From http://www.atimes.com/atimes/China_Business/JJ02Cb03.html on Dec 16, 2008.

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CHINA'S DOLLAR MILLSTONE, Part 4
Gold, manipulation and domination
By Henry C K Liu

All over the world, trade in gold had been the favored device for evading national foreign exchange controls from the end of World War II to 1971. In 1946, the Bretton Woods regime adopted in 1944 became operational, thereby forbidding the importation of gold for private speculative purposes in signatory nations. Britain was a signatory but Portugal was not.

Thus a gold-smuggling operation between the Portugal colony of Macau and the British territory of Hong Kong flourished until 1974, two years after the United States took the dollar off gold, in effect abolishing the Bretton Woods system of fixed exchange rates, when Hong Kong abolished a law that requires a special license to import gold for re-export. Tiny Macau became one of the world's biggest importers and re-exporters of gold during this period.

Instability in the exchange value of the British pound sterling in the late 1960s pushed Hong Kong, a British territory since 1841, to switch to a gold-backed US dollar pegged at $35 per ounce of gold. Hong Kong trading firms bought gold legally on the London gold market beyond the reach of US law forbidding private purchase and ownership of gold on US soil, at a pegged price of $35 per ounce. They then passed it along to Macau gold syndicates for a service charge to recast the gold into physical shapes suitable for smuggling back to Hong Kong, where it could be sold at above-peg prices for use in financial transactions around the world out of range of Bretton Woods regulations. London -> Macau -> Hong Kong -> World

From 1960 to 1980, Turkey strictly regulated the flows of gold in and out of the country. The government passed a law on the "Protection of the Value of Turkish Currency" to control gold smuggling. During this period, the price in the domestic market was around US$12 per ounce higher than in international markets. Before 1980, when importing gold was prohibited, smuggled gold volumes into the country reached 80 tons a year.

In 1980, together with a general policy change on liberalization and globalization, the foreign exchange market and a number of commodity markets were deregulated. In 1985, the central bank was given responsibility for importing gold against the Turkish lira. During this period, the average price difference between the domestic and international markets decreased to US$7.65 per ounce. In 1993, further liberalization ended the central bank's monopoly and allowed gold bullion imports and exports by authorized market participants on a declaration basis. In 1992, the average price difference between the domestic and international markets decreased to US$1.28 per ounce.

The opening of the Istanbul Gold Exchange (IGE) on July 26, 1995, and the price difference between domestic and international markets decreased still further to US$0.72 per ounce. This meant that Turkey's citizens were paying less for gold but the Turkish currency was appreciating as the money supply shrank to slow the economy.

In 1939, at the start of World War ll, gold imports into British India were controlled or banned. This British legacy of colonial exploitation was continued by Indian government. Gold control laws were enacted that stopped all legal gold imports into India. Gold smuggling continued the gold traffic. The gold control laws corrupted four generations of Western-trained Indian government officials and politicians, made gold expensive in relation to Indian income and kept Indians in poverty longer.

Overseas drain of gold from the US
By 1971, the US gold stock had declined by $10 billion, a 50% drop. At the same time, foreign banks held $80 billion, eight times the amount of gold remaining in US possession. A growing US balance-of-payments deficit meant that foreign governments were accumulating large amounts of dollars - in aggregate volume far exceeding the US government's stock of gold. The central banks of these governments could show up at any time at the gold window of the US Treasury and insist on trading in their dollars for gold, which would precipitate a run on the US gold reserve.

The issue was not theoretical. By the 1960s, many foreigners were buying gold at an artificially low price of $35 set by Bretton Woods and sold it in the black market for easy profit. The result was that the US began to bleed gold through her fiscal and trade deficits and by the increasing amount of dollars sent overseas, know as euro-dollars. France under Charles de Gaulle realized that this trend was unsustainable. The US was printing more dollars than its gold holding could support and dumping the dollars in world markets.

To deal with the problem, president John F Kennedy approved the suggestion of newly appointed undersecretary of the Treasury Robert Roosa that the US, Britain, France, Germany and other European nations pool their gold resources to prevent the commercial price for gold from exceeding the Bretton Woods mandated rate of US 35 per ounce. Acting on this suggestion, the central Banks of the US, Britain, West Germany, France, Switzerland, Italy, Belgium, the Netherlands, and Luxembourg set up the "London Gold Pool" in early 1961.

The London Gold Pool came unstuck when France under de Gaulle pulled out and began to send the dollars earned by exporting to the US back to the US and demanding gold rather than Treasury debt paper in return. Under the terms of the 1944 Bretton Woods Agreement, France was legally entitled to do just that. As the drain on US gold became acute, the London Gold Pool folded in April 1968 because it did not command enough gold to support the price at $35 per ounce. The demand by foreigners for gold held by the US surged.

George Pompidou, then as prime minister under de Gaulle and later French president observed: "The international monetary system is functioning poorly because it gives advantages to the country issuing the reserve currency. Such a country can have inflation by making others pay for it."

John Connally, Treasury secretary under president Richard Nixon, had told foreign finance ministers that "the dollar was America's currency, but your problem". To solve the problem, France redeemed its dollar holdings in gold in early August 1971 by sending a French battleship to New York to take delivery of French gold from the vault of the New York Federal Reserve Bank and to bring it to the vault of the Banque de France in Paris. The French raised gold reserves and dumped dollars. Banque de France eventually increased its gold holding to 92% of its reserves.

Even Britain, the ally with a "special relationship" jumped the monetary ship. On August 11, 1971, the British ambassador in Washington received instructions from London to go to the Treasury Department to request the conversion of $3 billion into gold and to have it moved from the United States Bullion Depository at Fort Knox to the underground vault of the New York Federal Reserve Bank, where foreign government gold was stored. US gold reserves had dropped from 20,000 tons to 8,500 tons (32,150 troy ounces = 1 metric ton). At $35 per ounce, 8,500 tons of gold had a cash value of $9.56 billion. Four days later, on August 15, 1971, President Nixon announced that the United States would no longer redeem dollars for gold, making it the final step in abandoning the gold standard.

