1998 – The End of Globalization
A Completely Imaginary Scenario
(Or Is It ?)

By: Dr. Sam Vaknin

(This article was published in "Nova Makedonija" on 30/4/98)
 

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It is from the least expected angle that catastrophes usually start. This time it was China. Its currency, the Yuan, weathered the financial storms of Southeast Asia, buffeted by hefty foreign exchange reserves, an apparently unflinching commitment to its stability by a decisive government and sound economic fundamentals. But behind this facade, a crisis was brewing. Gigantic state companies defaulted on hundreds of billions of dollars of loans. Banks became illiquid and then insolvent. The government secretly borrowed abroad in preparation for a massive capital flight through Hong Kong. It also resorted to the printing press, shovelling ever-depreciating Yuans at the problems. Insiders and smart currency traders began to hedge their Yuan positions by selling the local currency and buying Hong Kong dollars, actually any kind of dollars. It was only a matter of time – months – before the currency collapsed, sweeping with it the hitherto stable Hong Kong dollar. And this was how the Second Southeast Asia crisis began.

The rest is history. A flood of devaluations followed. All the major countries of the regions were forced to devalue their currencies to stem an export catastrophe. Had they not done so, their products would have been priced out of their export markets by now much cheaper Chinese goods. Japanese banks crumbled like so may houses of cards. Bad loans and corporate bankruptcies to match, soared. Unemployment in Japan – an hitherto almost unheard of phenomenon – tripled itself. When it crossed the 10% level – the highest ever – social and political unrest ensued and reverberated throughout the region. The Tokyo Stock Exchange was both ghostly and ghastly. Domestic Japanese interest rates began to reflect the increasing macro economic and micro economic risks (high rates of default and bankruptcy plus the liquidity crunch and the risk of re-emerging inflation). They rose to almost 6%. Japanese investors began to switch from US government bonds to domestic ones. The yields on American bonds started to pick up and with them short term interest rates in both the first and the second largest economies of the world.

The West was worried, but hardly affected. Japanese trade amounted to a mere 2-3% of the total trade of the European Union and even less with the USA. European banks hurt (they were exposed to Asian risk) but American banks did not (except in California). Actually, throughout the crisis, the Europeans were mostly occupied with the open hostilities between Germany and France over the philosophy behind the Euro. Germany wanted an independent European Central Bank, France wanted a socially and politically conscientious one. For a time, it looked as though the whole project is doomed.

It took a Wall Street full fledged crash to end the bickering and call the real issues into the limelight.

Wall Street did not collapse at once. By June, it reached a peak of 9418. Exuberance was rampant. People were elated. The belief that this was never going to stop was entrenched. That is, until it did stop. The first signs appeared during a few fateful and fitful trading sessions in June. The Dow crashed by almost 10% in one trading day and the next trading day witnessed no recovery. Only the weekend prevented an October type collapse. A respite of three months followed, in which the Dow was able to climb back almost to its previous highs. The 9420 was never breached, though. The echoes of the crisis in Asia began to penetrate people’s minds and even the insulated halls of Congress and of the stock exchange itself were not immune to the rumblings of a distant but present danger. When Russia caught the Asian contagion, trouble was in the air. The Rouble’s frightening free-fall, the wiping out of the Moscow Stock Exchange, the political upheaval following President Yeltsin’s final bow – all presaged a period of financial horrors.

And they surely transpired. Wall Street began an incredible 50% descent into its financial purgatory one unusually sunny day in October. Since that day, the Dow had no respite. An unstoppable decline ensued which erased close to 3 trillion dollars off the wealth of American citizens. Every second one was affected directly, or indirectly (through the pension funds and the mutual funds). Consumption contracted by 10%, the growth of the GDP halted and then transformed into a steep 3.5% decrease. Unemployment shot above the 7% mark in less than two months when all the part time and flexible time workers were fired. All the economic achievements of the last years of the Clinton administration were swept away by these torrential developments. The balanced budget was no more, business confidence waned, investments dwindled, the trade deficit skyrocketed due to the weaker Asian and European currencies. America was in the throes of an economic crisis, which yielded a recession of a size not known since the 1930s.

