Shell Game Finance

Friends,
One of the official "readers" of my book on globalization, noted that several sections of it could be stand-alone articles and that maybe I should pull out sections of it now and then and share them around to get comments and critiques. So, here's one. It's from a much larger section on the "rules" of globalization, but it has a lot to do with the economic meltdown of last year and was meant to help people put our own crisis in the larger context of a series of economic crises the world has been experiencing for decades.
Enjoy
Stan Duncan

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Here is a quick picture of how the global trading in the value of money works. Not the trade in products, but the trade in the relative value of money itself.

What most of us think of when we think of international trading is what is known as “foreign direct investment,” as when, for example, a corporation in the U.S. spends money to purchase shares in a factory in a foreign country. However, in truth, the vast majority of international trade is simply speculation on the value of money, or bets on the future value of that money. It’s old fashioned, “Old West”-style gambling. Some actually refer to it as “Casino Capitalism,” and for good reason. Investors, speculators, currency traders, etc., will literally place bets on the rise (or fall) of the value of currency on the global markets, selling now when they think it is going to go down and buying when they think it will soon go up. Or even if there is a legitimate investment in the building of a new marina in Jakarta, there might be at least as much if not more money speculated on its success or failure, or insurance policies taken out on it, as there is in the project itself. Sometimes this is done by third parties that are not even involved in the project. This element in the global economy is seldom mentioned in the business pages of our local papers, but it is a phenomenon that has ballooned in recent decades as regulations on capital transfers have been reduced or eliminated all over the world. It is now larger than all of the other international financial transactions combined. It was a contributing factor in the worsening of Argentina’s 1999-2002 recession, and was the key factor in creating the horrendous collapse of many South East Asian economies in the late 1990s.

These countries had just restructured their economies in a number of ways to make themselves more attractive to western investors and then the world came to an end. Following the advice of the experts in the developed world and their banking allies, they eliminated restrictions on the flows of money in and out of their countries, they allowed high domestic interest rates (to make the return for foreign investors higher), and they pegged their currency to the U.S. dollar (to assure foreign investors against risks). In the short term, these measures resulted in an explosion of new money flowing into the countries, creating a sharp (but shallow) boom in economic growth. However, even though large amounts of foreign capital was rushing in, little of it ever made its way into the “real” economy, such as manufacturing or farming. Instead most of it went to high yield, high risk sectors like the stock market, consumer loans, and real estate. The economy looked good, but with so many of the controls and regulations on money flows eliminated, the boom was far more fragile than anybody thought. People were in effect betting on the growth of the growth, and—though Alan Greenspan frequently and characteristically denied it in our own country—they were clearly creating a “bubble.” Things appeared good, so they invested in the appearances, not the reality, making the appearances, well, appear even better.

This kind of rapid slinging of money all around the world, borrowing, investing, insuring, and in fact gambling, looks a lot like the old shell game of our grandfathers. In that trick the magician claims he has eight peas covered by eight shells. He whirls them around rapidly, lifting one now, and then another, showing the pea underneath. But then at the end of the show you discover that it was all a slight of hand and there were only two peas under two shells; all the others were empty. His hands covered it up and the speed blurred it, but in the end the abundance of peas was just an illusion. And like the shell game of global finance, if the “magician” keeps slinging peas around too long, eventually he’ll get tired and some of the shells will flip over and we will discover that they were empty. And then everyone reaches for the two remaining peas and all hell breaks loose.

The government of Iceland got into game in 2001 when it raised its bond interest rates to about fifteen percent to encourage foreigners (mainly British) to invest in their country. It worked and for a while in the mid-2000s they received tons of outside money. At the same time, the high interest rates raised the costs for local Icelanders wanting to borrow money, so a large percentage of them arranged home and car loans from sources outside of the country, which brought in even more foreign money. For about six years these factors were sucking in outside money and making Iceland look like it had a booming economy. Its financial planners were all considered wizards. But the whole shell game was based on borrowed money, shifted from shell to shell, and eventually when the global economy began to teeter, someone looked under the shells and saw there was little of substance there and the whole charade evaporated. Interest on foreign loans for local Icelanders went up, foreign investments coming into the country went down, and the nation imploded. In 2008 their net losses were higher than their entire GDP. They became the first developed country to apply for IMF help in 30 years. It was a painful, terrifying disaster.

More recently, Greece got caught in a similar spiral of taking on debts and then betting that they could raise money fast enough to pay them all back. Our own Goldman Sachs played “enabler” for their gambling addiction by arranging a deal to swap $10 billion in Greece’s debt, issued in dollars and yen, for euro debt. They used a false exchange rate which gave them a huge profit in the swap. Then Sachs arranged for them to postpone paying anything back for several years, giving the country the illusion that it actually owned all of that borrowed, traded money. That kind of swap is illegal today, but Goldman put it together for the Greeks just under the legal wire. As with Iceland, when the global economy began to sputter and Greece’s “balloon note” came due, people looked under Greece’s shells and found bupkis, not many peas but plenty of lies and cover-ups.

The East Asian currency crisis of the nineties was an even larger and darker tragedy. Dropping controls on money flows allowed rapid new investments to come into the countries, but it also allowed rapid withdrawals if investors ever got jittery. And eventually they did. The Asian “Tigers” looked amazing during most of the nineties as investors sought greater and greater returns on their money, again investing in the promise or illusion that there would eventually be productive economies there which would catch up, turn a profit, and make everyone rich. As with any Ponzi Scheme, the early investors did make miraculous amounts of money off of these promises, but it couldn’t continue forever and in 1997, the currency of Thailand, the baht, began to falter. Investors questioned whether it was really worth what the government said it was. Some got nervous and began to pull their money out, which made other investors do the same, and within weeks the economy of Thailand collapsed. In a nanosecond, there was a withdrawal frenzy across the entire region, with each investor racing to pull more of its money out with the smallest losses. But in the process they created a cataclysmic currency implosion that nearly bankrupted all of the economies of South East Asia. Within months millions of people lost their jobs; tens of millions had declines in income. Factories closed. Wages were cut. Food riots broke out. Hunger and even starvation became common. In Indonesia unemployment rose to forty-five percent, and the government itself collapsed (which, by the way, was not an altogether bad thing). The IMF rushed in with the largest financial bailout in history (and made conditions worse with its usual people-punishing—business-rewarding strings attached). The crisis ricocheted across the globe and shook the ground under countries as different and as far away as Russia and Brazil.

If all of this sounds a bit familiar, it’s because you read our own version of this whole story recently in the U.S. during the unraveling of our own fast-and-easy money era. There were lots of Wall Street investors slinging buckets of money all over the world in insanely risky investments, gambling on potential changes in the exchange rates between various currencies, all claiming that their money was backed by this huge stash of peas they held under their shells. But then when their original source of money to play with, the shaky sub-prime mortgages, began to crumble, a few investors began lifting their shells and found barely anything there. The rest of us then began to stop spending what few peas we did have and the economy ground to a stop. And like the deep pockets of the IMF, the U.S. government stepped in with lots of cash to bail out and reward the investors who gambled away your grandmother’s savings (and within months they were back at the casino tables again.)
 It’s helpful to keep the stories of Asia, Greece, Iceland, and our American counterpart in mind when you hear pundits on TV speak of “economic globalization” and mainly mean by that the rules governing trade. As we saw when our own financial problems ricocheted around the world, the movement of money alone, and not just goods and services, can be a dramatic (and sometimes deadly) force in the global economy.