The breakdown of the Bretton Woods monetary system in 1971 was precipitated by short-term capital movements out of the dollar into the key European currencies, leading to the floating of the rising German mark and the Dutch guilder. But the long-standing payments deficit of the US and her deteriorating current account and fiscal account since 1965 were the fundamental causes.

At first the short-term capital flows of early 1971 signaled the reverse of the great floods of money that had moved to the US between 1969 and 1970 when the US business cycle peaked and the Federal Reserve made concerted effort belatedly to restrain the growth of the money supply. The combination of inflation momentum and abrupt tight money pushed interest rates to unconstructive levels. As usual, the Fed response on dated incoming data caused its time-lagged response to overshoot, exacerbating volatility. This is known in the market as the Fed always falling behind the curve.

When real data on the US business cycle topping out finally became visible, the Fed again belatedly eased monetary policy excessively to cushion the fall already in process. As frequently in previous crises, the time lag of the effect of Fed actions on market behavior caused the Fed to overshoot both coming and going. Dollar rates dropped precipitously in November 1970 and money flooded back to Europe like a tidal wave. The flow at first only reflected interest rate differentials, but as always, interest-rate-driven flows induced speculative runs.

The massive rush of funds into Germany threatened to undermine Bundesbank efforts to contain inflation in Germany. The German central bank opted to suspend the fixed exchange rate of the mark and allowed it to rise against the dollar to fight domestic inflation, against which Germans have a historical phobia. A similar sequence of events ensued in the Netherlands. The flight from the dollar continued and eventually accelerated. US gold reserves were visibly inadequate to maintain even the semblance of convertibility, forcing Nixon to close gold convertibility to foreigners. After the gold window was formally closed, the major currencies either floated or were shielded against further dollar inflows by capital controls.

The silver Hunts
The family of Texas oil patriarch H L Hunt was one of the richest in America. The sons, Nelson Bunker and William Herbert, played a very significant role in the discovery and development of the oil fields in Libya, which were later nationalized by order of Muammar al-Gaddafi. In 1973, the Hunt brothers decided to buy precious metals as a hedge against inflation. Gold still could not be legally held by private citizens at that time, so the Hunts began to buy silver in large quantity. By 1979, the Hunt Brothers, together with wealthy Mid-East investors, controlled a pool of more than 200 million ounces of silver, equivalent to half the world's deliverable supply.

When the Hunts began accumulating silver back in 1973, the price per ounce was in the $1.95 range. By early in 1979, the price had risen to $5. By September 1979, the price reached $11. But in January 1980, the price went to the $50 range, peaking at $54. Gold hit a then historic high of $850 in 1980, making the silver/gold ratio at 15.74/1, very close to the historical ration of 15/1. It looked like that the Hunts were restoring the gold standard with bimetal ratio.

Once the silver market was cornered by the Hunts, outsiders joined the chase. The Hunts and other silver traders were financing their silver buys and holdings with bank loans in futures contracts. A combination of changed trading rules on the New York Metals Market (COMEX) and the intervention of the Federal Reserve punctured the speculative bubble and the price of silver began to slide, culminating in a 50% one-day decline on March 27, 1980 as the price plummeted from $21.62 to $10.80. As the price of silver fell, the Hunt Brothers were unable to meet a $100 million margin call. [Jim Sinclair worked for the Hunts during this period. He's said that the problem with a corner is exiting your position: there's no one to whom to sell it.]

The collapse of the silver market meant countless losses for speculators. The Hunt brothers declared bankruptcy. By 1987, their liabilities had grown to nearly $2.5 billion against assets of $1.5 billion. In August 1988, the Hunts were convicted of conspiring to manipulate the silver market.

Soviet monetary system
The ruble has been the Russian unit of currency for about 500 years. From 1710, the ruble was divided into 100 kopeks. The amount of precious metal in a ruble varied over time. In a 1704 currency reform, Peter I standardized the ruble to 28 grams of silver. While ruble coins were silver, higher denominations were minted in gold and platinum. By the end of the 18th century, the ruble was set to 18 grams of silver or 1.2 grams of gold, with a ratio of 15:1 for the values of the two metals. In 1828, platinum coins were introduced with 1 ruble equal to 3.451 grams.

On December 17, 1885, a new standard was adopted that reduced the gold content to 1.161 grams, pegging the gold ruble to four French francs. This rate was revised in 1897 to 1 ruble = two-and-two-thirds francs, or 0.774 grams gold. With the outbreak of the World War 1 in 1914, Russia dropped the gold standard and the ruble fell in value to cause hyperinflation in 1920s. Between 1921 and 1922 inflation in the USSR reached 213%.

In 1992, the first year of post-Soviet economic reform, inflation was 2,520%, the major cause being the decontrol of most prices in January. In 1993 the annual rate was 840%, and in 1994, 224%. The ruble devalued from about 40 to the US dollar in 1991 to about 30,000 in 1999. In 2008, the ruble exchange rate is about 25.5 to the dollar. Russia's inflation rate in 2008 is around 3.2%.

Following World War II, the Soviet government implemented a redenomination of the currency to reduce the amount of money in circulation. This only affected paper money. Old rubles were revalued at one tenth of their face value. The 1961 redenomination was a repeat of the 1947 reform, with the same terms applying. The Soviet ruble of 1961 was formally equal to 0.987412 gram of gold, but, similar to the US, the exchange for gold was not available to the general public. Following the breakup of the Soviet Union in 1991, the ruble remained the currency of the Russian Federation. A new set of banknotes was issued in the name of Bank of Russia in 1993. During the period of high inflation of the early 1990s, the ruble was significantly devalued.

Soviets and the Marshall Plan
The Marshall Plan was more than an aid program to help Europe recover from war damage. It sought to restructure Western European economies away from their prewar socialist direction and launch them on a path towards US-style market capitalism based on a new monetary regime of a gold-backed dollar and to keep budding European social democracy from mutating into populist communism through elections.

