Brown Web of Debt The Shocking Truth about our Money System (3rd ed)

Web of Debt

Chapter 27

WAKING THE SLEEPING GIANT: LINCOLN’S GREENBACK SYSTEM COMES TO CHINA

The flowers had been too strong for the huge beast and he had given up at last, falling only a short distance from the end of the poppy bed

. . . . “We can do nothing for him,” said the Tin Woodman sadly. “He is much too heavy to lift. We must leave him here to sleep . . . .”

– The Wonderful Wizard of Oz,

“The Deadly Poppy Field”

Napoleon called China a sleeping giant. “Let him sleep,” Napoleon said. “If he wakes, he will shake the world.” China has now awakened and is indeed shaking the world. The

Dragon has become so strong economically that it has been called the greatest threat to national security the United States faces, accounting for the greatest imbalance of any country in the U.S. trade budget deficit ($150 billion of $500 billion by 2004).1

This balance-of-trade problem is not new. The British were already complaining of it in the early nineteenth century. Then they discovered that exporting opium from India to China could offset their negative trade balance and give them control of China’s financial system at the same time. The Chinese Emperor responded by banning the opium trade, after China started losing huge amounts of money to England. England then declared war, initiating the Opium War of 1840. The Chinese people wound up with two sets of imperial rulers, the British as well as their own.2

The leader of the revolution that finally overthrew 2,000 years of Chinese imperial rule was Dr. Sun Yat-sen, now revered as the father of modern China by Nationalists and Communists alike. Like the

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leaders of the Japanese Meiji revolution of the 1860s, he was a protegé of a group of American nationalists of the Lincoln/Carey faction. Sun’s fundamental principles, known as the “Three Principles of the People,” were based on the concept presented by Lincoln in the Gettysburg Address: “government of the people, by the people, and for the people.” Sun was educated in Hawaii, where he built up his revolutionary organization at the house of Frank Damon, the son of Reverand Samuel Damon, who had run the Hawaii delegation to the American Centennial in Philadelphia in 1876. Frank Damon provided money, support and military training to Sun’s organization; and Hawaii became its base for making a revolutionary movement in China.3

The Chinese Republic was proclaimed just before World War I. After Sun’s death, the Nationalists lost control of mainland China to the Chinese Communists, who founded the People’s Republic of China in 1949; but the Communists retained much of the “American system” in creating their monetary scheme, which was a Chinese variation of Lincoln’s Greenback program. Before that, banknotes had been issued by a variety of private banks. After 1949, these banknotes were recalled and the renminbi (or “people’s currency”) became the sole legal currency, issued by the People’s Bank of China, a wholly govern- ment-owned bank. The United States and other Western countries imposed an embargo against China in the 1950s, blocking trade between it and most of the rest of the world except the Soviet bloc. China then adopted a Soviet-style centrally-planned economy; but after 1978, it pursued an open-door policy and was transformed from a centrallyplanned economy back into a market economy.4 Private industry is now flourishing in China, and privatization has been creeping into its banking system as well; but it still has government-owned banks that can issue national credit for domestic development.5

By 2004, China was leading the world in economic productivity, growing at 9 percent annually. In the first quarter of 2007, its economic growth was up to a remarkable 11.1 percent, with retail sales climbing 15.3 percent. The commonly-held explanation for this impressive growth is that the Chinese are willing to work for what amounts to slave wages; but the starving poor of Africa, Indonesia, and Latin America are equally willing, yet their economies are languishing. Something else distinguishes China, and one key difference is its banking system. China has a government-issued currency and a system of national banks that are actually owned by the nation.6 According to Wikipedia, the People’s Bank of China is “unusual in

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acting as a national bank, focused on the country not on the currency.” The notion of “national banking,” as opposed to private “central banking,” goes back to Lincoln, Carey and the American nationalists. Henry C K Liu distinguishes the two systems like this: a national bank serves the interests of the nation and its people. A central bank serves the interests of private international finance. He writes:

A national bank does not seek independence from the government. The independence of central banks is a euphemism for a shift from institutional loyalty to national economic wellbeing toward institutional loyalty to the smooth functioning of a global financial architecture . . . [Today that means] the sacrifice of local economies in a financial food chain that feeds the issuer of US dollars. It is the monetary aspect of the predatory effects of globalization.

