GLOBALIZATION AND

THE MAIN ECONOMIES

• The ups and downs of the global economy depend upon events in the biggest economies, those of the US, Europe and Japan.

• Financial crises and recessions in the Third World were globally marginal events, because the Third World represented 1/5 of the global output.

• Ten years ago, if USA grows at 5% it adds 1.6 percentage points to the World growth rate.

• If China grows 5% it adds only 0.2 percentage points to the World’s growth rate (but things have changed today with rapid growth of Chine).

• Within the big three, the US and Japan have been actors while Europe has been a reactor over the last two decades.

• America is the global economic locomotive. • Europe and Japan are content to let the

American economic locomotive move them and the rest of the World’s economic train forward.

• And when the American locomotive stops, Europe and Japan sits passively waiting for the American locomotive to restart.

• In 1990’s America was the first to implement the new technologies of the third industrial revolution and the World was forced to react to this leadership.

• America boomed for most of the 1990’s, but its dot.com stock market crash in 2000, its economy went into recession in 2001 and 2002.

• By early 2003 NASDAQ has fallen by 80% and NY Stock Exchange 45%. For the American family $7000 billion in stock market wealth disappeared.

• This crisis did not start with capital flight or a balance of payment problem. It was home grown. But in an integrated World economy, the American stock market crash and recession spread to Europe, Japan and the rest of the world.

• The 1990’s opened with a Japanese financial crash. Japan’s crisis too, did not begin with foreign capital flight or with a balance of payment crisis. She held the largest foreign exchange reserves.

• The Japanese crises had nothing to do with globalization. The crises began with a correction of grossly overvalued stock market and inflated land values.

• Japan’s inability to deal with these crises produce ten years no economic growth (last decade) and still is continuning after 15 years.

• Japan had caught Capitalism’s worst disease, deflation.• The deflationary disease has spread to East Asia and threatens to

spread to Europe and America.• With European unfication at the beginning of the 1990’s it looked like

Europe would be an actor in the global economy but it did not happen.

• The Europeans were passive participants in the big economic events of the 1980’s and 1990’s.

1. Unstable Capitalism• The history of capitalism is full of financial crashes and

economic recessions. • Professor Kindleberg in his classic book Manias, Panics

and Crashes counted 28 major ones in the 19 th century alone.

• The crises of Capitalism aren’t accidental. They are genetic. To stop the bad would be to stop the good.

• As the globalization rests upon the capitalistic substructure, it has to be built to withstand Capitalism’s economic instability.

• The normal historical pattern in Capitalism is to cycle between periods of stability and instability.

• Memories of great depression make people cautious and led governments to impose tough regulations that crack down on speculative behavior.

• As a result, after World war II until 1970, there were no financial crashes.

• It started with the bankruptcy of New York, in mid 1970’s and continued with the bankruptcy of Chrysler Corporation.

• The savings and loan crises took place in mid 1980’s.

• The stock market fell 25% in mid 1987. It occurred in just three days. It was followed by a sharp fall in property prices that rolled around the rest of the industrialized world.

• A $12 million investment in London (Canary Wharf) ended up being purchased for $0.5 billion.

• Parisian apartments fell by 50% in price.

• Capitalism success and failure are caused by three fundamental attitudes: greed, optimism and the herd mentality.

• Why one would work one hundred hours a week, save most of his money instead of going on holiday, and then risk it on a business where there is a 95% probability of failure?

• The answer is simple ‘I want to get rich’. • Greed is what makes people work hard and take risk. • Greed leads to economic growth and higher standard of

living. • But, greed also causes financial crises.

• Tulip mania in Holland, in the 1620’s considered to be the first Capitalistic financial crash.

• Tulip bulbs came to Holland from Turkey. • Nobody knows which business models would work. • At the peak of tulip mania a six-story house along the

channels sold for four black tulip bulbs. • Everybody then, as now knew that this price was crazy.

In the long run the price of a tulip bulb can not be much higher than the cost of growing a tulip bulb.

