In late 2008 and early 2009, the G20 was able to coordinate policy effectively because the members were united by fear. The collapse of capital markets, world trade, industrial output and employment had been so catastrophic as to force a consensus on bailouts, stimulus and new forms of regulation on banks.
By 2011, it appeared the storm had passed and the G20 members were back to their individual agendas—continued large surpluses for China and Germany and continued efforts by the United States to undermine the dollar to reverse those surpluses and help U.S. exports. Yet there was no Richard Nixon around to take preemptive action and no John Connally to knock heads. America had lost its clout. It would take another crisis to prompt unified action by the G20. Given the policy of U.S. money printing and its inflationary side effects around the world, it seemed the next crisis would not be long in coming.
That crisis arrived with a jolt near the city of Sendai, Japan, on the afternoon of March 11, 2011. A 9.0 earthquake followed quickly by a ten-meter-high tsunami devastated the northeast coastline of Japan, killing thousands, inundating entire towns and villages, and destroying infrastructure of every kind—ports, fishing fleets, farms, bridges, roads and communications. Within days the worst nuclear disaster since Chernobyl had commenced at a nuclear power plant near Sendai, with the meltdown of radioactive fuel rods in several reactors and the release of radiation in plumes affecting the general public. As the world wrestled with the aftermath, a new front arose in the currency wars. The Japanese yen suddenly surged to a record high against the dollar, bolstered by expectations of massive yen repatriation by Japanese investors to fund reconstruction. Japan held over $2 trillion in assets outside of the country, mostly in the United States, and over $850 billion of dollar-denominated reserves. Some portion of these would have to be sold in dollars, converted to yen and moved back to Japan to pay for rebuilding. This massive sell-dollars /buy-yen dynamic was behind the surge in the yen.
From the U.S. perspective, the rise in the yen relative to the dollar seemed to fit nicely into the U.S. goals, yet Japan wanted the opposite. The Japanese economy was facing a catastrophe, and a cheap yen would help promote Japanese exports and get the Japanese economy back on its feet. The magnitude of the catastrophe in Japan was just too great—for now the U.S. policy of a cheap dollar would have to take a backseat to the need for a cheap yen.
There was no denying the urgency of Japan’s need to cash out its dollar assets to fund its reconstruction; this was the force driving the yen higher. Only the force of coordinated central bank intervention would be powerful enough to push back against the flood of yen pouring back into Japan. The yen-dollar relationship was too specialized for G20 action, and there was no G20 meeting imminent anyway. The big three of the United States, Japan and the European Central Bank would address the problem themselves.
Under the banner of the G7, French finance minister Christine Lagarde placed a phone call to U.S. Treasury secretary Geithner on March 17, 2011, to initiate a coordinated assault on the yen. After consultations among the central bank heads responsible for the actual intervention and a briefing to President Obama, the attack on the yen was launched at the open of business in Japan on the morning of March 18, 2011. This attack consisted of massive dumping of yen by central banks and corresponding purchases of dollars, euros, Swiss francs and other currencies. The attack continued around the world and across time zones as European and New York markets opened. This central bank intervention was successful, and by late in the day on March 18 the yen had been pushed off its highs and was moving back into a more normal trading range against the dollar. Lagarde’s deft handling of the yen intervention enhanced her already strong reputation for crisis management earned during the Panic of 2008 and the first phase of the euro sovereign debt crisis in 2010. She was the near universal choice to replace the disgraced Dominique Strauss-Kahn as head of the IMF in June 2011.
