do not live in a gold-standard world anymore, it seems important to understand that what China, Germany etc are doing is only voluntary. They choose to calibrate their economies so that they export, and they choose to accumulate reserves, and they choose to buy dollars to manipulate the exchange rate, or whatever.

As Bill Mitchell puts it:

"The Chinese (and any foreign entity) wanted to hold US dollar-denominated financial assets as a voluntary choice. Mostly this is to keep the value of their currencies down because they think exporting a lot of their wealth (resources) is good. Well as long as they think giving more real goods and services away net is good they will keep desiring to accumulate USD and other foreign currency financial assets. When they decide not to do that then they will stop exporting as much and the US currency will drop a bit in value and the Americans will have to ship relatively more real goods and services net than they did in the past to China. In other words, the party will be over for the US but this just means marginal adjustments in the scheme of things. The sky will not fall in on the US folk!"

Misthos said...

Jim,

I'll admit, I am not familiar with Bill Mitchell's blog, though I have just started to read it. But judging by the quote you posted, Bill Mitchell does not take into consideration credit growth - at least not the way I think he is doing. He is viewing things in a sterile environment, that is, he is not taking a larger view outside of the MMT view.

The US is facing a huge dilemma - one that is caused by excessive credit growth that has distorted the economy. The economy is being artificially propped up. It is a zombie. Just look at the condition of the banks, the FIRE economy, and the balance sheets of the states and local governments. Mitchell is overlooking this when he assures us that the sky is not falling.

I have said before that I will write on what collapse could entail, and will post on it this week. Feel free to critique it thru the views of Mitchell and MMT, I welcome it, as I believe there is still much to debate.

OKL said...

Jim,

I read Bill Mitchell's blog as well and I agree with most of the things he writes about.

Yet, I think its necessary to understand why China is accumulating USD and how they, together with the rest of the Asian Tigers, might transition to having more domestic driven consumption.

While it is theoretically correct that in this rebalancing US companies will begin to export more, we also need to be cognizant of the fact that Chinese jobs will be lost and if this occurs on a large scale, it will have geopolitical repercussions.

This is where re-balancing's effects is often underestimated; from the economic side, it is the role of debt in the economy that is often underestimated... while on the political side, nationalism-military.

Besides, it is difficult to think that MMT can solve the inflation woes... though when I read Mosler's article on financial reform, it would certainly go a long way to rein in the banks' influence.

http://www.huffingtonpost.com/warren-mosler/proposals-for-the-banking_b_432105.html

Misthos said...

@ Jim and OKL,

As you see in my introductory note on my blog, I write:

"This blog chronicles current events as they relate to the interwoven fields of geopolitics, economics, and monetary theory - because I believe that all three affect each other as this global economic crisis unfolds."

OKL - you refer to this as well in your post above. My view is that too many economics professors look at economics in a sterile environment - they overlook geopolitical implications. Their theories and their mathematical models, in my view, are extremely lacking other factors that exist in a complex and interconnected world of nation self interest and resource constraints.

It's not just the market or econmic theory that decides who gets to consume what resources or whose economic output. It's geopolitics, including military might and alliances - both economic and military.

I appreciate both of your views, and I hope as this blog continues, more people share their views here - from around the world. I will be the first to admit that I am no expert. However, I also often doubt the knowledge of "experts." But I believe that debate is necessary to share views and to help me evolve my own views.

Thank you both.