From http://www.atimes.com/atimes/China_Business/KD01Cb01.html

Page 1 of 5
OBAMA, CHANGE AND CHINA, Part 3
The New Deal dollar and the Obama dollar
By Henry C K Liu
This report is the third in a series.
Part 1: The song stays the same
Part 2: A dangerous balance

Much talk has been floating around comparing United States President Barack Obama with president Franklin D Roosevelt and the yet-to-be-fully-developed - or revealed - Obama recovery plan with the New Deal. So far, the differences between the two leaders in crisis are more visible than the similarities.

Obama's US$787 billion stimulus package is viewed by many economists as too small for the task and too diffused to tackle the immediate need of halting layoffs and promoting new job creation. The $275 billion home mortgage refinancing plan managed by newly installed Treasury Secretary Tim Geithner is beset with complexity that few seem to fully understand or know how to navigate.

The Obama 2010 budget, by trying to do too much on long-term problems such as healthcare reform at a time of crisis, is being hectored by Democrat congressional committee chairmen acting like independent political war lords. The president's call for sacrifice by all is answered by a Democrat-controlled Congress tacking on 8,000 legislative special interest earmarks to his $400 billion supplemental spending bill.

The bank bailout started by Republican Treasury secretary Henry Paulson is stalled in paralysis with the Obama team, now led by Geithner, former head of the New York Federal Reserve Bank, who had worked closely with Paulson and is refusing to admit all-out nationalization while unable to push through a "good bank - bad bank" arrangement to handle toxic assets to free up bank lending, or simply letting zombie banks, such as Citi, fail by market forces.

The Geithner plan
The Geithner plan for banks is designed to clear away "toxic assets", mostly complex instruments of structured finance (derivatives) that act as blood clogs in the vital veins of US financial system when the credit markets froze up.

The diffused nature of these instruments and associated counterparty risks add up to an unprecedented state of high anxiety and uncertainty in financial markets as no market participant can reliably assign final values to these assets not only because they may be worthless, but also because they imply unknown counterparty liabilities of possibly consequential dimensions. Thus these assets are toxic in the sense that they carry potential negative liabilities beyond being worthless to threaten the financial survival of institutions that hold them.

The banks and financial institutions that own these assets are caught by market failure as buyers cannot be found at any price. To continue to hold such assets at marked-to-market values will generate huge losses that grow by the day, eventually leading to insolvency as the availability of new capital dries up, leaving such institutions unable to meet their rising liabilities. Until banks can clear such toxic assets off their books, they will not be in a position to take on more risks by make new loans.

Geithner's plan involves government support of capital and finance to induce private investors to take problem loans and toxic assets off the balance sheets of banks.

The problem with the Geithner plan has a double edge. If successful, private investors may reap a windfall profit by exploiting taxpayer capital and finance. But the plan may fail because the Treasury's $1 trillion earmarked for the plan may not be enough to clean up the banks balance sheets, at which point the Treasury may have to go back to Congress for more money which Congress may not be in the mood to grant if the amount needed threatens the bankruptcy of the nation.

Obama wasting his first 100 days
With more than half of the crucial first 100 days in office spent, the Obama administration is having difficulty continuing to project an image of confident determination to turn the deepest global economic crisis of capitalism since the Great Depression into a new era of progressive politics not only domestically, but also a new world order of equity and justice.

Obama told the world during his presidential campaign that his presidency will be one of consequence. In his inaugural address, he proclaimed: "There are some who question the scale of our ambitions - who suggest that our system cannot tolerate too many big plans ... What the cynics fail to understand is that the ground has shifted beneath them ... The question we ask today is not whether our government is too big or too small but whether it works."

Rahm Emanuel, Obama's chief of staff, famously said that a crisis is a terrible thing to waste. A corollary is that government intervention is an even more terrible thing to waste, which is something that the Obama team has yet to realize.

Obama has the rare opportunity to reverse the Reagan revolution of smearing government as always being the problem, never the solution. There is now a growing general consensus that the abdication of government responsibility to regulate free-market fundamentalism has been the root cause of the current global economic crisis, and that the free-market solution adopted by Paulson during the George W Bush administration in response to failed markets has been in itself a failure.

Midway through his first 100 days, sensitive to criticism of his "tell it like it is" warnings about the seriousness of the economic crisis, Obama shifted his rhetoric to sound like his campaign opponent, John McCain claiming that the economy is fundamentally sound, a line that sank the Herbert Hoover presidency in the 1932 presidential election.

Very few people beside the diehard cheerleaders of free-market fundamentalism at CNBC, can now honestly conclude from either economic data or personal experience that the economy is fundamentally sound. By yielding to criticism that his rhetoric was talking down the market, Obama is in danger of letting a serious global crisis go to waste. An economy that is fundamentally sound needs no fundamental structural reform, only an emergency treatment before returning to business as usual.

Obama needs to understand that the market is not the economy. The market operating through a price system is only a partial mirror of the economy. The task at hand is to save an economy severely impaired by income stagnation. Restoring with future tax revenue the price bubble of financial markets that had been detached from the real economy is to mask the symptom while ignoring the disease. Such an approach robs the market's ability to self-correct imbalances and distortions caused by a dysfunctional monetary policy and government abdication of responsible regulation.

Larry Summers, Obama's top economic advisor, is known as a strong defender of free markets. In a predictable Faustian declaration, Summers explains: "The view that the market economy is inherently self-stabilizing, always, has been dealt a fatal blow ... This notion that the economy is self-stabilizing is usually right, but it is wrong a few times a century and this is one of those times."

The central ideological consequence of this fatal market failure, Summers says, is that there "is a need for extraordinary public action at those times ... The debate over whether you can love your country and hate your government has been settled with a negative answer." Love of country is now congruent with love of government, albeit smart government, which to Reaganites is an oxymoron.

Obama's new progressivism
Obama's new progressivism is based on the rehabilitation of government intervention in a failed market economy, even as his top economist only accepts the progressive battle cry as a temporary necessity. Even Obama himself has to clarify publicly that he realizes that Americans do not envy or resent the rich because even the American dream allows the poor to emulate the rich. But he stops short of proposing an income policy even when it is obvious that income disparity creates destabilizing imbalance between supply and demand. The failure of government intervention from misuse, such as intervention to help wayward financial institutions rather than victimized individuals, can turn the US into a failed state and the economy into a failed market.

Rather than a national income policy to raise income for all, Obama chooses an income redistribution path through raising taxes on the rich and cutting taxes on the poor and the middle class, whose members are really the working poor because of a decade of wage stagnation.

An income policy will relieve the working poor by guaranteeing every worker a good living wage to be an effective consumer without unsustainable debt. After all, it is a very American idea, which was first put into practice successfully by Henry Ford. Thus far, the reality is that the American dream has turned into a nightmare in which the poor emulate the rich by spending beyond their meager means and taking on unsustainable debt, not by spending rising income. Effective income parity does not aim at lowering the income of the rich, it aims at raising the income of the poor.

While Summers is continuing Paulson's aim of saving free-market capitalism with temporary transitional state capitalism, Obama's rhetoric until recently had been couched in a far-reaching progressive agenda of reversing widening income disparity and unsustainable wage/price imbalances that have left the world with overcapacity caused by insufficient demand, which had to be masked by excessive debt.

