immediate outflow of foreign-currency reserves, as local currency and other assets were exchanged into dollars to meet their collateral requirements. This would not only quicken the pace of the crisis, it would also deepen its impact by putting further downward pressure on the exchange rate and asset prices, thus increasing the losses to the financial sector. The mergers-and-acquisitions time bomb In 2006, the dollar volume for merger and acquisition deals was $4 trillion, which was one-third of US GDP. Mergers between corporations in theory create value by improving efficiency and synergy in an overcapacity economy. This is generally achieved by laying off redundant workers and executives to create a leaner merged company and by selling off non-core subsidiaries that could be run more profitably by others. Generally, mergers shrink production and business activities to improve profit margins and reduce competition. In other words, mergers squeeze financial value from downsizing the economy. Acquisitions of public companies by private-equity firms are attempts to create value by taking public companies private on the theory that public companies are inherently inefficient because of regulations on corporate governance, such as the US Sarbine-Oxley Act. By taking public companies private, the new private owner can restructure the company with greater flexibility out of the public eye with less disclosure and can resell the restructured company for high profit within a relatively short time, usually to a public corporate buyer or through an IPO (initial public offering). The irony is that private-equity firms are now lining up to sell equity to the public, which is the equivalence of an anti-prostitution church running a cathouse. These trends are by definition cyclical, depending of a fragile combination of abundant cheap money and low price of the target companies and an enabling tax structure. For example, one of causes of the 1987 crash, aside from the exchange-rate effects of the Plaza and Louvre Accords, was a threat by the US House of Representatives Ways and Means Committee to eliminate the tax deduction for interest expenses incurred in leveraged buyouts. Still another cause was the 1986 US Tax Act, which while sharply lowering marginal tax rates, nevertheless raised the capital-gains tax to 28% from 20% and left capital gains without the protection against inflated gains that indexing would have provided. This caused investors to sell equities to avoid negative net after-tax returns and contributed significantly to the 1987 crash. There were other factors, such as the effect of portfolio insurance on the futures market, etc. At present, the US federal tax authority, the Internal Revenue Service (IRS), allows carry fees earned by private-equity firms to be taxed at a 15% capital-gain rate rather than the 35% ordinary income-tax rate. A change in that ruling can do havoc to the private-equity sector. The Wall Street Journal ran a report by William M Bulkeley on June 7 that the IRS shut a corporate-tax loophole two days after IBM used it on March 29 to avoid $1.6 billion in US taxes by structuring a $12.5 billion share buyback through a new subsidiary in the Netherlands. The IRS called the IBM maneuver a "triangular reorganization", in which the foreign unit spent $1 billion in cash and $11.5 billion in borrowed funds to buy 188.8 million shares, or 8% of outstanding, from a group of investment banks what had borrowed the shares from institutional investors. The investment banks will buy share in the open market for returning the borrowed shared over the next nine months and IBM will make whole any losses to the investment banks if IBM share prices should rise. IBM intends to repay the loans with earnings from its foreign subsidiaries with tax rates averaging 22%, substantially below the average US rate of 40%, saving $1.6 billion. The contradiction, aside from tax avoidance with no business purpose, is that the transaction gave IBM a reduced incentive to see its share rise in the open market until the $11.5 billion loans are repaid. The PPI/CPI spread Since 2003, the Producer Price Index (PPI) has risen by 16.4% in the US, while the Consumer Price Index (CPI) is only up 12.5%. This is caused by globalized trade through cross-border wage arbitrage keeping consumer prices down. CPI is heavily weighted toward import prices while PPI is weighted toward export prices. Import prices fall while export prices rise when the dollar rises against foreign currencies. Even though exchange rate is only a part of the reasons for the US trade deficit, Congress has fixated on the idea of forcing China to revalue its currency upward against the dollar. But a falling dollar causes China's central bank to demand compensatory higher dollar interest rates for the US sovereign debt it buys, which in turn slows the US economy. A higher short-term rate is important in its inflationary effect on CPI because it drives the rates for much of consumer credit, such as credit-card loans and auto loans, as well as adjustable home mortgages. The long 10-year bond rate drives fixed mortgage rates only at the time the mortgage is taken, but rising long-term rates will depress the price of outstanding long bonds to compensate for the gap in yields.