The strategic geopolitical purpose was to integrate Western Europe firmly into postwar Pax Americana of free-market fundamentalism and a regional military alliance in the form of North Atlantic Treaty Organization (NATO) based on collective security, [(]having rejected the lesson of the role of interlinked alliances in igniting World War I[)]. The Marshall Plan was the linchpin of US strategy to neutralize a perceived rising Soviet threat. It helped to trigger the Cold War.

The Soviet leadership responded to post-Roosevelt US policy based on Soviet experience with the West before, during and after World War ll. This experience led Moscow to a policy that was not simply fuelled by a conditional reflex of anti-Americanism, which during the Roosevelt era had been kept in deep abeyance.

The Munich Pact of 1938 followed Franco-British rejection of two successive Soviet offers (in 1934 and 1937) to form an alliance against Germany in Europe and Japan in Asia, thus pushing the USSR to enter the Soviet-German Non-aggression Pact of August 23, 1939, less than a year after Munich. From the Soviet perspective, Munich was a Western scheme to turn Nazi aggression eastward and use German fascism to counter Soviet communism. The Soviet-German Non-aggression Pact was an attempt to turn the table back against capitalism by freeing up fascism against it.

Munich convinced the USSR that the Western powers were pursuing a policy of selective appeasement only toward German eastward expansion and were not interested in joining the Soviet Union in an anti-fascist alliance promoted through a popular front. In addition, there was concern about the possibility that Britain and France would stay neutral in a war initiated by Germany against the USSR, hoping that the two warring Eastern powers would wear each other out and put an end to both the Bolshevik Soviet Union and Nazi Germany.

In this sense, Munich was less a strategy of appeasement to secure peace than a Western capitalist democracy strategy of directing war eastward between fascism and communism. (See Beyond Munich: Geostrategy and betrayal, Asia Times Online, April 28, 2007.)

By late 1941, and with the USSR under attack from Germany, Western powers had not yet opened a second front (and would not do so until June 1944), Moscow had reasons to seek a separate peace with Germany. Churchill and Roosevelt were fully aware of this possibility.

After taking over as prime minister in the spring of 1940, Churchill refused to pledge that Britain would cease hostilities against Germany in the event of an internal coup to topple the Third Reich. This policy is known in British diplomacy as "absolute silence". Yet Churchill was flabbergasted, and later claimed that he had not been consulted, when after Roosevelt and Churchill met at Casablanca in January 1943 the idealistic US president emerged from the meeting to tell the world that the US and Britain would accept nothing short of unconditional surrender from Germany. Roosevelt needed to do this because he was aware that the US public did not want to go to war to save old Europe, only to save the world from tyranny.

Churchill later claimed that he had not been consulted but had to go along for the sake of the Atlantic Alliance. Churchill had in the back of his mind the use of Germans to resist postwar communist incursion into Europe, and was interested in preserving the Wehrmacht for that purpose. He knew that no Wehrmacht officer would support a coup against Hitler only to have his country invaded, occupied, and humiliated by the Allies that included a communist power. For the German military, better to stand by Nazi Germany, even if it meant following Hitler's madness toward total destruction, than to commit such dishonorable high treason.

But Roosevelt, driven by US public opinion, left Churchill no room to maneuver. Unlike Churchill, Roosevelt saw the possibility and merit of peaceful co-existence between capitalist and communist nations and did not look forward with relish to the need or value of a Cold War.

Coming when it did in January 1943, the same month the German 6th Army was defeated at Stalingrad, the Roosevelt unconditional surrender proclamation prompted Ulrich von Hassel, who had used his international contacts to arrange secret meetings with British and American officials, and had hoped that a successful coup would translate into an honorable peace treaty with Britain and the US, to conclude that the unconditional surrender proclamation had bailed out Hitler from domestic opposition over his military disaster at Stalingrad.

Risks of a separate peace
Roosevelt's unconditional surrender demand had its own logic. For Roosevelt, it was vital not to give Stalin any incentive that would tempt him to strike a separate deal with Germany that would lead to a separate peace. In World War I, generals Paul Von Hindenberg and Erich Ludendorff had pulled off such a separate peace with new Soviet Russia in early 1918, but it came too late to allow them to move their forces westward to smash the Anglo-French lines before US forces arrived.

It was very likely that the Allies might never have won World War II if Stalin, having regained the 1939 Soviet border, suddenly backed out of the war to allow German forces on the Eastern Front to be diverted towards the West. Moreover, the United States was eager to get the Soviet Union to declare war on Japan to reduce projected heavy US casualties since the Manhattan Project to develop the atomic bomb was still years away from completion in 1942 and success had not been guaranteed.

On June 5, 1947, Secretary of State George C Marshall spoke at Harvard University and outlined the Marshall Plan. Europe, still devastated by the war, had just survived one of the harshest winters on record. The nations of Europe had nothing to sell for hard currency with which to buy food and fuel, and the postwar social democratic governments in most countries were unwilling and unable to adopt the draconian proposals for recovery advocated by old-line classical market economists. Something had to be done, both for humanitarian reasons and also to stop the potential spread of communism in Western Europe.

The US offered for European relief up to $20 billion ($200 billion in 2008 dollars, or 10% of its GDP which would come to $1.4 trillion in 2008), but only if the European nations could get together and draw up a plan to act as a single cooperative economic unit. Marshall also offered aid to the Soviet Union and its allies in Eastern Europe, but Stalin denounced the program as a trick to spread market capitalism in the Soviet Union and refused to participate. Ironically, Soviet rejection made passage of the Marshall Plan through congress possible. In 1947, anticommunism in the US was much stronger than anti-Americanism in the Soviet Union.

While Europe was devastated by war, the US was blessed with record-breaking wheat harvests in 1944 and 1945. Its defense industry had produced for the war 196,000 aircraft, with 96,356 in 1944 alone, and more than 40 billion bullets. In 1943 alone, the US produced 19 million tons of merchant ships, up from prewar production of 600,000 tons. Gross national product (GNP) doubled from less than $100 billion in 1940 to more than $200 billion in 1945. Corporate profits also doubled from about $6 billion in 1940 to $12 billion four years later.