But Obama's March 12 speech before the Conference Board, a group representing the interests of big business, was disappointing in that it made our progressive reformer sound like just another garden variety "trickle down" market fundamentalist. Obama's strategy of first putting out the raging financial fires before dealing with long-term structural reform is fundamentally flawed because the arsonist responsible for the raging fires is a decades-long denial of the urgent need for fundamental structural reform. There is an overwhelming prospect that if and when the raging fire is contained, fundamental reform will give way to business-as-usual with a celebration of the resilience of market fundamentalism. The prospect of recurring crises every decade will continue.

Obama's initiatives blocked by centrists
Obama's three core progressive initiatives - universal education, universal health care and energy/environment transformation - if implemented without watered-down compromise, will be steps to restore US society to its true core values, not just a new, improve American dream that bears little resemblance to harsh reality.

Unfortunately, the Obama team is dominated by centrists who have now taken on the battle standard of the failed alliance of neo-liberals in global economics and neo-conservatives in global security. These centrists view their leader's grand progressive agenda as merely a convenient temporary antidote of emergency intensive care for a dysfunctional and unjust economic system and a militant hegemonic foreign policy.

According to Summers: "It is periodically the task of progressives to, ironically, save the market system from its own excesses." Centrists are reformers who believe that slavery can be eliminated simply by paying below-living wages.

The call by Summers, in his new post as chairman of the White House National Economic Council, for international coordination of stimulus programs is being rejected by his counterparts in the European Union. Disagreements between the EU and the US over how to deal with the global recession is widening as EU governments show little appetite for the US formula of piling up more public debt to fight the collapse in output and jobs caused by excess private debt. European social democrats are not on the same wavelength with the pro-big-business, pro-market approach of Paulson/Summers/Geithner, as three market fundamentalist musketeers, supported by Fed chairman Ben Bernanke as the ever loyal D'Artignan.

To the Europeans, shifting private debt to public debt is not only self deception, especially under a destructive regime of dollar hegemony, it is also particularly dangerous if all sovereign debts are denominated in dollars that EU central banks cannot print but have to earn through foreign trade.

Government stimulus packages are funded with future tax revenue. It is natural that tax money is viewed by the paying public as funds that should be spent within each country. Government bailout money to transnational financial institutions is likely to be used globally. Every government is now engaged in a race to maximize national multiplier effects of its stimulus programs. Thus while all governments are paying lip service to resist protectionism against movement of goods, few have faced up to the new form of financial protectionism practiced by transnational institutions.

The transfer of funds from London to New York by Lehman Brothers during the early hours of its bankruptcy filing is an example of the problem of financial nationalism. Scores of hedge funds that had hundreds of millions of dollars in cash and other securities parked with Lehman's prime brokerage operation in London have had their accounts frozen and the funds transferred to New York, leaving the United Kingdom with less money to settle the bankrupt firm's liabilities.

A number of hedge funds filed formal objections with the New York bankruptcy court and at least one fund, New York-based Bay Harbor Management, filed a legal challenge to the court's hastily approved sale of Lehman's brokerage arm to Barclays Capital.

A subsequent and even more troubling scenario arose from legal disputes on the estimated $1 trillion in market value exposure of derivatives transactions that Lehman had entered into on behalf of itself and its customers. At least three lawsuits are known to have been filed alleging that nearly $600 million in collateral posted by

Page 2 of 5
OBAMA, CHANGE AND CHINA, Part 3
The New Deal dollar and the Obama dollar
By Henry C K Liu
This report is the third in a series.
Part 1: The song stays the same
Part 2: A dangerous balance

some of Lehman's trading partners in derivatives transactions had not been returned as required and had disappeared from the UK as the bankruptcy process unfolded in New York.

The Bank of America (BoA) is seeking to recover nearly $500 million the bank "posted as collateral to "support derivative transactions between BofA and the respective Lehman Entities,'' according to a lawsuit filed in New York State Supreme Court that alleges the accounts at Lehman that held the collateral were "frozen'' when the investment house filed for bankruptcy on September 15, 2008. BoA contends that Lehman "wrongfully refused'' to return the collateral in violation of its agreement as a trading counterparty.

The dispute was expected to be the first of many since it is not uncommon for derivative transactions to be part of tangled web, in which trading counterparties are on the hook to make payments to other trading counterparties with whom they have no direct agreements. A derivative is a sophisticated contractual agreement that is dependent on the performance of the notional value of an underlying security, such as a bond, a stock or a commodity.

The dispute between BoA and Lehman stemmed from the fateful decision by Lehman officials in New York to transfer $8 billion in cash from the firm's London offices on the eve of the bankruptcy filing before funds were frozen in London. The $8 billion cash and securities sweep left Lehman's London offices with no money to pay employees or to provide cash to hedge funds that made use of the firm's overseas prime brokerage operations.

The list of hedge funds entangled in the Lehman bankruptcy kept growing by the day following bankruptcy filling. Besides Bay Harbor, the list of hedge funds caught in the great $8 billion cash transfer include GLG Partners, Newport Global Opportunities Fund, Amber Capital and Harbinger Capital Partners. Texas-based Newport Global, a nearly $700 million fund with close ties to private equity giant Providence Equity Partners, got squeezed when Lehman officials apparently failed to comply with the funds' request to move all its assets to Credit Suisse.

Newport, which used Lehman as a prime broker, notified Lehman on September 10, 2008, five days before bankruptcy filling, to transfer assets held by Lehman's London affiliate to Credit Suisse. Newport executives had believed the transfer was completed and were shocked to learn that the assets were never moved before Lehman filed for bankruptcy. As a result, Newport's assets were frozen in the wake of the $8 billion transfer. In court papers, Newport says "If these assets are not located and recovered immediately, there is the very real specter of serious and irreparable harm to not only the funds, but also to their respective investors."

IMF reform
As the lender of last resort for distressed central banks, International Monetary Fund (IMF) loans are denominated in dollars. The US contributes only 18% in funding but commands the deciding vote over the remaining 82% contribution by all other member governments.

The present focus on the reform of the International Monetary Fund (IMF) is pinned on the hope that the world's lender of last resort can contribute substantially to a recovery in 2010 from the greatest economic crisis in a century. The IMF, headquartered in Washington DC, is an international organization created in July 1944 during the United Nations Monetary and Financial Conference at Bretton Woods, New Hampshire. It is charged with the responsibility of overseeing the global financial system by monitoring those aspects of macro-economic policies of its 185 member states that have an impact on exchange rates and balances of payments. In theory, it has been designed as an organization to stabilize international exchange rates and to facilitate the balance of payments shortfalls of member states as an international lender of last resort.

The performance of the IMF during the 1997 Asian financial crisis has since been broadly and critically condemned as having unnecessarily exacerbated the pain for and damage to the affected economies, with its imposition of dilapidating "conditonalities" on debtor nations, such as privatizing industries and slashing government spending. (See Crippling debt and bankrupt solutions, Asia Times Online, September 28, 2002). In 2008, faced with a shortfall in revenue itself, the IMF executive board agreed to sell part of its gold reserves and to curb operating expenses.