If the G20 was like a massive army, the G7 had shown it could still play the role of special forces, acting quickly and stealthily to achieve a narrowly defined goal. The G7 had turned the tide at least temporarily. However, the natural force of yen repatriation to Japan had not gone away, nor had the speculators who anticipate and profit from such moves. For a while, it was back to the bad old days of the 1970s and 1980s as a small group of central banks fended off attacks from speculators and the fundamental forces of revaluation. In the larger scheme of things, Japan’s need for a weak yen was a setback to the U.S. plan for a weak dollar. The classic beggar-thy-neighbor problem of competitive devaluations had taken on a new face. Now, in addition to China, the United States and Europe all wanting to weaken their currencies, Japan, which had traditionally been willing to play along with U.S. wishes for a stronger yen, found itself in the cheap-currency camp too. Not everyone could cheapen at once; the circle still could not be squared. Ultimately the dollar-yen struggle would be added to the dollar-yuan fight already on the G20 agenda as the world sought a global solution to its currency woes.
PART THREE
THE NEXT GLOBAL CRISIS
CHAPTER 8
Globalization and State Capital
“It is a doctrine of war not to assume the enemy will not come, but rather to rely on one’s readiness to meet him; not to presume that he will not attack, but rather to make one’s self invincible.”
Sun Tzu, The Art of War,
Late fifth century BC
Historically a currency war involves competitive devaluations by countries seeking to lower their cost structures, increase exports, create jobs and give their economies a boost at the expense of trading partners. This is not the only possible course for a currency war. There is a far more insidious scenario in which currencies are used as weapons, not in a metaphorical sense but in a real sense, to cause economic harm to rivals. The mere threat of harm can be enough to force concessions by rivals in the geopolitical battle space.
These attacks involve not only states but also terrorists, criminal gangs and other bad actors, using sovereign wealth funds, special forces, intelligence assets, cyberattacks, sabotage and covert action. These financial maneuvers are not the kind that are the subject of polite discussion at G20 meetings.
The value of a nation’s currency is its Achilles’ heel. If the currency collapses, everything else goes with it. While markets today are linked through complex trading strategies, most still remain discrete to some extent. The stock market can crash, yet the bond market might rally at the same time. The bond market may crash due to rising interest rates, yet other markets in commodities, including gold and oil, might hit new highs as a result. There is always a way to make money in one market while another market is falling out of bed. However, stocks, bonds, commodities, derivatives and other investments are all priced in a nation’s currency. If you destroy the currency, you destroy all markets and the nation. This is why the currency itself is the ultimate target in any financial war.
Unfortunately, these threats are not given sufficient attention inside the U.S. national security community. Bill Gertz, reporting in the Washington Times, noted, “U.S. officials and outside analysts said the Pentagon, the Treasury, and U.S. intelligence agencies are not aggressively studying the threats to the United States posed by economic warfare and financial terrorism. ‘Nobody wants to go there,’ one official said.”
An overview of the forces of globalization and state capitalism, a new version of seventeenth-century mercantilism in which corporations are extensions of state power, is a step toward understanding the grave dangers facing the world economy today. Financial warfare threats can be grasped only in the context of today’s financial world. This world is conditioned by the triumph of globalization, the rise of state capitalism and the persistence of terror. Financial warfare is one form of unrestricted warfare, the preferred method of those with inferior weapons but greater cunning.
Globalization
Globalization has been emerging since the 1960s but did not gain its name and widespread recognition
until the 1990s, shortly after the fall of the Berlin Wall. Multinational corporations had existed for decades, but the new global corporation was different. A multinational corporation had its roots and principal operations in one country but operated extensively abroad through branches and affiliates. It might have a presence in many countries, but it tended to keep the distinct national identity of its home country wherever it operated.
The new global corporation was just that—global. It submerged its national identity as much as possible and forged a new identity as a global brand stripped of national distinction. Decisions about the location of factories and distribution centers and the issuance of shares or bonds in various currencies were based on considerations of cost, logistics and profits without regard to affection for a nominal home country.
Globalization emerged not through the initiation of any new policies but through the elimination of many old ones. From the end of World War II to the end of the Cold War, the world had been divided not only by the Iron Curtain separating the communist and capitalist spheres but also by restrictions imposed by capitalist countries themselves. These restrictions included capital controls that made it difficult to invest freely across borders and taxes that were imposed on cross-border payments made on investments. Stock markets limited membership to local firms and most banks were off-limits to foreign ownership. Courts and politicians tilted the playing field in favor of local favorites, and enforcement of intellectual property rights was spotty at best. The world was highly fragmented, discriminatory and costly for firms with international ambitions.
