Global financial system needs a major shake-up


Published in Arab News: Aug 14, 2011 23:37

The sinking US dollar and the euro crisis are threatening the world financial system. The US Federal Reserve’s recent decision to keep dollar interest rates near to zero at least for two more years was an unprecedented step, according to some economists. It is also being suggested that the US might be starting to look eerily like Japan — entering into long-term recession.

The Japanese economy fell into recession in early 1990s and is still experiencing a disastrous period of economic stagnation and deflation after bubbles in its stock market and real estate industry collapsed.

Interestingly, the Japanese did not learn any lessons from the great American Depression of the 1930s and the Americans failed to learn from the Japanese depression of 1990s.

Had the American policymakers even bothered to recall the reasons of Japan’s collapse, they could have avoided and saved themselves from the highly-leveraged housing bubble.

The American craze for “a house for everyone” went into a free-spin during Bill Clinton’s administration, which deserves a share of the blame for the housing bubble and the deadly bust.

Bill Clinton’s administration went to ridiculous lengths to increase the national home-ownership rate. It promoted paper-thin down payments and pushed for ways to get lenders to give mortgage loans to first-time buyers with shaky incomes.

It’s clear now that the erosion of lending standards pushed prices up by increasing demand, and later led to waves of defaults by people who never should have bought a home.

President Bush continued the practices because they dovetailed with his ownership society goals, and the US Congress was of course strongly behind the push.

The US is now experiencing a credit squeeze that is causing a sharp economic slowdown — unforeseen by most economists, including those at the Federal Reserve.

The US must find a new “China” (like it found China after Japan) — that could supply goods on credit (by accepting long-term US Treasury bonds).

US politicians and policy-makers might have thought of “India” as a replacement of China — but India’s response was very mild and it did not show any interest to take up the job of the largest manufacturer of the world after China.

It is also worth mentioning that China was the world’s biggest manufacturer until mid-1800s when it was overtaken by Britain in 1850. Then the US became the dominant manufacturer in 1895 and sustained its place until recently when China retook the crown again as the world’s largest manufacturer by claiming 19.8 percent of global output, compared with the US share of 19.4 percent.

The world has to find a global currency soon. It may not happen overnight but a gradual shift from the US dollar to new currency or currencies cannot be ruled out. It could be the Deutsche mark again or a new euro.

The euro currency was formally launched on Jan. 1, 1999. But the idea of a universal currency — euro — was not well received well from day one.

The idea was to replace the weaker currencies that were worthless against stronger global currencies with one strong currency i.e. euro — enabling the weaker countries in Europe to compete in the global marketplace.

In that sense, euro would have given those countries a more viable currency to boost their trade.

Euro’s role was always intended to boost weaker economies in Europe. In turn, the stronger economies were expected to lift the weaker ones, even in turbulent times.

However — as we see now — the opposite is happening with weaker economies dragging down stronger states, threatening even their financial structure.

Such ideas work well when times are good. A common currency may have allowed a much easier sale of goods across borders and probably helped weaker countries to smoothen their inflation rates.

But a single currency has become suicidal for many small countries in the long-term as they are unable to manipulate their exchange rates to suit their needs.

The financial needs of Germany and Greece can never be the same.

And, if opinion polls are to be believed, almost 50 percent of Germans would like to see the currency reintroduced as the country’s official means of payment.

In fact, pollsters at the EU’s euro-barometer have determined that: “For many Germans, the Deutsche mark was the symbol of economic security, stability and prosperity.”

It seems that the years of easy money is over.

We need to look at the following factors.

1. Would the markets lend to US again as they generously did in the past?

2. Would the markets lend at the rate, manipulated and dictated by the US?

3. Would lenders to the US, request for the loans to be denominated in SDR or other currencies backed by gold or some other commodities?

While it remains to be seen is; how big a deal would be a sovereign default in an advanced industrial country?

Let’s hope that Citicorp Chairman Walter Wriston was right, when he famously said that: “Countries don’t go bust, but banks lending to sovereigns can go out of business. Countries don’t go out of business…. The infrastructure doesn’t go away, the productivity of the people doesn’t go away, the natural resources don’t go away. And so their assets always exceed their liabilities. This is the technical reason for bankruptcy. And that’s very different from a company.”

— Mohamed H. Zakaria is CEO of Saudi Steel and senior vice president of Ahmed Salem Bugshan Group, Jeddah.