The IMF now hopes to at least double its lendable resources from $50 billion to more than $500 billion so that it is ready to help out and provide confidence that economies will have access to funds during the crisis. Japan has provided $100 billion in extra money and the European Union has committed 75 billion euros (US$99 billion). Emerging economies such as the BRIC nations, Brazil, Russia, India and China, are expected to provide the bulk of the remaining funds.

IMF plans to sweeten a $100 billion lending program announced in October that failed to attract any borrower. The new program of less-restrictive loans is designed to boost the fund's impaired standing as an authority in containing the global meltdown and to assuage member-nation concerns about borrowing from a lender often seen as heavy-handed and intrusive in internal national policies to protect transnational lenders. IMF loan conditionality is being adjusted so that economic structural reforms agreed with a country will be monitored in a broad context. The change is also applicable to low-income countries.

If successful, the new IMF program could help many distressed economies weather the global economic downturn. If not, global recovery will be delayed and the IMF will become less relevant.

Lending reforms will be followed by further changes to country representation at the fund, with emerging markets and low-income countries being given a bigger voice. The April 2 G-20 summit in London is expected to bring forward the process of reform of the quota systems that determines country representation.

Together, the G-20 represents around 90% of global gross national product, 80% of world trade (including trade within the European Union), as well as two-thirds of the world's population. It comprises 19 countries: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the UK, and the United States, plus the European Union, represented by the rotating European Council presidency, and the European Central Bank. The managing director of the International Monetary Fund and the president of the World Bank, plus the chairs of the International Monetary and Financial Committee and Development Committee of the IMF and World Bank, also participate.

Despite major stimulus packages announced by advanced economies and several emerging markets, trade volumes have shrunk rapidly, while production and employment data suggest that global activity continues to contract in the first quarter of 2009.

Global activity is now projected to contract by 0.5 to 1% in 2009 on an annual average basis - the first such fall in 60 years. Global growth is still forecast by the IMF to stage a modest recovery next year, conditional on comprehensive policy steps to stabilize financial conditions, sizeable fiscal support, a gradual improvement in credit conditions, a bottoming of the US housing market, and the cushioning effect from sharply lower oil and other major commodity prices. Such institutional optimism is not shared broadly.

Obama has no plans for monetary reform
Most importantly, in the US, the world's largest economy, Obama has yet to put forward any plans for monetary reform, let alone a new international finance architecture, while FDR's monetary reform was the centerpiece of the New Deal, albeit it was a distant echo of 19th century agrarian insurgency against the gold standard.

Since the 1997 Asian financial crisis, there have been vague talks in the Federal Reserve and the US Treasury about the need for reform of the existing international finance architecture that is generally accepted as a fundamental cause of the current and previous financial crises, but the official Obama strategy appears to be that the teetering banking system must be stabilized before any fundamental monetary reform can be entertained. The question is left begging whether the critically impaired global banking system can be stabilized without fundamental reform of the international financial architecture which had been the cause the crisis to begin with.

Roosevelt's Executive Order 6102 proclaimed on January 31, 1934, a $35-per-fine-troy-ounce dollar parity to replace the traditional gold standard parity of $20.67 per fine ounce (1,504.63 fine milligrams, with 25.8 grains 0.9 fine). To sustain the devaluation of the dollar, FDR suspended the rights of US citizens to own gold, requiring all to turn in their gold holdings to the government for payment at $20.67 per ounce. Individuals were permitted to hold up to $100 in gold coins.

Executive Order 6120, deriving its authority from the 1917 Trading with the Enemy Act, which gave the president the power to forbid people from "hoarding gold" during a time of war, also forbade all private contracts to be denominated in gold. Though the US was not at war in 1934, FDR claimed that the economic crisis was creating emergency conditions equivalent to war.

Normally, Executive Order 6120 would have been opposed by an outraged freedom-loving American public as the constitution stipulates that the executive branch is vested only with the authority to execute laws and policies enacted by the people's representatives in Congress. Even the Progressives had never dared move so far as to allow the executive branch to make laws unconstitutionally and to impose such unconstitutional laws on the people without their consent.

However, by 1933, the US judiciary branch had upheld government restrictions on freedom of speech and other civil liberties during World War I and Congress had surrendered many lawmaking powers to the executive branch, a trend that has continued today to the extend that the president can now routinely launch limited foreign wars without having first asked Congress to declare war. Historians refer to this development as a move toward an imperial presidency.

Most Americans by 1934 had been put in a situation of viewing economic and political freedom as having been captured by the moneyed interests at the expense of the common people for whom freedom had come to mean only freedom to be unemployed and left starving. The people were willing to give the president whatever he wanted to save them from oppression by the moneyed class and to restructure market capitalism as a more fair and equitable system.

The US gold-based monetary system at the time of the Great Depression would not permit the debasement of money caused by increases in the money supply as a convenient solution to price deflation which could cause and did cause widespread destruction of wealth and massive unemployment.

If market participants sensed that too many dollars were being issued by central bank quantitative easing or by Treasury borrowing beyond anticipated revenue, they could protect their wealth by redeeming dollars for gold from the government as a legal right and at a rate committed to by government, draining the government's gold holdings below the accepted gold standard level of a 40% gold backing for the money supply.

More money supply required more government holdings of gold to maintain the gold parity. New Deal principles of temporary deficit financing would be hampered by the rules of the gold standard because the government gold holdings could not be increased easily and certainly not by money devaluation, as more money would be required to buy new gold as money is devalued.

Section 9 of Executive Order 6120 stipulated that anyone who refused to comply could be fined up to $10,000 ($1,533,653 in 2007 money) or be sentenced to a maximum of 10 years in prison, or both. Foreign governments still could trade in their US dollars for gold, but only at $35 an ounce instead of the gold standard rate of $20.67 per ounce. Since international trade at the time did not generate large foreign holdings of dollars, and the dollar was not the prime reserve currency and other currencies were also backed by gold at various rates, the impact while not insubstantial was still limited.

The Gold Standard Act had been enacted in 1900 for the US under President William McKinley. He had defeated William Jennings Bryan, the brilliant populist orator, a backer of free silver, who had stampeded the Democratic convention with one of the most famous speeches in US political history:

There are two ideas of government. There are those who believe if you just legislate to make the well-to-do prosperous, their prosperity will leak through on those below. The Democratic idea has been that if you legislate to make the masses prosperous, their prosperity will find its way up and through every class that rest upon it ... Having behind us the producing masses of this nation, and the world, supported by the commercial interests, the laboring interests and the toilers everywhere, we will answer their demand for a gold standard by saying to them: You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold.

For the first time since 1860, the 1900 election turned on a clear issue of major importance between the two political parties. The question of free silver had become symbolic of the conflict between capitalism and agrarianism, between the Hamiltonian concept of a nation dominated by big corporations and the wealthy elite who controlled them, and on the other side, the

Page 3 of 5
OBAMA, CHANGE AND CHINA, Part 3
The New Deal dollar and the Obama dollar
By Henry C K Liu
This report is the third in a series.
Part 1: The song stays the same
Part 2: A dangerous balance

Jeffersonian ideal of economic democracy behind populist agrarianism.

