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Creato Martedì, 01 Gennaio 2008

Finance is Sovereign, by Toni Iero (n°98)

(translation by Coopit)

Holders of financial capital are the real winners in the social upheaval triggered by the so-called liberalization initiated at the start of the 1980s by Mrs Thatcher in the United Kingdom and President Reagan in the United States.

The consequences of the financialization of western economies are clear. You only need to see how income is distributed between the social classes. In Italy, from 1980 to 2007, the share of gross domestic product assigned to employees shifted from 50% to less than 43%. If the raw data regarding percentage GDP are transformed into money, the result would be that, distributing Italian income produced in 2007 according to the 1980 criteria, employees would be owed a good 110 billion euros more than they actually received! Broadly speaking, each one of us would have approximately 4,500 euros more in his or her pocket. And this has been happening for decades ... perhaps it is best not to think about it.

In short, we have witnessed the triumph of unearned income which, without damaging profits, has taken a fine revenge on the purchasing power of salaries. I remember, right at the end of the 70s, the Communist Party of Enrico Berlinguer and the CGIL of Luciano Lama pressing for the so-called policy of sacrifices. The workers, in their opinion, should be satisfied with lower wages in order to contribute to the economic recovery of the State. They got half of what they wanted. They obliged us to make the sacrifices. They "forgot" the recovery of the State finances, because the money went into the  pockets of various new millionaires, some from the political left!

Financial Mathematics: 1 + 1 = 3

An article which appeared on Le Monde Diplomatique and on Znet on 11 November 2007, signed by Ignacio Ramonet (Il Capitale di Rischio Avanza / Private equity is on the prowl), describes the methods used by private equity funds in the acquisition of companies. "The basic principle is simple: a group of wealthy investors buys up a company and manages it privately... To acquire a company worth 100 units, the fund invests an average of 30 units from its own pocket and borrows the remaining 70 from the banks... In 3 or 4 years the fund reorganises the company ... taking some or all of the profits to repay the debt. It then sells the company on for 200 units... with a 300% return in four years.”

The Author presents this type of transaction as the final frontier, attacked by financial capital in the search for ever higher profits. But is this really the cutting edge of finance? It is true that in Europe we are less used to these takeovers; however, it is equally true that the takeover of companies, directed at making financial profit, is a practice which goes back to the 80s.

Do you remember the film Pretty Woman (the United States, 1990)? It is the story of an unscrupulous raider (played by Richard Gere) whose activity consists of purchasing companies in order to then break them up and resell them, thus making a profit not from the products manufactured by these companies, but rather from the difference between the purchase and selling prices.

A similar type of transaction involved junk bonds, issued by dubious speculators who took out large loans to take over companies exclusively in order to earn money from their sale. Therefore, Ramonet's article states nothing more than the extension to Europe of a type of behaviour which is now well-established in the Anglo-Saxon world. Nothing new under the sun.

The Monetary Bunch

It is on another front where, helped by world economic imbalances, something new is emerging. Since the start of the 70s, the United States has been showing an increasing deficit in external accounts. The record came in 2006, when the American trade balance recorded a deficit equivalent to 7% of American GDP. The oil-producing states of the Persian Gulf were the first to lend the Americans all this money, followed by, from the 90s onwards, the East Asian countries with a large foreign trade surplus, chiefly Japan and China. This heterogeneous group of countries has invested a significant proportion of its savings in bonds issued by the United States Treasury. Incidentally, the irony of this situation is that China and the Arab oil monarchies, purchasing shares of the National Debt of the United States, in practice have financed the recent American military adventures: the money to pay for the arms used in Iraq came from the Saudis, and the American troops who operate in Afghanistan, on the border with China, are paid for with money from Beijing! International cash flow wizardry!

The interpenetration of Chinese and Saudi interests with American interests is so strong that they are the first to fear an economic catastrophe in the USA. Of course, every so often the Chinese leaders declare their intention of diversifying their foreign exchange reserves. However, so far they have not done this and, in any event, it could only be a very gradual process. It is estimated that China has approximately 1,400 billion dollars worth of US bonds. A drop in the value of the greenback of 1% produces a loss for the Chinese of 14 billion dollars. It is better to play safe when figures like these are involved!

This monetary bunch has kept the world economy on its feet for about thirty years. It has permitted the Arab emirs to finance Islamic fundamentalist groups whilst continuing to live in opulence and has led to the emergence, albeit with all its contradictions, of Chinese communist capitalism. At the same time, the Americans, the progeny of a real economy which is increasingly strangled by financial capital, have continued to consume, obtaining the money from credit. They have been assisted in this by Alan Greenspan: until the end of 2005, the American Fed Fund interest rates were kept at an all-time low. The economy had to be supported, in particular family consumption, at risk due to the bursting of the New Economy bubble.