By 1944, the US was able to spend on war more than its entire national income in all previous time in peace. More than $50 billion of lend-lease goods were sent to allies, mostly to Britain and to a lesser amount to the USSR. US national income tripled to $198 billion by the end of the war from $72 billion in 1939.

Unlike the rest of the war-torn world, the US had never had it so good, which left the national psyche with greatly reduced phobia against war. For the US public, war meant prosperity and inspiring entertainment as portrayed in Hollywood war movies. Operationally, both world wars were limited wars, for the US fought only on foreign land. The positive socio-economic impacts from these two conflicts left the US with a cavalier mentality for future limited wars, first Korea, then Vietnam, then Kosovo, then Iraq, then Afghanistan, then Iraq again and possible Iran before long.

In one stroke, World War ll swept away the blight of economic depression that had afflicted the US for 12 stagnant years before the Japanese attack on Pearl Harbor. Roosevelt's lowest unemployment rate during the New Deal years was still over 14%. In 1945, the unemployment rate was close to 1%, even with a much larger labor force, adding 30% more workers to the total workforce of 64 million, including 3 million housewives.

Regional economic disparity was moderated. The depressed south received a disproportionate volume of defense contracts, including nearly $6 billion of federally financed industrial facilities. Wartime federal spending gave birth to the "Sun Belt" of new high-tech manufacturing, ironically a region that would in time form the electoral base for ideological assault on government intrusion in the economy.

The National Bureau of Economic Research showed that whereas in 1929 the richest 1% received 16% of the national income, in 1948 they received only 8%. World War II had a significant effect on the equalization of income and wealth in the US, but economic democracy did not last long. In 2007, the richest 1% in the US received 22% of the national income. The top marginal income tax rate in 1947 was 86.45% while the top rate in 2008 is 35%. The highest rate was 94% in 1944-45. Any way you cut it, the rich in the US have been favored by the government since soon after World War ll ended. Economic democracy receded soon after the war to defend democracy ended.

World War II amplified to unprecedented proportions the intrusive role of the federal government in US society in the process of defending freedom abroad. After the war, the Federal Bureau of Investigation (FBI) turned from a federal agency against organized crime to one that routinely violated the civil rights of large number of citizens in its mission to protect freedom. Ideological witch hunts were conducted in all levels of society, reaching even to the highest level of government, culminating in General Marshall being accused of being a communist sympathizer.

World War ll also turned the US into a superpower at the expense of European powers, allies and enemies alike. The nation that had entered the war to protect the weak and the poor of the world abandoned the purpose of the "good war" after the death of Franklin D Roosevelt, its great populist leader, and turned its support towards preserving post-war Western colonialism in the name of anticommunism.

Harry S Truman, an insecure leader who became president by default, allowed himself to be manipulated by Winston Churchill not only to see communism as an evil ideology but also as an opportunity to exploit anticommunism to collect the geopolitical dividends of victory. It nurtured US "exceptionism" in foreign policy and gave the young nation a messianic mission of enlarging democracy and Christian values around the world, to distant lands whose names most US leaders could not pronounce properly and most US citizens had never heard of in their daily lives.

The postwar US began to view itself as God's new chosen nation and marveled at its own holy perfection. It transformed itself into the role of "the indispensable nation" as a justification for hegemony. The only challenge to postwar US hegemony came from its former wartime ally, the USSR, the "evil empire", as president Reagan later came to call it.

Soviets reject Marshall Plan - onset of Cold War
The opening salvo of the Cold War was Soviet rejection of the Marshall Plan. In saving Europe from war-induced starvation, the Marshall Plan also saved the US economy from a repeat of the postwar depression of World War I. The financial aid was denominated in US dollars, to be used to buy goods from the US shipped across the Atlantic on US merchant vessels.

By 1953, the United States had pumped $13 billion into the Marshall Plan account, moderating the adverse impact of military demobilization on the US domestic economy. Moreover, the plan included former arch-enemy West Germany, which was thus reintegrated into the European community. It neutralized war reparations normally required of a vanquished country through the division of the German nation into capitalistic West and socialist East.

More significantly, the Marshall Plan established the US dollars as the reserve currency for intra-European and international trade and laid the economic foundation for gold-backed dollar dominance, which turned into a fiat currency after Nixon closed the gold window in 1971 and emerged as dollar hegemony with globalization of finance after the end of the Cold War.

Aside from helping to put Europe economically back on its feet, the Marshall Plan led to the Schuman Plan, the Coal and Iron Community and the Common Market, and pointed to what may yet evolve into an economically and politically united Europe. The Schuman Plan in turn led to the European Atomic Energy Community (Euratom), which was signed (along with the EEC Treaty) in Rome on March 25, 1957, and entered into force on January 1, 1958. It was one of the founding treaties of the EU, which called for support for nuclear power across the EU and is the only treaty that supports the development of a particular energy source.

However, currently in the EU seven member states do not have nuclear power, while four more have the political objective of phasing out their nuclear power programs. Throughout the EU there are no reactors under construction since May 2008. Despite this the Euratom Treaty remains.

Soviet policymakers understandably viewed the Marshall Plan as a US strategy to exploit the war-ravaged conditions of Europe to establish US domination through monetary imperialism. To Soviet leaders, the Marshall Plan was a realpolitik strategy cloaked in humanistic ideals. The USSR rejection of the Marshall Plan turned the Cold War into economic position warfare.

While US policies militarily assumed a defensive geo-strategic position against communist expansionism, its economic policies took on aggressively assertive initiatives designed to expand the reach of the capitalist system throughout the world. From this perspective, Soviet rejection of the Marshall Plan was a natural response of a socialist state trying to resist external market pressure and internal revisionist agitation for reintegration of hard-won socialism back into the capitalist Western economy, and the subordination of new socialist nations to new domination by the capitalist West.