McKinley's victory was a definitive triumph of the Hamiltonian model, as Henry Adam observed: "The majority at last declared itself, once and for all, in favor of a capitalistic system with all its necessary machinery." One of the necessary machinery is the integration of business and government. In recent decades, titans of investment banking and industry had been running the US Treasury under both Democratic and Republican administrations. Larry Summers was the first academic economist to run the Treasury and Geithner is the first technocrat to do so. Both are strong supporters of neo-liberalism. No labor leader has ever run the US Treasury.

Labor, on whose back wealth is created, has never commanded control over monetary policy in the history of the US, despite that fact central banking was adopted by Congress to maintain the value of money with the accompanying objective of promoting full employment.

Since 1913, when the Federal Reserve was established, US labor has been at the dictatorial mercy of capital. Wealth, instead of being created and enjoyed by independent labor, has been separated from its creator to become capital, the requisite master for creating jobs in an economic system of contract labor. In the current financial crisis in free market capitalism, protesters against taxation on capital gain argue against "punishing" capital, without which jobs allegedly cannot be created. Such protests are in essence calls for punishing labor to keep unruly capital from self inflicted losses.

By February 1933, a little over two years after the market crash of October 1929, depositors were still withdrawing money from banks in such panic quantities that state governments had to intervene to arrest widespread bank failure. Michigan declared a bank holiday on February 14, 1933 and by the time FDR took office on March 4 all states had taken similar actions to create a national bank holiday.

The new president immediately took control of the entire national banking system. Congress passed the enabling Gold Reserve Act of 1934 on January 30, and FDR issued his devaluation proclamation on January 31, in less than 24 hours. FDR forbade US citizens to buy or own gold and devalued the dollar 60% by making gold valued at $35 an ounce, up from $20.67 an ounce established by the gold standard, and kept interest rates at historical low levels. Still, US export trade did not rise with dollar devaluation against gold, nor employment in the domestic private sector picked up. Most of the drop in unemployment was absorbed by the expanded public sector. The US economy did not revive until the US entered World War II with the US adopting national planning for war production. (See National planning and the American myth, Asia Times Online, June 13, 2002.)

Britain's gold standard
Winston Churchill, as chancellor of the Exchequer in the Conservative government, returned Britain, a fading superpower after World War I, to the gold standard in 1925, again devaluing silver against gold, although a higher gold price and significant inflation had followed the wartime suspension of the gold standard. Under the gold standard, the US fixed the price of gold at $20.67 per ounce from 1834 until 1933; Britain fixed the price at 3 pounds 17 shillings and 10.5 pence per ounce until World War I, and restored it in 1925. The exchange rate between dollars and pounds - the "par exchange rate" - necessarily came to $4.867 per pound sterling during these periods. Currency speculation did not and could not exist.

Churchill followed tradition by resuming conversion payments at the pre-war gold price. For five years prior to 1925, the gold price in pound sterling was managed downward to the pre-war level, causing deflation throughout those countries of the British Empire and Commonwealth using the pound sterling. But the rise in demand for gold for conversion payments that followed the similar European resumptions of the gold standard from 1925 to 1928 meant a further rise in demand for gold relative to goods and therefore the need for a lower price of goods because of the fixed rate of conversion from money to goods.

Because of price deflation caused by the gold standard and the predictable depression effects, the British government finally abandoned the gold standard on September 20, 1931. Sweden abandoned the gold standard in October 1931, and other European nations soon followed. Even the US government, which at the time possessed most of the world's gold, moved to cushion the effects of the Great Depression by raising the official price of gold (to $35 per ounce from $20.67) and thereby substantially raising the equilibrium price level in 1933-4.

The FDR Gold Parity Dollar
The deflation in the years of the Great Depression disconnected the Roosevelt gold-based dollar held by foreigners with the de facto domestic fiat dollar of January 1934. The Consumer Price Index for January 1934 was 132 with July 1914 set as 100, making the January 1934 dollar worth 75.75 cents of gold standard dollar of 1914.

For this reason, the domestic dollar of January 1934 was endowed with 132 cents (100/75.75 = 1.32) in 1914 gold standard dollar at $20.67 per ounce. In terms of the Roosevelt dollar with its gold parity of $35 an ounce, it was endowed with 223.5 cents. But up to 1934, before Roosevelt devalued the dollar, it was convertible through central banks at $20.67 per ounce of gold to yield 100 cents. Foreigners could buy US goods and assets with 100 cents that would cost US citizens 223.5 cents. This explained why investment in the US from gold standard economies grew during 1914 and 1934 until the Great Depression finally set in after the market crash of 1929.

The Roosevelt dollar became a two-tier currency whose purchasing power at home did not match its set gold parity abroad at $35 per ounce. At home, it was a de facto fiat monetary unit, not convertible to gold; and abroad, it was convertible to gold at a devalued $35 per ounce.

When this "international gold bullion standard" was set up on January 31, 1934, a gold standard without redemption of currency in gold coin, the Roosevelt dollar was worth 132 cents at $20.67 per ounce of gold abroad and 223.5 cents at home in terms of its own gold parity of $35 per ounce. At home, the dollar was loosing purchasing power steadily, while abroad it stayed constant against gold. On Christmas Day 1942, because of wartime price control, the fiat dollar, descending from 223.5 cents level of January 1934, finally met its foreign twin when it reached 132 cents level. But the reunion was to last three months only, after which US prices began to rise even under price control.

The two-tier Roosevelt dollar, while fixed in value against gold abroad, continue to lose purchasing power at home. On July 22, 1944, when the Bretton Woods agreements were signed, the dollar was worth only 95 cents at home as registered by the Consumer Price Index (CPI), while abroad the same dollar was still worth 100 cents against $35 gold. On August 4, 1945, president Harry Truman signed into law the Bretton Woods regime, approved by US Congress as a simple bill that required only a majority, not a treaty that would require a two-thirds majority in the Senate. The next day, Truman authorized dropping the atomic bomb on Hiroshima. CPI for August 1945 put the dollar as worth only 93 cents at home while abroad it was still worth 100 cents.

By August 1947, when the International Monetary Fund (IMF) born of the Bretton Woods regime became fully operational and member countries pegged their currencies within 1% of their official par values to the 100-cent dollar, convertible to gold at $35 per ounce, the dollar was worth only 75 cents at home after war-time price control was lifted. Under the Bretton Woods agreements, the currencies of the IMF member countries were to be defined pro forma in weight of gold, and those "gold parities" were to be translated into par values against the US dollar, whose gold parity at $35 per fine troy ounce was 888.67 milligrams (or 15 and 5/21 grains 0.9 fine). The currencies of the IMF member countries became convertible to dollars at "fixed but adjustable par values", while only dollars were made officially convertible to gold, but not to individual US citizens, only to foreign central banks.

The Bretton Woods regime became a rigged system of exchange in which 75-cent fiat dollars could be cashed for 100-cent gold-convertible dollars. As the dollar was the sole reserve currency for international trade under the Bretton Woods monetary regime, the US enjoyed a 25% premium in all world trade. The same US goods commanded a higher price against gold overseas than at home.