Historically, the term “central bank” has been interchangeable with the term “national bank.” . . . However, with the globalization of financial markets in recent decades, a central bank has become fundamentally different from a national bank.

The mandate of a national bank is to finance the sustainable development of the national economy . . . . [T]he mandate of a modernday central bank is to safeguard the value of a nation’s currency in a globalized financial market . . . through economic recession and negative growth if necessary. . . . [T]he best monetary policy in the context of central banking is . . . set by universal rules of price stability, unaffected by the economic needs or political considerations of individual nations.7

In 1995, a Central Bank Law was passed in China granting central bank status to the People’s Bank of China (PBoC), shifting the PBoC away from its previous role as a national bank. But Liu says the shift was in name more than in form:

It is safe to say that the PBoC still follows the policy directives of the Chinese government . . . . Unlike the Fed which has an armslength relationship with the US Treasury, the PBoC manages the State treasury as its fiscal agent. . . . Recent Chinese policy has shifted back in populist directions to provide affirmative financial assistance to the poor and the undeveloped rural and interior regions and to reverse blatant income disparity and economic and regional imbalances. It can be anticipated that this policy shift will raise questions in the capitalist West of the political independence of the PBoC. Western neo-liberals will

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be predictably critical of the PBoC for directing money to where the country needs it most, rather than to that part of the economy where bank profit would be highest.8

Besides its “populist” banking system, China is distinguished by keeping itself free of the debt web of the IMF and the international banking cartel; and by refusing to let its currency float, a policy that has fended off the currency manipulations of international speculators. The value of the renminbi is kept pegged to the dollar; and unlike Mexico in the 1990s, China has such a huge store of dollar reserves that it is impervious to the assaults of speculators. In 2005, China succumbed to Western pressure and raised its dollar peg slightly; but the renminbi continued to be pegged to its dollar counterpart, and the government retained control of its value.

As in Hitler’s Germany, the repression of human rights in China deserves serious censure; but something in its economy is clearly working, and to the extent that this is its self-contained monetary policy, the Chinese may have the nineteenth century American Nationalists to thank, through their student Dr. Sun Yat-Sen.

The Mystery of Chinese Productivity

In the eighteenth century, Benjamin Franklin surprised his British listeners with tales of the booming economy in the American colonies, something he credited to the new paper fiat money issued debt-free by provincial governments. In a May 2005 article titled “The Mystery of Mr. Wu,” Greg Grillot gave a modern-day variant of this story involving a recent visit to China. He said he and a companion named Karim had interviewed a retired architect named Mr. Wu on his standard of living. Mr. Wu was asked through an interpreter, “How has your standard of living changed in the last two decades?” The interpreter responded, “Thirteen years ago, his pension was 250 yuan a month. Now it is 2,500 yuan. He recently had a cash offer to buy his home for US$300,000, which he’s lived in for 50 years.” Karim remarked to his companion, “Greg, something doesn’t add up here. His pension shot up 900% in 13 years while inflation snoozed at 2-5% per annum. How could the government pay him that much more in such a short period of time?” Grillot commented:

[T]he more you look around, the more you notice that no one seems to know, or care, how so many people can produce so much so cheaply . . . and sell it below production cost. How

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does the Chinese miracle work? Are the Chinese playing with economic fire? All over Beijing, you find people selling things for less than they must have cost to make.

. . . Karim and I looked over the books of a Chinese steel company. Its year-over-year gross sales increased at a fine, steady clip . . . but despite these increasing sales, its debt ascended a bit faster than its sales. So its net profits slowly dwindled over time.