• They are a chance to get rich. They don’t come everyday. • Everyone knows that those prices can not last, but they

all believe that they will get out before the end comes- and that they must trade today.

• Who did not know in the late 1990s that ‘dot.com’ companies with no profits and little sales could not be worth tens of billions dollars? We all know that.

• But it was a chance to get rich. We all saw people getting rich with little or no effort.

• We felt stupid if we weren’t participating. As in the case of tulips 400 years ago, none of us could resist.

• We know that when prices reach silly levels, they will eventually come down, usually very fast.

• Sophisticated insiders and naive outsiders get caught in the quick downturns, very few of the dot.com billionaires cashed

out. 

• Optimism is the second characteristics necessary to make capitalism work.

• Those running must believe that their firms are going to succeed. If they don’t believe this, they would not risk their money and their careers.

• They over invest and then the economy is automatically going to have cycles of the over investments

• The herd mentality is the third factor lying behind the instability of capitalism.

• Suppose an antelope sees a lion. It should run! If the antelope stops and investigates whether there is or is not a lion and whether the lion is or is not hungry is the one that gets eaten.

• Running is both good fun and great exercise.

• The same applies to financial markets. • During the dot.com boom small number of mutual fund managers

refused to buy the dot.coms on the ground that they were overvalued.

• What happened to these fund managers? All they were fired because they could not keep up with the market averages.

• But the fired mutual fund managers have been proven right. The ‘dot.coms’ was not worth those high prices.

• Have any of the fired managers rehired? The answer is no. • The message is simple. It always pays to run with the herd even

when you believe the herd is wrong.• Understanding the genetic structure of capitalism (greed, optimism

and the herd mentality) tells us that any global economy has to be built to minimize the economic shocks that will eventually occur.

2- America and Globalization• America is the global economic locomotive. • When the American economy moves the rest of the

world economies (Europe, Japan, BRIC countries, etc.) move and when the American locomotive stops, Europe, Japan and other economies wait for American locomotive to restart.

• America entered its tenth recession since World WaR II in 2001.

• In 2001 recession felt worse since manufacturing entered an extended recession.

• America did not face the “perfect storm” the only unusual thing about 2001 recession was that it had been 10 years since the last recession.

• The Federal Reserve Board would raise interest rates to slow the economy and stop inflation. So the housing and auto sales would plunge.

• Since the economy had been stopped by raising interest rates, it could be restarted by lowering interest rates.

Everything Is Going To Work; Nothing Is Going To Work

• New firms in any new industry effectively participate in a lottery.

• Most investors will lose their money; a few will get rich.• As any new industry develops, it will go from an

overoptimistic (everything is going to work) to an overpessimistic (nothing is going to work) period.

Assigning Blame

• Investors accused the Federal Reserve Board of not tightening monetary policies earlier to force stock prices down.

• To stop stock prices from rising in the midst of a bubble would have required very high interest rates – they would have thrown the rest of the economy into a sharp recession.

• Although economic models are good when it comes to fundamental forces and pressures, no economic model can predict the precise timing of events.

Telecoms• The precise causes of 2001’s recession are found in the

re-evaluation of telecommunications investments.• Almost all of the decline was located in

telecommunication equipment investment.• Given these big ups and downs in telecom investment,

the 2001 recession is no mystery. The decrease in telecom investment is due to investing more than $70 billion to fiber optics.

• Everyone believed this to be true and rushed in – the herd mentality. 3G telecommunications licenses were auctioned off for $35 billion in Great Britain. Think of five pieces of paper that only give one right to invest a lot more money in infrestructure sold for $35 billion.

• In Germany for $46 billion and across Europe $150 billion

• If those 3G licences were auctioned off again today, they would have no value.

Double Dip Recession

• Americans quit saving for their future.• The stock market was roaring upward, and they were

getting rich without saving out of their annual incomes. • Stock market gains would allow them to provide for their

future and to raise their consumption level simultaneously. Economists call these the “wealth effect”. Wealth, not just income, affects consumption.