As the US after World War II was the only exporting nation to war-torn countries around the world, what cost 75 cents in fiat dollars in the US would sell for 100 cents in gold at $35 per ounce. While this greatly enhanced profitability of US exporting corporations, it also discouraged US companies from bringing their overseas dollars home where the dollar would be worth less because US citizens could not convert dollars into gold. This created what later came to be known as euro-dollars, dollars that stayed permanently overseas to preserve a higher exchange value.

During the 1960s, as US commitments abroad drew gold reserves from the Federal Reserve, confidence in the dollar weakened, leading some dollar-holding countries and speculators to seek exchange of their dollars for gold. A severe drain on US gold reserves developed and, in order to correct the situation, the so-called two-tier system was created in 1968. In the official monetary tier, consisting of central bank gold traders, the value of gold was kept at $35 an ounce, and gold payments to non-central bankers were prohibited. In the free-market tier, consisting of all nongovernmental gold traders, gold was completely demonetized, with its price set by supply and demand. In 1971, president Richard Nixon abandoned the Bretton Woods regime and disconnected the dollar from gold altogether as he restored the right of US citizens to own gold.

Foreigners thought erroneously they were getting rich by holding US dollars but in effect their economies were slipping into the control of the US because whoever controls the currency of an economy also controls the economy, as Gresham's Law states: "Bad money drives out the good." When wealth is denominated in fiat dollars, the US essentially owns that wealth; foreign holders of that wealth are merely acting as temporary agents of the US. (See History of monetary imperialism, Asia Times Online, September 26, 2008.)

Obama and China's yuan
On the second day of the new Obama administration, Geithner, Obama's choice for Treasury secretary, in his Senate confirmation hearing supported by written testimony, accused China of "manipulating" its currency and pledged "aggressive" diplomatic action to drive Beijing into action if confirmed as Treasury secretary. The comment, a politically loaded term calculated to raise tensions with China, appeared to be a direct appeasement to Democratic Senator Schumer, whose pet issue has been for "tough approach to force China to stop currency manipulation or risk being sapped with large (20%) tariffs on its exports."

It is a "lets get China to force her to stop beating her grandmother" issue, as most trade economists, including Summers, consider the exchange rate issue as an ignoratio elenchi (irrelevant conclusion), the informal fallacy of presenting an argument that may in itself be valid, but does not address the issue in question.

Geithner's testimony marked the Obama administration's first public pronouncement in what will be one of its most critical international economic relationships. It is an indication of the gap between US foreign policy and domestic domestics. It is also an indication of Obama's less-than-forceful leadership. Geithner claimed he was merely repeating Obama's views, with which he was no doubt very familiar. The connection between Obama and Geithner goes back a long way, to an earlier generation. During the early 1980s, Geithner's father, Peter, oversaw the Ford Foundation's microfinance programs in Indonesia being developed by Ann Dunham-Soetoro, Obama's mother.

In a written response to questions from concerned senators, Geithner, whose nomination was supported by a clear majority of the Senate's finance committee despite minor personal income tax problems, said: "President Obama - backed by the conclusions of a broad range of economists - believes that China is manipulating its currency." Obama would "use aggressively all the diplomatic avenues open to him to seek change in China's currency practices", Geithner added. Thus the position was not just to buy confirmation votes.

The price of long-term US Treasury bonds fell after Geithner's remarks, with some traders concerned that Beijing might ease up its purchase of US debts and assets. China is the largest foreign holder of US Treasuries. More than $3 trillion of the $5.5 trillion US Treasury market is held by foreign investors, with China being the biggest, holding $727.4 billion in December 2008, with Japan in second place with $626 billion. China reportedly holds $1.5 trillion in dollar-denominated assets out of nearly $2 trillion in foreign exchange reserves. Beside Treasuries, China at the end of 1008 held $600 billion in agencies debt (Fanny Mae), 150 billion in corporate bonds, $80 billion in bank deposits and $40 billion in equities.

The spectacular growth in China's foreign currency reserves appears to be moderating as the inflow of speculative "hot money" started to reverse flow out of the Chinese economy in the fourth quarter of 2008. China's foreign reserves rose by $40.4 billion in the fourth quarter of 2008 to $1.946 trillion, well below the total trade surplus and foreign direct investment over same period a year earlier, indicating a substantial outflow of short-term capital.

While China continues to register trade surpluses from a sharper fall in imports even as export falls, and with her foreign reserves still expected to rise above $2 trillion in 2009, the period of

Page 4 of 5
OBAMA, CHANGE AND CHINA, Part 3
The New Deal dollar and the Obama dollar
By Henry C K Liu
This report is the third in a series.
Part 1: The song stays the same
Part 2: A dangerous balance

explosive export growth is expected to end and growth of foreign reserves is expected to moderate. Some analysts are suggesting that China's liquidity cycle may be ending after a six-year boom as current policy continues. This projection can be rendered inaccurate substantially by impending and further government stimulus measures to deal with the impact of the global financial crisis on the Chinese economy.

Obama flirting with bankruptcy for the US
The Obama administration will face a budget deficit of over $3 trillion in 2009 and a still higher deficit in 2010 and beyond as it tries to re-monetize up to $2.5 trillion of practically worthless toxic assets with yet-to-collect taxpayer money. Globally, the dollar-denominated financial system has seen its equity market capitalization value fall by between 40-60% by February 2009. The Dow Jones Global Total Index of all publicly trade companies, a comprehensive benchmark series designed to measure the performance of global equity markets with readily available prices covering 65 countries and nearly 13,000 securities, peaked at 4,480.66 on October 11, 2007. Since then, it has fallen more than half to 2,206.14 by January 20, 2009.

On October 31, 2007, the total market value of publicly traded companies around the world was $62.6 trillion. By December 31, 2008, the value had dropped nearly half to $31.7 trillion. The gap of lost wealth, $30.9 trillion, is approximately the combined annual gross domestic product of the US, Western Europe and Japan. Asian shares lost around $9.6 trillion in 2008, according to the Asian Development Bank.

The financial structure of most assets normally carries a debt to equity ratio of between a conservative 3:1 and an aggressive 10:1. With a fall in market value of over 50%, even conservatively leveraged assets are now substantially underwater, meaning they have substantial negative equity. Family net worth hit a record high of $64.36 trillion in the second quarter of 2007. By the fourth quarter of 2008, it had fallen to $51.48 trillion, a loss of $12.88 trillion.

To restore the wealth lost in the current financial crisis, the Treasury would have to monetize some $30 trillion of toxic assets, almost 10 times what the Geithner Treasury is currently contemplating, and twice the size of current US annual GDP. Add to that about $10 trillion of value lost in the collapse of commodity prices and another $10 trillion in real property values, and we have a wealth loss of $50 trillion.

According to the Bank of International Settlements, the total outstanding notional value of derivatives as of June 2008 was $684 trillion. Each percentage point loss can cost $6.8 trillion to investors. No one knows what the final loss will be in derivatives when fully unwounded.