By the late 1990s, these costs and barriers had mostly been removed. Taxes were reduced or eliminated by treaties. Capital controls were relaxed, and it became easy to move funds into or out of particular markets. Labor mobility improved and enforcement of legal rights became more predictable. Stock exchanges deregulated and merged across borders to create global giants. The expansion of the European Union politically and economically created the world’s richest tariff-free market, and the launch of the euro eliminated countless currency conversions and their costs. Russia and China rose as protocapitalist societies eager to adopt many of the new global norms they saw emerging in Western countries. Economic and political walls were coming down while, at the same time, technology facilitated ease of communication and improved productivity. From the point of view of finance, the world was now borderless and moving quickly toward what legendary banker Walter Wriston had presciently called the twilight of sovereignty.
Infinite risk in a borderless world was the new condition of finance. Globalization increased the scale and interconnectedness of finance beyond what had ever existed. While issuance of bonds was traditionally limited by the use to which the borrower put the proceeds, derivatives had no such natural limit. They could be created in infinite amounts by mere reference to the underlying security on which they were based. The ability to sell Nevada subprime mortgage loans to German regional banks after the loans had been bundled, sliced, repackaged and wrapped with worthless triple-A ratings was a wonder of the age.
In a globalized world, what was old was new again. A first age of globalization had occurred from 1880 to 1914, roughly contemporaneous with the classical gold standard, while the period from 1989 to 2007 was really the second age of globalization. In the first, the wonders were not the Internet or jets but radio, telephones and steamships. The British Empire operated an internal market and single-currency zone as vast as the European Union. In 1900, China was open to trade and investment, albeit on coercive terms, Russia had finally begun to throw off its late feudal model and modernize its industry and agriculture, and a unified Germany was becoming an industrial colossus.
The effect of such developments on finance was much the same at the turn of the twentieth century as at the turn of the twenty-first. Bonds could be issued by Argentina, underwritten in London and purchased in New York. Oil could be refined in California and shipped to Japan on credit provided by banks in Shanghai. The newly invented stock ticker brought near real-time information from the New York Stock Exchange to “wire house” brokerage offices in Kansas City and Denver. Financial panics with global repercussions did occur with some frequency, notably the Panic of 1890, involving South American defaults, and the rescue of the leading London bank, Baring Brothers. This first age of globalization was a time of prosperity, innovation, expanding trade and financial integration.
In August 1914, it all collapsed. A London banker, surveying the scene from the window of his City club early that summer and contemplating the pace of progress in his time, could not have imagined the run of tragedy that would ensue over the next seventy-five years. Two world wars, two currency wars, the fall of empires, the Great Depression, the Holocaust and the Cold War would pass before a new age of globalization began. In 2011, globalized finance is omnipresent; whether it is here to stay remains to be seen. History shows that civilization and the globalization it presents are no more than a thin veneer on the jagged edge of chaos.
State Capital
Globalization was not the only geopolitical phenomenon developing in the late twentieth century; state capitalism was another. State capitalism is the in-vogue name for a new version of mercantilism, the dominant economic model of the seventeenth through nineteenth centuries. Mercantilism is the antithesis of globalization. Its adherents rely on closed markets and closed capital accounts to achieve their goal of accumulating wealth at the expense of others.
Classical mercantilism rests on a set of principles that seem strange to modern ears. The main forms of wealth are tangible and found in land, commodities and gold. The acquisition of wealth is a zero-sum game in which wealth acquired by one nation comes at the expense of others. International economic conduct involves granting advantages to internal industries and imposing tariffs on foreign goods. Trading is done with friendly partners to the exclusion of rivals. Subsidies and discrimination are legitimate tools to achieve economic goals. In its most succinct form, the mercantilist takes the view that trade is war. Success in mercantilism was measured by the accumulation of gold.