In 1947, Soviet economist and Hungarian expatriate Evgenii Varga proposed the notion of a "Third World" that would be a decisive arena of opportunity and conflict in the post-World War ll era. The First World was occupied by the two superpowers: US and the USSR, and Second World was occupied by the major powers that were allies of either the two superpowers. The main arena of opportunity and conflict was in the Third World countries in Asia, Africa, and Central and South America. Since World War II, all limited wars, some lasting longer than the world wars, have been fought in the Third World

The Soviet leadership also viewed the Marshal Plan as an attempt to use economic aid not only to consolidate a Western European bloc, but also to undermine recently won, and still somewhat tenuous, Soviet geopolitical gains in Eastern Europe. It feared that the US economic aid program sought to transform the new chain of Soviet-oriented buffer states into a revamped version of the "cordon sanitaire" of the interwar years. The plan appeared to aim at the reintegration of Eastern Europe into the capitalist economic system of the West, with all the political ramification that implied.

Thus the Marshall Plan, conceived by US policymakers primarily as a defensive measure to stave off economic collapse in Western Europe to keep communism from electoral triumph in European domestic politics, proved indistinguishable to the Soviet leadership from an offensive attempt to subvert Soviet security interests.

Offensive aspects of Marshall Plan
The Marshall Plan was openly offensive in that its authors, notably George F Kennan, whose writings formed the basis of the Truman Doctrine to support any nation economically and militarily to prevent their falling under Soviet control, did indeed aim at luring some of the Eastern European states out of the Soviet orbit and integrate them into the Western European economy. In this sense, the economic motives behind the Marshall Plan were undeniably more than just a geo-strategy to counter Soviet expansionism. It was rather a plan to constrict and reduce socialism in Eastern Europe.

In conversations with Harold Stassen, a perennial candidate for the Republican presidential nomination, Stalin particularly focused his queries on the possibility of government intervention heading off a future economic crisis. And he seemed more optimistic than Stassen that such intervention could succeed. Stassen, a Roosevelt Republican who lost the nomination as Republican candidate against Truman in the 1948 presidential election to Thomas Dewey, ran for president a total of nine times, the last being in 1992.

Stassen delivered the keynote address at the 1940 Republican Convention to help secure the nomination for Wendell Willkie, when senator Robert Taft of Ohio stressed that the US needed to prevent the New Deal from using the international crisis to extend socialism at home. Had Stassen received the Republican nomination in 1948, he might have defeated Truman to reach an understanding with the Soviet Union to prevent the Cold War.

Time Magazine in its Monday, May 12, 1947 edition reported:

Last week, Harold Stassen, peripatetic Republican presidential candidate, disclosed the full report of his recent conversation with Russia's Generalissimo Joseph Stalin. It went something like this:
Stassen: Generalissimo Stalin ... I would be interested to know if you think [our] two economic systems can exist together in the same modern world in harmony ...
Stalin: Of course, they can ...
Stassen: ... There have been many statements about not being able to cooperate. Some of these were made by the Generalissimo himself ...
Stalin: It's not possible that I said that the two economic systems could not cooperate ...
Stassen: The statements I referred to are those made by you at the 18th Communist Party Congress in 1939 and the Plenary Session in 1937 - statements about "capitalist encirclement" and "monopoly ..."
Stalin: There was not a single Party Congress or Plenary Session ... at which I said or could have said that cooperation between the two systems was impossible.
Stassen: I had an informal talk with Mr Molotov ... and it developed into an invitation to visit Russia on the occasion of my trip to Europe.
Stalin: Things are in very bad shape in Europe as a whole. Is that true?
Stassen: Yes, in general, but there are some countries ... Switzerland, Czechoslovakia -
Stalin: Those are small countries ...
Stassen: The low production of coal in the Ruhr has caused a shortage of coal throughout Europe.
Stalin: Yes. It is very strange ...
Stassen: It is fortunate that we have had such large production of coal in the United States ...
Stalin: Things are not bad in the United States.
Stassen: Our [the US] problem now is to see to it that we do not have a depression, an economic crisis. [1947]
Stalin: Do you expect a crisis?
Stassen: ... I believe we can regulate our capitalism and stabilize our production and employment at a high level without any serious crisis ...
Stalin: The Government must be vested with wide powers to accomplish that ... Magazine analysts and the American press carry open reports to the effect that an economic crisis will break out.
Stassen: ... The problem is one of leveling off at high production and stabilizing ...
Stalin: The regulation of production?
Stassen: The regulation of capitalism.
Stalin: But what about businessmen? Will they be prepared to be regulated?
Stassen: No. Some will have objections.
Stalin: Yes, they do ...

The influential economist Varga suggested in 1946 that the increased role played in the economy by the governments of the Western capitalist states might make possible the emergence of a limited form of economic planning in those economies after the war. With such planning, Varga contended, these economies might be able to avoid economic crises of the type that had caused the Great Depression in the 1930s. (See National planning and the American myth, Asia Times Online, June 13, 2002).

The implication was that Western market economies would be stabilized by adopting aspects of war planning in peace time, using an enlarged public sector to counterbalance the volatile business cycle. Such views coincided with those expressed by Joseph Schumpeter's 1942 work Capitalism, Socialism and Democracy and later given further analysis by Hyman Minsky's work on financial instability. As Western capitalist powers adopted mixed economies, they would be less aggressive against communism. Consequently a moderate Soviet policy of cooperation with the Western powers might pay large peace dividends fro the whole world.

Varga's contention that US confidence in its capitalist economy would reduce US aggressiveness against communism was obvious wishful thinking, given the ideological wind of the Truman era. As it turned out, the enlarged public sector in the US was mostly concentrated in defense spending. Still Varga's prediction that market capitalism would be saved through planning and Keynesian intervention held for half a century until the US went on a wholesale market deregulation binge in the Reagan era.

The credit crisis that began in August 2007 appears to be spinning out of control with a high probability that financial capitalism will be drowned by excessive debt beyond the power of the government to rescue. How this mess will finally play out over the course of the next few years is hard to predict because of the uncertainty of government policy and action.

One thing is certain: when the dust finally settles, the global economy will be fundamentally different from what it was before 2007. In many ways, countries with emerging economies such as China, India and Brazil, can affect the shape of the new global economy if their leaders have the wisdom and creativity to forge a new direction, instead of continuing to play passive supporting roles to a dying system.