Obama's stimulus package will not create jobs
The Federal Reserve can absorb some of the loss to keep mark-to-market value of these instruments from falling further. But that would require such massive injection of new money that the time when prices stop falling will be the time hyperinflation starts. Thus, either way, deflation from market losses continues, first from falling prices and then inflation taking over from falling value of money. This is why the Obama stimulus package will not create jobs at any substantial scale, because all the good money is essentially going to monetize bad assets, with little financial energy left to have significant job creation impact.

Global assets under management (AuM) have shrunk 8% from 2007 to 2008, from $110 trillion to $100 trillion. The reason global AuM shrank only by $10 trillion while the equity markets fell 50% losing $30.9 trillion was because much AuM was invested in US Treasuries and other top-rated fixed-income instruments in a flight to safety. Equity funds AuM have fallen from $6 trillion to $3 trillion. Investment managed by hedge funds has fallen by over 50% from $2 trillion to $1 trillion. China, as the largest foreign holder of US Treasuries, will impact US financial market materially if Chinese policymakers have to reduce China's foreign reserves due to rising outflows of foreign capital, or as countermeasures against ill-advised US trade sanctions.

China's dollar holdings
In the first half of 2008, Chinese foreign reserves rose by $280.6 billion, largely due to capital inflow on expectation the yuan would continue to appreciate by policy pressure from Washington. However, those flows began to reverse in the fourth quarter at a time when the offshore currency market was signaling pending yuan depreciation.

Calculating how much money left China using the reserves data is complicated because of exchange value movements in the currencies in which China is invested and changes in reserve requirements for Chinese commercial banks, some of which are held in foreign currencies. Nevertheless, in the fourth quarter of 2008, China saw capital outflows of $45 billion to $70 billion a month on average.

Slower or negative growth in foreign reserves will mean China will have less funds to buy new dollar assets in 2009 but that does not necessarily mean weaker demand for US Treasuries. Capital outflows from China are likely to go into US Treasuries, given the risk-averse mood in capital markets. A short circuit of dollar funds released by the Treasury and the Federal Reserve may be created by US recipients of government funds investing in US Treasuries to de-leverage, leaving the US in a perpetual liquidity trap.

Near-zero return on US sovereign debt will force market participants, including China, to seek alternative investments in their own domestic markets, particularly if monetarily-induced inflation is no longer a serious problem in most non-dollar economies with heavy export reliance because of deflationary pressure from the global financial meltdown.

China's demand for Treasuries was augmented in early 2008 by the Chinese sale of US government sponsored enterprise (GSE) debt (such Fannie Mae and Freddie Mac) before the issuing entities were nationalized. Heavy hot money outflow created sell-offs in the Chinese equity and real estate markets, but it also provided opportunities for China to expand Chinese money supply to stimulate the Chinese economy without causing inflation. The net effect was a replacement of foreign capital by domestic capital.

The Chinese stimulus package will also accelerate China's strategy to upgrade its economy, increasing investment in physical and social infrastructure and welfare benefits. Market forces are likely to reverse direction to depreciate the Chinese currency, making Washington's pressure on China to further appreciate the Chinese currency through government intervention an anti-market demand.

Geithner, as nominee for Treasury secretary, in his Senate confirmation hearing stopped short of pledging that the US Treasury under his direction would formally name China as a currency manipulator in its annual currency report, due in the spring of 2009. "The question is how and when to broach the subject in order to do more good than harm," he hedged.

To disprove the validity of the accusation that China is manipulating the exchange rate of its currency, all China has to do is to release records showing that its government did not intervene directly, albeit the effective exchange rate of the yuan for Chinese exporters is periodically affected by government non-monetary measures. But the US is not really interested in proving its accusation of China as a currency manipulator. It only wants appease the US manufacturing sector and the labor unions by empty posturing while pressuring China to cooperate in other areas of economic relations under threats of protectionist backlash.

The currency issue dates back decades in US-China relations. By Reagan's second term, which began on January 20, 1985, it became undeniable that US policy of a strong dollar, while it benefited the US economy as a whole, was doing much damage to the manufacturing sector of the US economy. It was also threatening the Republicans with the loss of political support from key industrial states in permanent recession, not to mention the labor unions, which the Republican Party was trying to woo with a theme of Cold War anti-communist patriotism as elite east-coast liberal Republicanism gave way to macho redneck Republicanism of the southwest. The exchange value of the dollar then became a red herring in US geopolitical discourse to divert attention from cross-border wage disparity, the true cause of the trade imbalance.

The US has long claimed that China was artificially depressing the value of its currency to a falling dollar to boost exports to the detriment of US business. Since such claims are factually and theoretically of no merit, both the Bill Clinton and George W Bush administrations always stopped short of formally declaring China a currency manipulator - the economic facts showed that the US economy was benefiting as a whole more than it was losing in its manufacturing sector. More over, the US was in denial of the fact that it was the dollar that was falling as a result of US policy, therefore the yuan being pegged to the dollar was robbing the dollar of any benefit of depreciation.

Hank Paulson, Geithner's predecessor, to appease US domestic special interests, repeatedly criticized Beijing for holding down its currency but resisted pressure from anti-China hawks in Congress to formally name China as a manipulator because he knew the US was the real currency manipulator - but the manipulation was neutralized by the yuan-dollar peg. Existing US legislation requires only that the administration starts negotiations with any country designated as having manipulated its currency, so the Strategic Economic Dialogue between the US and China was the convenient solution.

To appease US demand, China abandoned a fixed yuan-dollar peg in 2005 for a managed float against a basket of currencies within a band and at a crawl rate (BBC). Since then the yuan has appreciated by about 20% against the dollar. When the yuan was pegged to the dollar, it lost value relative to other currencies when the dollar fell, as it did between February 2002 and 2005. Thus the US was the main manipulator of the Chinese currency during that time, with the China's currency acting only as a derivative of the real manipulator.

In November, 2008, in response to adverse impacts on the Chinese export sector from the global financial crisis, the Chinese authorities let the currency depreciate modestly by market forces, prompting speculation about a shift in foreign exchange policy. Since then, the yuan has traded in a narrow band against the dollar, leading some economists to argue that a de facto peg has been restored.

Between 2005 and 2008, despite the gradual appreciation in the yuan, China continued to record large current account surpluses with the US, leading many economists to conclude that the trade imbalance between the US and China was not caused primarily by exchange rates. (See The US as leading currency manipulator, Asia Times Online, February 15, 2007).

Geithner's confirmation hearing testimony solicited an immediate response in China. In an article published in the Chinese media, Zhang Jianhua, head of the research bureau of the People's Bank of China, the central bank, said that "wrong economic policies and improper market monitoring [in the US] are the primary reasons for the current financial crisis". He added: "Any attempts to shift the responsibility to other countries reflect an inability to develop the right attitude for seeking solutions."

The Geithner statement at his confirmation came in response to written questions from Democratic Senator (New York) Charles Schumer who once co-wrote a bill to impose punitive tariffs on China if it did not revalue its currency; and Democratic Senator Debbie Stabenow (Michigan) who wrote a similar bill co-sponsored by then Democratic senator Obama (Illinois). The statement appeared calculated to send a number of messages at once: to fulfill campaign promises to US labor and to anti-China trade hawks in Congress, warning Beijing not to devalue its currency even as its export sector was collapsing from the global financial crisis and highlighting the need for an eventual process of global economic rebalancing. The statement also set the stage for tough talks with Beijing, and puts pressure on the IMF, which had been expected to shy away from any formal finding that Chinese policy was in breach of its international commitments.