Although mercantilism had its roots in the Hundred Years’ War of the fourteenth and fifteenth centuries, it reached new heights with the formation of the East India Company in England in 1600 and the Dutch East India Company in the Netherlands in 1602. While these companies operated as private stock companies, they were given wide-ranging monopolies supported by the power to raise armies, negotiate treaties, coin money, establish colonies and act in the place of the government in dealings in Asia, Africa and the Americas. Scholars have focused on the private features of these firms, such as stock ownership, dividends and boards of directors. However, given their quasi-sovereign powers, they are more properly understood as extensions of the sovereign with private owners and managers. This arrangement bears comparison to regional Federal Reserve Banks in the United States, which are privately owned but act as a financial arm of the government.
It was only in the late eighteenth century, with the industrial revolution and the publication of The Wealth of Nations by Adam Smith, that a more modern form of laissez-faire capitalism with private ownership and banking arose. Yet through the twentieth century, despite the success of private enterprise, state-controlled businesses still prevailed in societies dominated by communists, fascists, oligarchs and many other antidemocratic forces.
What we today take for granted as the dominant financial paradigm of private capitalist free enterprise and entrepreneurship is, in fact, exceptional in most times and most places. Private enterprise may have the greatest claim to efficiency and wealth creation, but these are not universally held values. Capitalism’s claim to dominance in the future of global trade, finance and technology would seem to have no stronger historical basis than the claims of monarchy, imperialism, communism and other systems in their day.
Companies that appear private but have nearly unlimited state resources behind them, such as China Petroleum and Chemical Corporat
ion (known as Sinopec), are able to bid on natural resources, buy competitors and invest in equipment without regard to short-run financial impacts. They are able to gain market share by selling below cost. They do not have to worry about losing access to capital markets in times of economic distress. Such entities need not fear investigation by their own government if they bribe dictators and their troops to protect their interests. This neomercantilism is the power of the state dressed up as a modern corporation: old wine in new bottles.
Exemplars of this new breed of enterprise are sovereign wealth funds, national oil companies and other state-owned enterprises. These entities are plentiful in Russia, China, Brazil, Mexico and other emerging markets. Western Europe also has its state-owned megacorporations. EADS, the European aircraft, defense and space giant, has publicly traded shares but is majority owned by a consortium that includes French and Spanish government holding companies, a Russian state-controlled bank and Dubai Holding. The Italian oil company Eni, owned 30 percent by the state, is another example—just one among many. Americans are tempted to throw stones at these state-owned entities and call them unfair competition, only to be reminded that in 2008 the U.S. government bailed out Citibank, GE and Goldman Sachs. The United States has its own state-sponsored enterprises; it is really not that different.
To understand globalization and state capitalism, a different, non-U.S. perspective is needed. Intelligence analysts are trained to avoid “mirror imaging,” which is the tendency to assume that others see the world as we do. In trying to discern the intentions of adversaries, mirror imaging can be a fatal flaw. Threat analysis requires the analyst to put herself in the shoes of Russians, Chinese, Arabs and others to understand not just the differences in language, culture and history but also the differences in motivation and intent. When Russian leaders think of natural gas, they see not only export revenue but also a stranglehold on the industrial economy of Europe. When Chinese strategists consider their holdings of U.S. government bonds, they understand they have a weapon that can either destroy the U.S. economy or blow up in their faces. When Arab rulers move down the path to modernity, they are acutely aware that they are placing themselves in a reactionary and religious vise that can crush them. A twenty-first-century Grand Tour through Dubai, Moscow and Beijing will help us to see ourselves the way billions of Arabs, Asians and Russians see us—and to understand that the dollar’s destiny is not entirely in American hands.
Currency Wars: The Making of the Next Global Crisis Page 17