[OPE] Mark Weisbrot, "South America Recession Can Be Avoided"

Mark Weisbrot is usually pretty level-headed and sober in his assessment. Whether Latin America can grow through the recession, however, depends among other things on how long the recession will last. I think it will last longer than an ordinary recession and that almost no country can escape from its impact. Perhaps they can in Liechtenstein. The main reason for that is I think that the whole global structure of dodgy loans accumulated over many years is now unravelling. If it had not been the subprimes, it would have been some other financial shock.

All over the world, people capitalised on the expectation of rising house prices and other asset prices, and many businesses built up balance sheets where assets and liabilities vastly exceeded equity, with the aim of extracting more profit with funds borrowed at a competitive rate. That is pretty much the essence of it - the fact, that fund managers also helped themselves to a nice big salary is merely the surface of the phenomenon.

The fund managers themselves argue "clients want large, steady profit from their capital assets without doing anything for it, we have to take that responsibility for that, and it's a big responsibility, for which we ought to be paid accordingly". Their "risk-pricing" begins with the risks they have to take themselves, and for which they are personally responsible. Simply put, your reputation is worth X amount of money. Most people go wild already if there's an error in their savings account - now imagine what happens if you place billions of dollars with a financial institution.

The true "risk-spread" consists in the fact that the gap between those who own, those who control, and those who use resources has widened greatly, making it much more difficult to exercise effective responsibility. Corporations have known this all along, and carved themselves up into numerous smaller business units with individual cost-centres spread across the globe, but for many reasons this does not finally solve the problem (though it helps obviously if you can communicate very fast internationally).

Anyway this dodgy capital structure makes many businesses (and a sizable fraction of the working population) much more susceptible to cashflow problems. So long as demand grows steadily, there is no real problem, but as soon as demand drops, the margins of what you can do are small, and often you then have to sell off assets at a value lower than what they previously fetched in the market, unless you can somehow renegotiate debts. That in turn impacts on final expenditure, and so it goes on.

This process is difficult to stop, among other things because as soon as you inject fresh capital, people try to capitalize on it again. It is just that the financiers now become stricter, and are less likely to lend if there is any doubt of creditworthiness ("financial discipline"), but this again reduces final demand and entrepreneurial risk-taking. Creditworthiness is in good part based on expectations of future income growth, or future yields, and if prospects are gloomy or unpredictable, credit ratings go down. The search is then on for who is really creditworthy, and here the "real economy" discussion plays a role.

The fact is, that people simply HAVE to buy and sell certain items, it's not optional, and thus if you buy up those activities, you more likely get a steady return or an economic rent. I call this "resource-based capitalism". In Marxist language, what holds society together is its social and material reproduction process, meaning that people necessarily have to do certain things to survive and prosper, whether they like it or not, whatever ideology of liberal freedom or market proclivities they may have. Marx refers similarly to the "the dull compulsion of economic relations" (Kapital, ch. 28). http://www.marxists.org/archive/marx/works/1867-c1/ch28.htm In the "real economy" people use the cash they actually have available.

But obviously the impact will be greater here, and lesser there. For example, the USA has a low average personal savings rate, the Netherlands and Germany a much higher one, and thus to some extent the Dutch and Germans have some financial buffers that Americans don't have as much in an aggregate sense (though America has a wealthy middle class; the credit card problem is financially a comparatively small problem affecting mainly poorer people). But I wouldn't exaggerate that difference, because the Netherlands is heavily dependent on foreign trade in products and assets, and if Germany goes into recession the Netherlands typically follows.

The Chinese economy will most likely still grow for the meantime, but at a reduced rate. If GDP (gross value added) reduces by a few percent, this is a relative contraction, but the economy is still growing - this is what a recession means (reduced growth); a "depression" conventionally means sustained negative GDP growth (below 0%). The European GDP is supposed to grow negligibly next year, virtual stagnation in aggregate; the growth of some industries is almost fully cancelled out by the decline of others. Of course, as I have shown, GDP is only a very crude indicator of national income. It does not include foreign factor income, property income, capital gains and the like, and includes fictitious items such as the rental value of owner-occupied housing, or items such as government expenditure/income/output which could be viewed in different ways. Factor income is not the same thing as national income.

As regards merchandise exports, North America is the largest importer of Latin American goods by value, I think four or five times more is typically exported to North America than to Europe, by value, each year.
(The big exporters by value are countries like Brazil, Venezuela, Chile). Thus if demand drops in Europe, North America, and Japan, the value of Latin American exports is likely to be reduced, impacting on earnings and therefore on the ability to borrow, in Latin America. But exports of goods are only one aspect; much more important really is the ability to borrow new funds for investment. If the major international banking institutions are reluctant to lend funds, and concentrate more on safe investments, this has a negative impact directly or indirectly on economic growth, also in Latin America. Obviously you cannot easily lend for long-term projects, if you have no idea what currency exchange rates are going to be like in the future.

President Rafael Correa of Ecuador is threatening to default deliberately on Ecuador's foreign debt. It's about $10 billion and I think he is probably ill-advised to do that, it is much better to review and renegotiate, on the basis of a legal inquiry which educates the citizenry about the difference between good loans and bad ones. After all, you try to create a culture where people deal more sensibly with credit, and you are going to have to do that no matter what kind of society you have. They will learn, either proactively, or because they find themselves unable to pay. You do need "sound macroeconomic policies" as Mark Weisbrot says, meaning realistic ones based on a thorough understanding of the national economy you have and the foreign countries you deal with.

Of course, to a leftist, deliberate debt defaults sound morally righteous, but the real effect you have to reckon with is that your reputation is shot with creditors, and that it becomes more difficult to get another loan. Argentina defaulted on IMF loans, but irrespective of whether you think that was justified, the IMF is not going to bail the country out again, in which case they have to try somehow to lend elsewhere. No doubt more debt defaults will occur in the future, but that is just because some countries may simply not be able to pay in the foreseeable future.

You just get more countertrade (barter), as Prof. Ernest Mandel pointed out to me 24 years ago. Of course, he was a revolutionary dreamer, and so the tendencies which he diagnosed in the abstract took much longer, or are taking much longer, to work themselves out. For non-academics like businessmen or real politicians, what is most important is what is happening now, they cannot easily deal with scenarios far in the future ("A week is a long time in politics") except at the level of principles. Many ecological policies are matters of principle, for example. And for the financier, timing and predictability are everything. That is what fills the pages of the press.

What the social and political consequences are, I have already sketched in many previous posts, I'll leave it there.

Jurriaan

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Received on Wed Nov 19 16:30:42 2008