Geithner's confirmation statement, if translated into policy, could increase trade tensions at a time of global recession and fast-rising unemployment in both countries. However, the White House can be expected to pre-empt binding legislation by convincing US legislators that the Treasury secretary shares their concerns but he intends to find solution to the problem through negotiation with his Chinese counterpart.

At any rate, there is mounting consensus that China needs to reorient its economic policy to reduce over-reliance on foreign trade and to develop its own domestic market. With China's policy shift, US trade sanctions on whatever pretext would have less effect on China, particularly if trade is being reduced by the reality of economic downturn in the US anyway. Even before the current crisis, growth of US-China trade has been slowing as China shifts it trade to markets in other regions.

Most economists agree that exchange-rate policy cannot substitute for structural economic adjustments necessary for mutually beneficial trade between two economies. Nor can exchange-rate policy be a substitute for sound domestic monetary or economic policies. When two economies are at uneven stages of development trade, a trade surplus in favor of the less-developed economy is natural and just, until the less-developed economy catches up with the more-developed one. Otherwise it would be imperialistic exploitation, not trade.

In a conference on China's exchange rate policy at the Petersen Institute in Washington DC held on October 19, 2007, three months after the global credit crunch broke out, attended by Wu Xiaoling, deputy governor of the People's Bank of China and by

Page 5 of 5
OBAMA, CHANGE AND CHINA, Part 3
The New Deal dollar and the Obama dollar
By Henry C K Liu
This report is the third in a series.
Part 1: The song stays the same
Part 2: A dangerous balance

Summers, the former Clinton-era Treasury secretary Summers concluded that the real concern should be with China's large global surplus rather than with the negligible effect of the yuan on US workers. It would be better to follow a multilateral, rather than a bilateral US-led, approach with China to correcting global payments imbalances. Summers did not see the yuan exchange rate

as the primary source of US current account deficit. Any attempt to blame the yuan exchange rate for the concerns of US middle-class workers is based on flawed economic judgment.

Summers' position on the falling dollar
In an article in the October 28, 2007 edition of the Financial Times entitled (How to Handle the Falling Dollar), Summers wrote:

The vast majority of the US current account deficit is now being funded by central banks accumulating reserves as they seek to avoid appreciation of their home currencies. While the US dollar is usually viewed as a floating rate currency, substantial and critical parts of the world economy operate with currencies pegged to dollar parities or at least managed with them in mind.

This suggests the need for rethinking traditional approaches to dollar policy at a time when the global economy is more vulnerable than it has been since 1998.

The Clinton administration approach of asserting the desirability of a strong dollar based on strong fundamentals while allowing its value to be set on foreign exchange markets was highly successful in its time and has largely been followed by the Bush Treasury. But it is insufficient in the current world, where the dollar's trade-weighted exchange rate is to an important extent managed abroad. Some means of engagement must be found with those who have yoked their currencies and so their financial policies to that of the US.

The US has responded in an ad hoc way by carrying on a "strategic dialogue" with China, by far the largest economy with an exchange rate linked to the dollar, backed by congressional threats to address exchange rate issues using the tools of trade policy and references to communiques from the Group of Seven leading industrial nations. In reality, the dialogue is anything but strategic. Like so much of American international policy in recent years, it seems to confuse the firm statement of legitimate desire with the serious conduct of diplomacy.

Think of the questions Chinese policymakers must ask themselves. What is the highest US priority - global financial stability or market access for well-connected US firms? Can the US take yes for an answer or is it a certainty that a new president will insist in 18 months on a new set of economic diplomacy accomplishments with China? In which areas, if any, is the US prepared to adjust its policies in response to global interests? Given that the Chinese authorities have presided over nearly double-digit annual growth for a generation, do US officials who make assertions about what is in China's interest have the experience and knowledge of China that should cause their views to be taken seriously? Why is China being singled out? How could China - even if it wished to - act in ways that the US prefers without appearing to yield to international pressure?

Maintaining global financial stability and the role of the dollar requires a more strategic approach - a task that, given the political calendar, is likely to fall to the next US administration.

Unfortunately, the Obama administration so far in its early weeks has yet to show any sign of a new strategic approach. All the pronouncements from the Obama team have the tone of emergency firefighting, only after which would the restructuring of the economy begin. But so far no one has any detail idea of what the Obama team will do and how it plans to accomplish its ambitious agenda.

Obama's call for bipartisan cooperation was answered by a house divided even within his own party. Even the vetting for nominations for key cabinet positions faced repeated setbacks, indicating that the Obama White House is up against a steep learning curve in a crisis situation that cannot afford long learning periods. Obama's foreign policy machinery has yet to start its strategic engine while the administration, consumed by having to deal with its own economic house on fire, is merely rushing to quench hot spots in Afghanistan, Pakistan, the Middle East, Iran, and to explain confused signals on China.

US foreign policy floundering
It is not surprising that US foreign policy is floundering. The country's geopolitical leadership is based primarily on US economic prowess that translates into military power. As the US model of neo-liberal market fundamentalism faces imminent collapse from its own internal contradiction and abuses, Washington appears to be deprived of the advice of Teddy Roosevelt: "Speak softly and carry a big stick; you will go far".

The US big stick is shrinking along with the falling exchange rate of the dollar, reflected by massive fiscal deficits and a sharply deflated economy while Washington's rhetoric is becoming louder. Obama declares he plans to cut US annual fiscal deficit by half by the end of his first term. His 2009 budget request totals $3.66 trillion, including $442 billion for financial rescue (12%), $524 billion for defense (17% - not including expected supplemental war funding) and $196 billion for interest on the national debt (5.4%).

Projected tax revenue for 2009 is $2.29 trillion, yielding a deficit of $1.3 trillion. Add to the mandatory and discretionary mix the $2.1 trillion-and-counting that has been committed to rescue the banks and credit markets, the auto industry, the housing market and financially strained consumers and businesses. With a potential fall in tax revenue, the deficit could balloon to $4 trillion.

How is the US going to expect China to appreciate the yuan as Washington dictates while the US market is shrinking even at current exchange rates? China's export sector is in free fall and the Chinese central bank cannot possibly allow the yuan to appreciate against the dollar under such circumstances. The dollar fell from 0.7388 euro on July 1, 2007 to 0.6276 euro on July 16, 2008 and rose to 0.7904 euro on February 18, 2009 as the economies of the euro zone fell into crisis. The dollar rose from 123.466 yen on July 10, 2007 to 99.2911 yen on March 30, 2008, fell to 88.7730 yen on January 24, 2009 and rose to 92.1410 yen on February 18, 2009. The rise in the yen has caused much pain on the Japanese economy.

Summers, whose credibility was irrevocably tarnished internationally by his inept handling of the 1997 Asian financial crisis, gave another admonishing speech in Japan on February 26, 1999, warning Japan not to depend on a weak yen to boost its economy, using worn-out slogans such as: "the exchange rate cannot be a substitute for policy."