• “Double Dip” recession;

• The first downturn would be caused by the fall in business investment, and the second downturn would be caused by a fall in consumption.

• For %90 of American families the value of their home is at least three times as important as the value of their stock market portfolios.

• The Fed’s strategy worked. The stock market’s negative wealth effect was offset by the housing market’s positive wealth effect.

• Lower interest rates also provided a source of cash for spending on items other than housing.

Scandals

• Every capitalistic boom ends in a scandal.• No one wants to look too closely at the numbers and be

the one who announces that the good times are over.• Highly predictable but not precisely identifiable scandals

break out. American charges in 1997 that the Asian crisis was caused by “crony capitalism” were always the height of chutzpah.

Skating On Thin Ice

• America’s recovery from 2001’s recession, wasn’t great. With unemployment rising,it didn’t feel like a recovery.

• Somehow, it all felt like America was skating on thin ice.• The fear induced by skating on thin ice is far worse than

actually falling through the ice. A sudden unexpected fall through the ice will cause that you have been in water. Wet clothes and cold weather that create for an uncomfortable situation but they cause no fear. That’s why, ‘skating on thin ice’ and not ‘falling through the ice’ is used.

• The ‘skating on thin ice’ applies to America’s current economic experiences. America suddenly and unexpected fell through the economic ice with stock market crash in 2000 and a recession in 2001.

• For the average person much of the feeling of skating on thin ice flowed from the jobless nature of the 2002 recovery. One million workers finding no work.

• When analyzing recoveries, it’s important to understand that there’re two definitions of a recovery. To economists a recovery is simply a return to sustained growth rates. To people a recovery is a growth rate, high enough to make expansion.

• For ordinary workers a recovery means jobs are easier to get .

• Everyone would like the thick ice of a vigorous recovery. But for a vigorous recovery to occur something has to recover sharply. There’re only seven possibilities which constitute the GDP: personal consumption, business investment,residential investment, changes in inventories, net exports, state and local government spending and federal government spending.

• A stronger recovery will need stronger federal government fiscal policies.

Japan:A brake of enormous proportions

• Japan was an economic organism genetically well suited to its circumstances.

• The Japanese crisis started with stock market crash.• In capitalism stock prices later have to be justified by

earnings but in japan they weren’t and stock prices fell.• By 2003 Japan’s crisis had lasted longer than the Great

Depression.• As the crisis continues; it prevents Japan from playing

any significant leadership role in the third industrial revolution.

Not Coping• One of the benefits of having had a long history of

financial crashes is that, everyone knows what must be done to restore normalcy. New solutions don’t have to be invented. All the potential options have been explored. That’s the good news. The bad news is that what must be done involves some painful economic restructuring.

• Technically, Japan understands what must be done but is unwilling to make the painful short-run adjustments necessary to reestablish long-run growth.

• Solutions start with an honest third party dividing the existing assets of the banking system into good assets and bad assets.

• Capitalism simply doesn’t work when assets have to carry debts whose value is greater than the market value of the assets themselves.

• Since asset prices have fallen sharply, debts(negative assets)have to have a corresponding fall in value if growth is resume. The process of writing down debts and getting them back in line with the value of other assets is called bankruptcy.

• In the U.S four things were necessary to make the takeover of bad debts of the banking system politically acceptable to the taxpayer.

• First, all shareholders lost all of their equity before any public funds were used.

• Second, in any failing institution all members of the top management team were fired without golden parachutes.

• Third, where criminal actions have occured, such as insider trading, those involved are thrown in jail.

• Fourth, when politicians were criminally involved, in the American crisis, they were also thrown in jail.

• Government credibility is important in speeding up the effects of good policies.

Bad Monetary and Fiscal Policies:

• Japanese monetary policies have been timid and ineffective, and they’re now exhausted with interest rates zero. Japan is effectively caught in what Lord Keynes during the Great Depression called a ‘liquidity trap’.

• Fiscal policies have been worse. Fiscal stimulus packages don’t work if an economy is drowning in debts.