Happy days! The low interest rates, in addition to making mortgage payments acceptable, also caused the value of property to rise. The financial vultures dived in on this increase in family wealth. Look, with what your house is worth now, why don't you ask for a loan to go to the Caribbean on holiday ? And then, isn't it time to change your car? There are the new SUVs, great cars! Of course you have the money. Your moneybox is the house which you have bought with a mortgage. Its value has gone up again! What are you waiting for? Don't worry about getting into debt, the interest rates are low! It is the American dream.

The American nightmare

The trick seemed to work well. Then reality regained the upper hand. The confounded price of crude oil squirted up. In 2001, a barrel didn't even fetch 20 dollars. Today it is close to one hundred. The same thing has happened to many other raw materials; it is the effect of the remarkable economic growth in Asia. The first signs of inflation were beginning to show. The Federal Reserve, like other central banks, had no choice. It had to increase interest rates. This was the beginning of 2006.

The increase in interest rates continued until the early part of 2007. The payments to be made on mortgages grew. The growth in property prices first began to slow down, then stopped entirely. It was August. The subprime mortgage bubble burst. It transpired that a considerable number  of mortgage holders were no longer able to make their payments. Still worse for those who lent them the money! No, because the mortgages were converted into bonds and debenture stock and sold to other banks. Was there anybody who had stocks or bonds linked to mortgages who would not be reimbursed? Don’t ask me! Nobody knew what was happening any more. It became a banking crisis. Credit institutions did not trust one another and ceased to lend each other money. There was no more liquidity on the interbank market. The stock exchanges went down. The dollar went down. For the  United States economy, the worse possible crisis opened up: a crisis of credibility.

The American nightmare began.

Here come the good guys!

One after the other, the big American banks had to show their expected losses in their balance sheets. Billions of dollars. The repercussions also reached Europe. German, French and Swiss credit institutions were the first to pay the price. The situation was terrible. The central banks flushed the markets with liquidity, the Fed even lowered interest rates. Nothing could be done. The commodity which was in short supply on the market was trust.

The situation now seemed destined to go into a spin. The case of the subprime credit cards also exploded, another 900 billion dollars at risk. Just what we needed. And now, what was to be done?

Just before Christmas, under the tree, the first presents arrived. The good guys are coming to save us! The World Bank? The International Monetary Fund? No! The Arabs and Chinese.

The Abu Dhabi sovereign fund bought almost 5% of the biggest western bank, Citibank, for 7.5 billion dollars. Temasek, a Singapore sovereign fund, came to take over 17.2% of the Standard Chartered Bank. It has 2% of Barclays. Another Singapore sovereign fund, Gic, saved the Swiss bank UBS, injecting 9.7 billion dollars.

The China Investment Corporation, owned by the Beijing government, supported Morgan Stanley with 5 billion dollars. The Chinese Development Bank possesses 3% of Barclays. The Dubai sovereign funds have shareholdings in Deutsche Bank and HSBC.

If it is true that a friend in need is a friend indeed, then nobody more than the Arab emirs and Chinese "communists" can be termed a friend of the United States. According to Morgan Stanley estimates, in 2007, sovereign funds invested over 70 billion dollars in overseas financial institutions. It is calculated that the assets of these government bodies amount to 2,500 billion dollars. Thanks to their intervention, the banks did not collapse. The dollar exchange rate stabilised, the  euro did not break the 1.5 barrier and the stock exchanges ceased to tumble. Perhaps the crisis is not over. But now the tools are in place to deal with it.

Of course, something is changing. The world is no longer what it was before the subprime crisis. The sovereign funds are the superpowers of financial capitalism in the 21st century. The change in their strategy is significant. Countries rich in raw materials or big exporters of manufactured goods are reducing their investments in western government bonds. They are beginning to acquire pieces of European and American economies and finance. In the acquisition of important shareholdings in the most prestigious western financial institutions by sovereign funds, there are at least two curious paradoxes:

·   Public bodies, controlled by governments, are taking their seat at the centre of the current phase of globalization, in the face of those who thought that State intervention in the economy had finished;

·    The wizards of profit without production, the finance corporations, become the property of the producers and exporters of real goods. Perhaps the astonishing flight into the virtual reality of financial engineering is about to finish.

However, overshadowing all this, one thing is quite clear; this is the end of the line for American-dominated globalization.


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