It was an amazing posture after Treasury secretary Robert Rubin and his deputy, Summers, turned down a Japanese/EU joint proposal for a three-currency stabilization regime at the 1999 G-7 meeting in Bonn in continuation of the effort to reform the international financial architecture for the 21st century. (Rubin was succeeded as Treasury secretary by Summers on July 1, 1999). Japan proposed the creation of an Asian Monetary Fund at the G7-IMF meetings in Hong Kong during September 20-25, 1997. Washington vetoed that proposal, which called on the Asian Development Bank to support Asian currencies that came under speculative attack with a special $100 billion fund to be provided by Japan.

The United States took a hands-off attitude at this early stage of the Asian Crisis. The Washington Post noted on August 12, 1997, that the "United States [was] conspicuous by its absence" during the organization of the Thai bailout that summer. Japan's Ministry of Finance officials noted that the Thai support meeting had created an "Asian Consensus" and to some extent legitimized Japan's role as a regional leader at the expense of the United States.

When financial contagion hit South Korea in December from Thailand, where the problem started on July 2, the 1997 Asian financial crisis showed itself as not a local problem but global one. The New York Times reported that the US decision to rescue Korea was reached by Rubin, the then Treasury secretary, in the last minute before a Korean default on its sovereign debt because of the surprise discovery that Brazilian banks were holding a lot of Korean bonds and total return swaps (TRS) contracts used to capture "carry trade" profit from interest rate differential between pegged currencies.

A Korean default would quickly spread to South America with more direct impact on the US economy than previously realized. US multinational banks, the US Treasury and the Fed colluded on the classification of non-performing loans in Korea for regulatory purposes to safeguard the exposure of US bank. But the local banks in Korea enjoyed no such flexibility. (See The Dangers of derivatives, Asia Times Online, May 23, 2002.)

Having been humbled by his own dismal record of first diagnosing the Asian crisis as merely transient and local, and subsequently mistaking IMF off-the-shelf "conditionalities" as the only cure, and finally non-intervention of free financial markets as an inviolable guiding principle for Asia, Summers a decade later proposes for the current financial crisis the Paul Krugman reflation cure. He declares vaguely: "What I think is crucial is the recognition that the goal of price stability includes the responsibility to avoid deflation."

In 1999, having declared only a month earlier that while free markets are not perfect, all other forms intervention alternatives are worse, Summers went to Japan and again asked the Japanese to fix their economy with interventionist monetary policies.

Yukihiko Ikeda, a senior member of the ruling Liberal Democratic Party, reportedly told the press: "Mr Summers says, do this, do that. But we will continue with steps already in the works."

Japanese officials were generally of the opinion that reflationary policies would further weaken the yen, due to pressure on the value of the yen from increased money supply. It might lead to further competitive currency devaluations in other parts of Asia. Officials at the Bank of Japan, the central bank, thought Summers was offering snake-oil cures in the notion of fighting deflation with easing the money supply. Stephen Roach of Morgan Stanley pointed out in an interview on CNBC On February 23, 2009 that the bursting of the Japanese bubble in the 1990s affected only its capital sector, which constituted only 17% of GDP, while the US bubble burst in 2007 is infecting the consumer sector, which is 72% of GDP. The US is facing a crisis four times bigger than what Japan faced in the 1990s.

Yet a decade after the 1997 Asian financial crisis, in 2007, Summers declared that "the G-7 process has lost its focus on exchange rate issues over the years as its member governments stopped trying to manage their rates." The G-7, which Summers describes as "an anachronism in the current international context", needs to be radically reinvented, starting with enlarging its composition. Any new approach must be premised on "the desirability of a strong, integrated global economy that benefits the citizens of all countries, not on the idea that economists or politicians can calculate 'fair' exchange rates". The right and potentially effective case for adjustments in the current alignment of exchange rates relies "on their unsustainability and the distortions they induce in macroeconomic policies, not on ideas of fairness to workers".

Summers warned that "multilateralism is better politics and economics than unilateralism but it must not become an excuse for inertia". Any new group should be "analytically informed but everyone should know that key decisions will ultimately be taken by senior officials in the national interest, not by international organizations ... History tells us that poorly managed finance foments instability and economic insecurity."

Yet the US has repeatedly mismanaged its finances for decades by exploiting the hegemonic character of the fiat dollar as a global reserve currency for international trade. US unemployment rate is set by US monetary policy, not by China. US economic and trade policies have transferred wealth from US workers to Wall Street, not to China, only via China.

China needs an independent economic strategy
As for China, following the US model of economic growth through unregulated market fundamentalism will create the same income disparity and social inequality that US political culture concedes as natural and US ideology accepts as structural in a market economy. But such blatant inequality would cause widespread sociopolitical discontent and instability for a socialist political culture that forms the ideological foundation of modern China.

Worse yet, the efficiency that supporters of free-market fundamentalism claim to be inherent in the market system has turned out to be a mirage of a castle in the sky build by debt. It is a house of cards held together by systemic fraud. Wealth in market fundamentalism had not been created by honest work in recent decades, but by systemic manipulation of credit to turn risks into safety and debt into assets. From the central bank down to the average home owner, every participant in the market economy was abusing the false effect of unearned wealth as the miracle of finance capitalism. Many are now realizing that the Federal Reserve has been the biggest Ponzi scheme operator, not Bernie Madoff.

The fantasy mirage of debt capitalism has been brought back to earth fundamentally by the current unprecedented financial crisis to show that the US neo-liberal model of miracle growth and debt prosperity via free markets is unsustainable. As predatory dollar hegemony turns international trade into a process of spreading dollar denominated debt around the world, ending in sudden bankruptcy, prolonged depression and widespread resultant poverty, rather than one that achieves sustainable growth and solid prosperity, populist national politics will force all governments to refocus on orderly domestic development away from over-reliance of foreign trade, making the issue of exchange rates less relevant.

China is not the cause of the financial problems the US inflicted on itself and the globalized economy. In many ways, China has been a double victim of the misleading lure of the empty promise of easy prosperity promoted by the false prophets of US market fundamentalism, by holding down Chinese wages to compete in the export market and unwittingly shipping real wealth created by its workers for fiat currency that the US can print at will, money that cannot be used in China. China's trade surplus is not the reward of 19th century mercantilism because Chinese exports do not earn gold, only superpower fiat currency of no intrinsic value.

On the other side, US consumers who want to enjoy a good life without working are like Pinocchio, the wooden puppet who yearns to be a real boy as promised by the good fairy. But he is sidetracked by a boy named Romeo - nicknamed Candlewick because he is so tall and skinny; just the type of boy Pinocchio wishes to become - who lures him to go to the Land of Play, where everyone plays and eats candy all day long and never does any work. Pinocchio goes along with Candlewick and they have a wonderful time in the Land of Play, until one morning Pinocchio awakes with donkey ears. Belatedly, a mouse tells him that boys who do nothing but play and never work always grow into donkeys after the initial fun.

Allan Greenspan is Candlewick of the US economy and the Land of Play is the house of cards that Greenspan built.

Next: Brzezinski's grand strategy

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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