No one was left to power the world economy. All the major economic locomotives were either in disarray (trying to adapt themselves to an ever more ominous world), or in the clutches of stagflation. Inflation picked up. It was to be expected : the production sectors (agriculture and industry) cut their production down. Money was chasing ever fewer products and goods. Prices shot up. Inflation set in and with it the dark apparition of stagnation, economic uncertainty and the inefficient allocation of resources due to the distortion of the price mechanism.

Economists all over the world warned the politicians not to repeat the mistakes that were directly responsible for the emergence of monsters like Hitler in the 1930s. At first, the politicians obliged. They restrained themselves, tried to educate their nervous constituencies, collaborated with each other across national boundaries. They did not impose import restrictions, quotas and tariffs. They did not prevent free capital flows. They did not slap administrative constraints on internal and external competition. They instituted measures, which were supposed to let the market correct its own failures, using that famous “hidden hand”. But the markets continued to fail them. The situation got worse and worse. More and more people were made redundant. Savings were consumed. Unemployment queues lengthened as factories and farms closed or were foreclosed by irritated and under-capitalized banks. Whole industries were at risk.

And some countries were cheating or expressly resentful of the role that the USA played in all this. Others were too hesitant, too prone to react reflexively. Yet others claimed prerogatives due to their special status as poor countries or geo-strategically important, or geo-politically stable, or whatever.

France was the first Western country to break the ranks. Decrying “American neo-colonialism”, it went its own way and surrounded itself with a protective wall of regulations. This was contrary to EU policy but the tumult was so severe and the centrifugal forces wrought by the turbulence so irresistible that it was “each one on his own” rather than European solidarity that ruled. Some countries, like Israel, Cyprus and most of the former Yugoslav republics, were cheating outright, serving as illicit conduits, transhipment stations, places were labels and documents were altered, no questions asked. India and many African countries said that they were too poor to engage in free trade and free capital flows. So did China. Gradually, more than 70% of the countries in the world – whole continents : Africa, Latin America – isolated themselves in a bid to protect their national industries and their working places. Even regional and bilateral arrangements crumbled under the pressure. No amount of international conventions seemed to advance the cause of rationality. Politicians the world over were terrified, amok-ridden, at a loss as to what to do. Some economists provided them with the intellectual alibi, which they needed. Seizing upon the only clear solution, they sealed their economy from outside competition. Legislators in the USA and the UK did not withstand the pressure, finally succumbed to violent public opinion and initiated a long list of notoriously protective laws. International trade ebbed, then retreated, receded, back almost to the level of the early 1970s.

It was then, when the largest economies disengaged themselves from the rest of the world that the Second Great Depression started. Export economies contracted by double-digit numbers. Prices spiralled up uncontrollably as cheaper imports disappeared from the markets. Inflation brought in its wake further devaluations, which fuelled inflation. Real income was eroded, savings vanished, people cut savagely on their consumption. The only thriving industry was the legal professions as defaults, bankruptcies, receiverships, insolvency and foreclosures soared. Each such cycle exacerbated the next one by spewing into the labour market its latest victims. Poverty stricken, sometimes hungry, sickly and psychologically demolished – a new class of unemployed was thus being formed.

As globalization trends were bucked and then reversed under the attack of economic reactionary forces, previous multilateral collaborative efforts vanished or were actively dismantled. Congress, for instance, refused to approve any additional funding for the likes of the United Nations or the International Monetary Fund. The latter, teetering on the verge of insolvency itself, its last funds exhausted, refused to disburse additional loans to any country. Many a country were thus reduced to begging in specially arranged donor conferences and, when no donors were left, they defaulted on their debts, in droves. The confidence in the world monetary system and arrangements was irreparably shaken. The price of precious metals skyrocketed. People bought land both as a hedge against the erosion of the value of their savings and as a source of food in case of “real trouble”. A barter economy flourished side by side with the official monetary one. As currencies lost their meaning, their convertibility greatly reduced, their value constantly eroded by inflation (the mirror side of the scarcity of goods) – people regressed to earlier methods of exchange and of storing value.

This was the beginning of an end. Politicians were still bickering. The Internet was still gathering pace. Some mergers were still made. Trading in Wall Street was brisk, though bearish. Diamonds were in vogue again. The monetary orchestra was playing in full force as the Titanic ship of the world economy was sinking, ever more deeply and inexorably.