In the latter part of 1947, once confrontation had come to dominate Soviet-US relations, Varga would be publicly criticized in the Soviet press and forced to recant this views, which by then no longer comported with the thrust of Soviet response to hostile US posture. But in April of that year, Stalin in his conversations with Stassen was merely gathering information from a high US source to confirm his impression that despite some economic difficulties, the Western economies were not on the verge of collapse, nor was the US moving towards a mixed economy. The lack of progress at the December 1945 Moscow conference to discuss occupation of Germany, peace establishment, and Far East issues signaled only that Stalin was holding out for a better deal on Germany, primarily on reparations, and not to start a Cold War.

In May 1948, Moscow tried to counter the creation of the Organization for European Economic Cooperation (OEEC), which was the institutional embodiment of the Marshall Plan, by proposing the establishment of "a committee for the development of economic relations between European states" under the auspices of the UN Economic Commission for Europe. The OEEC later became an international organization of some 30 countries, some outside of Europe, that accept the principles of representative democracy and free market economies with the name Organization of Economic Cooperation and Development (OECD).

Imminent crisis of capitalism
In the fall of 1948, the debate among Soviet academic experts about the imminent general crisis of capitalism was about Soviet policy on where the US-dominated Western bloc was heading and what Soviet response to its likely development ought to be. The USSR in January 1949 inaugurated the Council for Mutual Economic Assistance, later known as Comecon. To Eastern European officials invited for the occasion, Soviet leaders suggested Western European allies of the US, particularly Italy and France, could be pulled loose from the US if they were pit in a position of being critically dependent on the Soviet supply of raw materials. In 2008. the European Union, dependent on Russia for 34% of its imported oil and 40% of imported gas, did not venture beyond verbal condemnations over Russian invasion of Gerogia.

Soviet planners thought that Comecon, by creating a raw material base for the whole of Europe, would become more important than the Cominform, the official forum of the international communist movement since the dissolution of the Comintern. Cominform was founded in September 1947 in response to divergences among eastern European governments on whether or not to attend the Paris Conference on Marshall Aid in July 1947. Stalin was quoted as saying that he "does not attach much importance to military matters", as he saw little probability of war in the next eight to 10 years. Stalin's prediction was wrong. Five years later, in 1951, the Korea War was started by US client state South Korea.

Russia viewed the end of the Cold War not as the beginning of a new equitable world order of peace and prosperity for all, but a world dominated by a US driven by a philosophy of confrontation with the assumption that it was empowered by destiny to do anything it wants.

Now Russia, boosted by its energy leverage drawn from a commodity price structure largely engineered by US policy, is pushing back by copying US post-Cold War unilateralism. In marching into Georgia, Russia did not bother to seek United Nations diplomatic cover. Topping the list of Russian grievances with post-Cold War US aggressiveness is the expansion of NATO to Russia's sphere of influence and the planned basing of a US anti-missile system in former Soviet satellites Poland and the Czech Republic. "In their eyes, this is payback time," admits Jack Matlock, former US ambassador to the Soviet Union during the Reagan administration. "We have set some very bad precedents for Russia."

The US system of relying on private defense contractors was in a better position to reap economic benefits from nuclear and conventional armament than the Soviet system of state enterprises. The strategy to bankrupt the USSR with arms spending was essentially the one that Ronald Reagan employed to win the Cold War. But the key factor for Soviet economic failure was its decision to engage Western capitalist markets denominated in dollars, which the US could print at will after 1971, while the USSR had to earn through trade.

By joining Western markets, the USSR found it increasingly difficult to fund with socialist sovereign credit denominated in rubles its share of the arms race with the US. After the Soviet leadership allowed the Soviet economy to fall into the trap of needing dollars to achieve Soviet planning goals, it was a matter of time before the socialist system in the USSR would collapse.

Ironically, the fall of the USSR launched the US on a path of national hubris divergent from its core national interest. In 1951, the academic and pioneer in the field of international relations theory Hans Morgenthau published In Defense of the National Interest, in which he warned US policymakers about confusing two important issues: Russian imperialism and genuine revolution.

American foreign policy ought not to have the objective of bringing the blessings of some social and political system to all the world or of protecting all the world from the evils of some other system. [...] If we allow ourselves to be diverted from this objective of safeguarding our national security, and if instead we conceive of the American mission in some abstract, universal, and emotional terms, we may well be induced, against our better knowledge and intent, yet by the very logic of the task in hand, to raise the banner of universal counter-revolution abroad and of conformity in thought and action at home. In that manner we shall jeopardize our external security, promote the world revolution we are trying to suppress, and at home make ourselves distinguishable perhaps in degree, but not in kind, from those with which we are locked in ideological combat....

It is not an exaggeration to note that much of the national security problems faced by the US after the end of the Cold War were created by US policy.

Ownership of the means of production
The defining characteristic of a socialist system is the public ownership of the means of production. Karl Marx observed that the historical-cultural pattern of the ownership of the means of production (OMP) gave rise to the social phenomenon of class and the politics of class struggle.

Membership in either class, bourgeoisie of proletariat, is defined by the individual's relationship to the means of production. When workers, through their pension funds, participate indirectly in OMP as shareholders, they become members of the petite bourgeoisie. Self-employed professionals are also members of the petite bourgeoisie, even as they are increasingly corporatized. For a market system to remain balanced, the public sector needs to be dominant.

Minsky pointed out in his 1996 paper "Uncertainty and the Institutional Structure of Capitalist Economies" that capitalism is an ever-evolving construct that recently entered a new stage: money manager capitalism. In this form of capitalism, nearly all businesses are organized as corporations; pension and mutual funds are the predominant owners of financial assets; and managers of these funds are judged solely on the total return on fund assets (dividends and interest plus appreciation in share value). One consequence of the money manager structure is predominance of short-run considerations in decision making. A robust public sector is needed to rebalance excessive uncertainty in the private sector.