A falling dollar will artificially lift overseas profits of US transnational corporations and in turn lift equity prices while the US domestic economy stagnates or declines. Among the objections against globalization, including income inequality and abuse of workers' rights and the environment, the most serious has been the devastating recurring destruction brought on by currency-induced financial crises in developing countries. In the past decade, globalization has also depressed wages in the advanced economies. But now the destructiveness of financial globalization is beginning to be undeniable. Even pro-globalized-trade economists now are forced to acknowledge cross-border capital flows as the Fifth Horseman of the Apocalypse of financial globalization through no-holds-barred deregulation and liberalization in structured finance that leaves large segments of the world's population in all countries in financial ruins. The comparative advantage of "free trade" has long been neutralized by a dysfunctional international finance architecture that devastates the poor and weak in all economies, rich or poor. Amid this growing resistance, the United States is trying to pry open financial markets faster everywhere, particularly in China. Central banks distort domestic prices In today's globalized financial markets, the central bank in every nation distorts all prices in the local economy to prevent economic adaptation to changing world prices in key commodities, such as oil. Domestic interest rates are forced to rise during a recession to prevent capital flight. This is true regardless of whether the currency is free-floating or pegged to the US dollar. The only difference is that the penalties manifest themselves in different forms, via asset depreciation for floating currencies and via a drain in foreign reserves in pegged currencies. As noted earlier, dollar hegemony uses currency crisis as the widely deployed IED in finance terrorism against domestic development in all countries, rich and poor. Ironically, while the advanced economies are plagued with overcapacity from stagnation and disparity of income, there is rising evidence that low-wage production in East and South Asia, which in the past decade has been the main factor in containing global inflation, is going through a sea change to build pressure for global inflation. While unemployment is still serious all over Asia, including booming economies such as China and India, existing plants in the export sectors of these countries are running near full capacity. This is because foreign investment goes only into projects that yield extraordinary returns from low wages in the export sector, while unemployment continues to rise in the domestic sectors. Social and political pressures in reaction to income disparity are giving labor everywhere a stronger voice in demanding more equal distribution of the benefits of globalized trade, in the form of living wages and more liberal benefits and protection of workers' rights. Thus while both China and India are still burdened with oversupply of human resources with a glut of underemployment or high unemployment, plant capacity in their export sectors can grow only at higher costs to meet consumer demand in their export markets for low-cost goods. This is because the excess labor is in the rural interior, where there are no plants and where the cost of building them and the transportation network to serve the export sector are not economically viable. And the plants along the coastal regions are experiencing a labor shortage because more migrant workers cannot be accommodated for lack of low-cost housing. But higher costs in China will result in higher prices for Chinese exports and reduced US demand for goods until US wages rise, which is registered as inflation. As a result, central banks of the world are increasingly anxious about structural inflation, forcing them to tighten monetary policy by raising interest rates. The Goldilocks era of a happy combination of high growth, low inflation and low interest rates may be coming to an end. Fed chairman Ben Bernanke told a bankers' conference in South Africa on June 5 that rising wages and environmental costs in China will have an upward effect on US inflation. The International Monetary Fund has calculated that low-wage imports from China have reduced US inflation by 1 percentage point. Many economic projections expect global growth will no longer contain inflation. Rather, further global growth will translate into inflationary pressures. With cost-pushed inflation bringing higher interest rates in a cycle of slowing economy and weaker earnings caused by a housing bust in the United States, rising wages that still fail to keep up with real inflation from currency devaluation, dwindling consumer demand from income disparity, and trade friction threatening to turn into protectionist measures, cheap money can evaporate quickly, to put a sudden stop to the recent merger-and-acquisition frenzy by private-equity firms, and turn completed deals into bankruptcy candidates. While each of these developments may not by itself be serious enough to bring the US economy to a halt, a confluence of all such interrelated developments could produce a whirlpool effect that sucks everything down a black hole of vanishing virtual money. Income is all The fountainhead of this financial whirlpool is in the conundrum that rising interest rates are impotent in reversing the decline of the purchasing power of the dollar. What is needed is a redefinition of economic growth, to be measured by rising purchasing power of wages rather than by nominal GDP increases. And that path is through closing the disparity of income and wealth in every economy, rich and poor, among people and between economies. The timeless adage in economics that income is all holds even more true today. This is the concluding article of this report. For Part 1, click here. Henry C K Liu is chairman of a New York-based private investment group. His website is at www.henryckliu.com.
Nothing new. Read: http://www.mises.org/mysteryofbanking/mysteryofbanking.pdf Everything being stated by Henry C. K. Liu article is plain ole common sense once you understand the banking & money game.
I was advised to read that here at ET a few months ago when I first arrived here and it was the best bit of education I have ever received....
I don't advise anyone to read both this article, mystery of banking, and watch the Money Masters all in one week's time.. it'll REALLYYYYYY PISSSSSS YOU OFFFFFFFF!
That's from the Power's point of view... "Inflate = DESTROY"... from [most] citizen's point of view. Through history, inflation has been a business-as-usual policy for governments. But when citizens "inflate", it's punishable by imprisonment and, at times, death. If this were a just world, Government Powers and Central Bankers who inflate would be castrated, have their genitals shoved inside their mouth and put on public display.