Friday, August 5, 2011

Globalization and the Great Debt Machine

Today the Dow plunged 512 points, on top of prior losses over the past two weeks that now exceed 1297 points, a development that should not surprise any reader of this blog (particularly this, this and this). The downturn arises from growth concerns as well as Europe's debt malaise which I first blogged upon over one year ago, warning: "That [it] could cause a huge financial crisis like what occurred in late 2008." Over $1.9 trillion in wealth vaporized in this equity sell-off, in the US alone, enough to fund the kind of fiscal stimulus needed to restore sustainable growth and reduce debt burdens.

And, debt is the core issue plaguing the global economy. The subprime debacle, the problems in Greece and the Eurozone, and the American fiscal problem all boil down to too much debt. That debt is a direct result of our distorted model of globalization, a topic on which I have written three or four law review articles. Consider the US current account deficit depicted in the above chart. In order to cover the current account deficit someone in the US must write an IOU. Usually, that someone is the American government or the US consumer. While the current account deficit moderated a bit after the subprime crisis, the chart above shows it continues in full swing again today, after a rapid deterioration in the last few quarters.

The flip side of the American current account deficit is the currency reserves held by developing nations. These reserves are usually held in highly liquid and safe debt instruments such as Treasury obligations. Recent data from the IMF show that the world now holds $10 trillion in currency reserves, including at least $5.5 trillion in dollar denominated instruments and $1.4 trillion in Euros. Of course, the constant demand for Eurozone and American debt implicit in these enormous reserves lowers interest rates in the Eurozone and the US, thereby inducing excess debt than otherwise. In other words, when interest rates are artificially lower than they otherwise would be debt becomes more enticing than otherwise because it is cheaper.

This is the basis for John Maynard Keynes' dictum that the nation that furnishes the reserve currency increasingly gets into debt.

So, as the markets continue their meltdown in response to a global financial system that is choking on debt keep in mind that the primary source of that excess debt is the rigged system of globalization that is specifically designed to create excess debt in the Eurozone as well as the US.

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