Two important points need to be borne in mind in understanding the concept of ownership of the means of production. The first point is that private ownership of the means of production is more than owning physical and intellectual property, or owning the financial capital behind it. The second point is that private ownership of the means of production in a capitalist system refers to a socio-cultural practice in which a small number of individuals within a larger corporation, namely shareholders represented by the board of directors, operating under the capitalist law of private property rights and the sanctity of contracts as if the corporation were one single individual, can control and decide what is done with all the profit created by the entire corporation composed largely of workers who are legally disfranchised of their economic rights merely because they do not own the means of production.

As represented by management under the supervision of the board of directors, these absentee owners of the means of production do not have anything to do with the operation of the corporation besides ownership of its capital. When corporations make good profits, only their management and shareholders benefit. Workers are paid a fixed wage and generally do not receive bonuses based on profit earned by the corporation that employ them. This may be legal and appear fair under the doctrine of private ownership rights, but it is the fundamental injustice of capitalism.

While shareowners of a corporation, members of the bourgeoisie class by definition, contribute only financial capital that enhances the productivity of workers, and workers, members of the proletariat class, produce the profit, shareholders command complete legal control over that profit and how it is used and distributed.

The owning bourgeoisie have complete legal control over both how much the working proletariat are paid in wages and complete legal control over how the profit from worker productivity is used, thus giving rise to a class division.

In Chinese political nomenclature, the term bourgeoisie stands for the "propertied class" and the term proletariat stands for the "property-less class". The politics of class struggle is a battle between uneven power commanded by capital and labor. Under a central banking regime in a market economy, non-inflationary monetary policy requires the maintenance of "structural unemployment", thus systemically weakening the bargaining power of labor against capital, unionism or no unionism.

Workers become their own oppressors
Charles Dickens wrote on the inhumanity of capitalism as a natural outcome of the Industrial Revolution to promote reform. But Marx and Engels wrote on the structural contradiction of capitalism to show that even if workers were treated more humanely by capital as an enlightened utilitarian necessity, capitalism will still not escape collapse from its internal contradiction.

The introduction of meta-wage benefits via pension funds turns classical capitalism into mass capitalism, making workers simultaneously into their own oppressors through a system that allows capital in the form of labor's own retirement savings to continue to oppress labor. The search for high return on workers pension funds is pushing wages down everywhere in the globalized economy and relocating jobs from high-wage economies to low wage economies. The neoliberal name for capitalism is market economy. The concept of a labor market is merely a modern version of slavery.

Capitalist bias notwithstanding, labor is not a factor of production. It is the core component in the economy around which factors of production, such as capital, land, technology, organization, and so forth are applied to increase labor productivity. Marx considered it a reification to treat labor as just another factor of production. Workers are people who should not be used as things, with profit they create extracted to benefit solely others who own things that workers use to be more productive. Return on capital should not be achieved through robbing labor of its fair share of the fruits of workers' labor.

Profit should only be realizable pari passu with wage increases. As corporate revenue rises, wages must rise with it to prevent obscene profits. Rather, corporate profit should be shared with labor in the from of wage bonuses along with dividends to shareholders.

Privatization of the public sector is an abdication of government responsibility to the governed. It is economically unsound, financially inefficient and socially unjust when national public infrastructure, either physical or social, are privatized.

The public sector is not merely another component of the national economy. It is the critical component that defines the limits of the globalized market in a functioning sovereign state. Minsky pointed out that a sizable and strong government sector is indispensable for a capitalist market economy to maintain macroeconomic stability and avoid recurring deep recessions. In a globalized economy, national public sectors are necessary to maintain global macroeconomic stability.

Privatization of the public sector exposes the capitalist market economy to cyclical disasters that require nationalization measures to bail out, as the recent collapse of the finance sector of the US economy aptly illustrates. Even in the boom phase of the business cycle, privatization of the pubic sector drives socioeconomic resources and development to where there is highest profit rather than where the nation's most critical needs are located. The nature of private finance is such that privatized public enterprises are forced by market pressure to focus on the short term, often leading them toward long-term problems and even insolvency.

Privatization of the public sector provides needed public services only to those who can afford them rather than to all who need them as a matter of rights of citizenship. The dilemma over universal health care and insurance in the US is an obvious example. The market by its very nature rewards the financially strong and punishes the financially weak, in opposition to the function of government to protect the weak from the strong. The market is the venue of choice for owners of capital, notwithstanding that the market value of capital is basically defined by state actions, such as monetary policy, interstate trade and antitrust regulations, tax policies, and above all by the productivity of labor.

Fundamentally, capital is merely idle assets when deprived of the opportunity to invest in enhancing the productivity of labor. Capital is merely an auxiliary factor of production. Without capital, labor can still produce, albeit at a lower productivity rate, but without labor, capital cannot exit [exist?]. This is why capital, when allowed to move freely, tends to go to where workers are and where worker productivity is underdeveloped. This fundamental truth is often distorted by the supporters of capitalism who promote the flawed concept that capital is the driving force in a capitalist economy and therefore must be given preferred advantage or it will move to another economy that does.

Dollar hegemony operating on a globalized trade regime pushes capital to where wages are lowest without any intention of developing global parity in worker productivity. [But you get the effect even without the intention!] The sole aim is to maximize the return on capital with lowest wages. For centuries, capitalism prospered because it enhanced labor productivity that yielded rising wages. For the past two decades, free market capitalism has worked to drive wages down throughout the global economy [well, by employing the mass army of the unemployed ...], a trend that will spell self-destruction.

Further, just as the rich can enjoy a life of riches only if they control money, but not when money controls them, an economy can prosper only when its workers control the capital needed to enhance their productivity. It is a very American idea that workers should be able to become rich by their labor, an idea deeply rooted in the founding of the new nation. The founding fathers of the United States considered the concept of financial capital unnatural and an unholy obstacle to the inalienable right of the pursuit of happiness.

On February 12, 2005, I wrote:

The US Declaration of Independence issued on July 4, 1776, states that to secure "inalienable rights", among which are life, liberty and the pursuit of happiness, "governments are instituted among men". It goes on to accuse King George III of England of having "abdicated Government here, by declaring us out of his Protection". The declaration characterizes England as a failed state and justifies the separation of the American colonies from it to institute a new government. Yet privatization, a movement to abdicate government by declaring the people out of the government's protection and placing them at the mercy of the market, has since gathered much ideological support in the name of liberty. (See The privatization wave.