• Fiscal stimulus should have come in one big installment after debts had been written down.

• The political reasons why Japan cannot do what is necessary are as simple as they are hard to solve. Japan is a consensus society with a narrow establishment at the top. When problems occur due to outside forces, consensus societies have huge economic advantages. They’re great at uniting people and directing their energy toward common solutions. But they have huge weaknesses in turbulent times when their problems ara internally generated.

• To do what must be done, consensus has to be at least temporarily abandoned.

Deflation

• Capitalism can live with inflation, even substantial levels of inflation.

• In the 19th century America grew in a deflationary environment, but economy was still mainly an agricultural economy where falling transportation costs led to falling food costs in family budgets that were still dominated by food costs.

• Once started, deflation is extremely difficult to stop

• Since the value of money is going up while the value of other assets going down, the riskless option of holding cash, doing nothing, becomes the smartest investment.

• Since getting costs down is the name of the game in a deflationary world, firms have no choice but to lower the wages of their employees.

• The winners are those who can push wages down faster than the rate of deflation.

Prospects

• Japan is a strong economy embedded in a weak economic structure. It has a bright, well-educated, hardworking labor force. Its companies are leaders in technology, productivity, and marketing. Yet its economy is sinking, and as time passes more and more of its powerful companies are reporting that they are loosing money.

• Recessions and meltdowns are intrinsic to capitalism. They are built into its genetic code. They have occured at many times and in many places in the past, and they will occur at many times and in many places in the future.

• The Japanese system have to be rebuilt so it can deal with recessions and financial meltdowns.

Europe: Sitting On Its Hands

• Central Banks can prevent recessions only if they start lowering interest rates aggressively well before a recession begins. That is usually impossible, since normally no one can predict that a recession is on the horizon with enough certainty to take action. But this time Europe had a lot of warning, since they could see the recession developing in the United States six to nine months earlier.

• What the European Central Bank forgot was that the same factor causing the recession in the United States, overinvestment in telecommunications, was present in an even bigger recession in Europe. American firms overinvested in equipment, something that will eventually be used, but European firms overinvested in pieces of paper – those 3G licences – that have no real value.

Global Locomotives

• If Japan and Europe were willing to become independent locomotives, the global economic train would have a smoother ride.

• The global economy would clearly be better off with three locomotives rather than one, but the other two non-American locomotives have yet to be built. They do not now exists.

First World Inequality

• While globalization, capitalism and new technologies may be accelerating the growth in wealth of those who live at the top of the global tower, there are losers among winners.

• As new technologies were introduced, the need for previously skilled, well-paid workers, such as glass blowers, would disappear. Wages would fall.

• Successful entrepreneurs lead to an unequal distribution of income and wealth.

• In capitalism the new big firms of the future have to be built on the efforts of people setting up new small firms today.

• Earnings inequality is built-in to capitalism. Profit maximization is a strong motive for efficiency, but it also calls for discarding those individuals capitalism does not need and minimizing the wages it pays to its workforce.

• Economic uncertainty is very high in capitalism. Workers, not just entrepreneurs, have to be willing to take risks. Few jobs last alifetime.

• Knowledge-based firms demand many fewer relatively unskilled production workers and more skilled designers, engineers, technical sales reps, and managers. Design, marketing, finance, and research rise in importance while production declines in importance.

• Economic inequality became a social or political issue only after the first industrial revolution.

• First, before the invention of the steam engine economic historians believed that there were no significant per capita income gaps between the richest and the poorest countries in the world.

• Second, when most economic output is made in factories and does not dependent upon differences in the climate, rainfall, and land fertility, it becomes obvious that humans can, if they wish, control the level of their output.

• Third, before the first industrial revolution there were differences in how much people had to eat, how big their bedrooms were, and how many servants they had to help them, but all these factors were inherently self-limiting.

• Fourth, with the advent of democracy we came to believe that all humans were created equal and that, therefore, they had an equal right to at least an equal chance at being reach - and perhaps an equal probability of becoming rich.