Operationally, the public sector performs a stabilizing effect on volatile business cycles inherent in the private sector market. Private-sector market participants can then be allowed to fail from their own business misjudgments without the risk of bringing the entire economy down because the public sector can keep the economy going while orderly market correction takes place in the private sector.

'Too big to fail' syndrome
The "too big to fail" syndrome would be less likely to surface amongst private enterprises. If Fannie Mae and Freddie Mac had remained government entities, and not been privatized, with the original mandate to provide government subsidies to low- and moderate-income families not overridden by profit incentives and the income ceiling for qualifying for government guaranteed mortgages not amended beyond low- and moderate-income levels, the housing bubble crisis of 2007 would have been less systemic.

Transnational investment banks and private equity firms such as Goldman Sachs, Blackstone, the Carlyle Group, Merrill Lynch, Morgan Stanley and so forth are eager to pounce on juicy privatized public assets such as infrastructure projects worldwide. But privatization of the public sector (the sale or lease of public assets) means governments will be relinquishing control over and responsibility for key infrastructure for the common good for the term of the sales. It usually also means higher fees for users, since private borrowing tends to be more costly than sovereign credit, and investors always insist on taking their profits off the top from gross revenue, thus increasing user fees and reducing the cost-competitiveness of those users depending on such infrastructure for efficient operation.

And rising user fees seldom translate into improved service. To the contrary, surveys have shown that in-house operation of publicly provided services is generally more efficient than contracting them out to private operators, while privatizing public infrastructure for private profit has typically led to increased inefficiency and corruption.

State-owned-projects can keep user fees to a minimum and recoup public investment from increased tax receipts generated by economic growth. Many counterproductive cases are cited in a large body of work on privatization, including my article cited immediately above. Much of the blame for the current housing credit crisis can be laid at the footstep of the privatization of government sponsored agencies, namely Fannie Mae and Freddie Mac.

Privatization of the public sector in China is not simply the benign transfer of ownership from the state, as a political institution representing all the people, to corporatized entities controlled by private financial institutions and private individual shareowners. Rather, it is the very process by which the system of private property is reintroduced into the public sector, a socialist society in the process of transitioning to a socialist market economy. This involves fundamental questions about social justice in ownership distribution, valuation of assets being privatized, and the fairness of the privatization sale process of state-owned assets.

Privatization for transitional economies requires not only the restructuring of the economy but also the creation or redefinition of private property rights and market institutions and mechanism while ensuring maximum economic growth with minimum socio-economic and political disruption. Above all, the issue of social justice needs to be a controlling consideration.

Ronald Coase, 1991 Nobel Laureate in economics, developed the Coase theorem in his 1937 paper describing the economic efficiency of financial allocation in the presence of externalities. Externality in economics involves impacts on parties not directly engaged in economic decisions or actions, or in plain language: the spillover effect. Externality in finance occurs when others besides the actors must pay for the cost or share the benefits of a decision, action or transaction.

The theorem, clarified in his 1960 article "The Problem of Social Cost", states that when trade in an externality is possible with no transaction costs bargaining will naturally lead to an efficient outcome regardless of the initial allocation of property rights. By extention, given well-defined property rights, low bargaining costs, perfect competition, perfect information and the absence of wealth and income effects, resources will be used efficiently and identically regardless of who owns them.

The Coase theorem has been cited as a basis for most modern economic analyses of government regulation. According to Coase, disputes over resources stem mostly from a situation where no one owns them, as in the case of nature, or everyone owns them, as in the case of public property. However, these disputes could be resolved automatically if the unclaimed resources were divided up as private property, even if the division contain inherent unfairness.

The folly of privatization
This is the basic argument used by those promoting privatization of the public sector. They view the problem of air pollution as no one owning the air, or everyone owns it. The same argument applies to water. If these natural resources were privatized, economic efficient [efficiency] over their use and preservation would improve, these privatizers argue. But the nature of the economic man is such that whoever is assigned to own the air would rather charge others for permission to pollute it than to pay everyone else to stop polluting it. Privatization of air would then end up promoting air pollution for profit.

Another obstacle to applying the Coase theorem is the wealth and income effects. This is defined as the change of wealth or income that occurs when public property or property rights are awarded unevenly to private parties. Coase made his "invariance claim" that outcomes will be similar of not identical regardless who the favored owners are. But effects of wealth and income disparity on equality and social stability are ubiquitously obvious enough to invalidate the Coase theorem.

Coasians argue that the social results may be different, but they will be equally efficient economically. The problem with this argument is that changes in supply and demand caused by different ownership patterns have rippling effects throughout the entire economy that affect efficiency. And even if efficiency is unaffected, social stability will certainly be affected that will in turn affect economic efficiency.

History has shown that no national resurgent strategy can succeed without a clear understanding of the importance of a viable monetary strategy for successful independent national development. Chinese monetary strategy in recent decades has been reactive, lacking political will to take the initiative and playing a game in ways that show her policymakers as not having full understanding or the necessary skills to control the outcome, despite the fact that China has become the world's biggest creditor nation and the top manufacturer.

China cannot continue to allow her currency to be a derivative of the dollar; nor can she rely on a foreign trade surplus denominated in dollars to finance much-needed domestic development. China must stop further privatization of her public sector, stop exposing her strategic sectors to international market forces and take steps to reverse the disparity of wealth and income and free up sovereign credit to develop much need physical and socio-economic infrastructure at a much faster pace.

After three decades of reform and opening-up to the outside world, Chinese policymakers should realize its time to review and redirect toward new approaches of national revival not merely to catch up with a decadent West, but to restore Chinese civilization as the guiding light towards a world free of exploitation and oppression.

Next:Fulfilling China's national destiny

Henry C K Liu is chairman of a New York-based private investment group. His website is at http://www.henryckliu.com.

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