. . . But it also looked like the company never pays down its debt.

. . . If the Chinese aren’t paying their debts. . . is there any limit to the amount of money the banks can lend? Just who are these banks, anyway?

Could this be the key? . . . In the land of the world’s greatest capitalists [meaning China], there’s one business that isn’t even remotely governed by free markets: the banks. In the simplest terms, the banks and the government are one and the same. Like modern American banks, the Chinese banks (read: the Chinese government) freely loan money to fledgling and huge established businesses alike. But unlike modern American banks (most of them, anyway), the Chinese banks don’t expect businesses to pay back the money lent to them.

Evidently the secret of Chinese national banking is that the government banks are not balancing their books! Grillot concluded that it was a dangerous game:

[E]ven if it’s a deliberate policy, an economy can’t be deliberately inefficient in allocating capital. Things cost money. They cannot, typically, cost less than the value of the raw materials to make them. The whole cannot be worth less than the sum of the parts.

. . Some laws of economics . . . can be bent, but not broken . . . at least not without consequences.”9

Benjamin Franklin’s English listeners would no doubt have said the same thing about the innovative monetary scheme of the American colonies. Or could Professor Liu be right? Our entire economic world view may need to be reordered, “just as physics was reordered when we realized that the earth is not stationary and is not the center of the universe.”10

How the Chinese economy can function on credit that never gets repaid may actually be no more mysterious than the workings of the U.S. economy, which carries $9 trillion in federal debt that nobody ever expects to see repaid. The Chinese government can print its own money and doesn’t need to go into debt. Before 1981, it had no federal

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debt at all; but when it opened to Western trade, it made a show of conforming to Western practices. Advances of credit intended for national development were re-characterized as “non-performing loans,” rather like the English tallies that were re-characterized as “unfunded debt” at the end of the seventeenth century. As a result, today China does have a federal debt; but it remains substantially smaller than that of the United States.11 China can therefore afford to let some struggling businesses carry perpetual debt on their books instead.

In both China and the United States, the money supply is continually being inflated; but the Chinese mechanism may be more efficient, because it does a better job of recycling the money. The new money from Chinese loans that may or may not get repaid goes into the pockets of laborers, increasing their wages and their pensions, giving them more money for producing and purchasing goods. Like in the early American colonies, China’s newly-created money is increasing the overall productivity of its economy and the standard of living of its people, promoting the general welfare by leavening the whole loaf at once. In twenty-first century America, by contrast, the economy keeps growing mainly from “money making money.” The proceeds go into the pockets of investors who already have more than they can spend on consumer goods. American tax relief also tends to go to these non-producing investors, while American workers are heavily taxed. Meanwhile, the Chinese government is cutting the taxes paid by workers and raising their salaries, in an effort to encourage more spending on cars and household appliances. The Chinese government recently eliminated rural taxes altogether.12

Another Blow to the Quantity Theory of Money

In March 2006, the People’s Bank of China reported that its M2 money supply had increased by a whopping 18.8 percent from a year earlier. Under classical economic theory, this explosive growth should have crippled the economy with out-of-control price inflation; but it didn’t. By early 2007, price inflation in China was running at only 2 to 3 percent. In 2006, China pushed past France and Great Britain to become the world’s fourth largest economy, with domestic retail sales boosted by 13 percent and industrial production by 16.6 percent.13 As noted earlier, China has managed to keep the prices of its products low for thousands of years, although its money supply has continually

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been flooded with new currency that has poured in to pay for those cheap products.14 The “economic mystery” of China may be explained by the Keynesian observation that when workers and raw materials are available to increase productivity, adding money (“demand”) does not increase prices; it increases goods and services. Supply keeps up with demand, leaving prices unaffected.

We’ve seen that the usual trigger of hyperinflation is not a freely flowing money supply but is the sudden devaluation of the currency induced by speculation in the currency market. China has so far managed to resist opening its currency to speculation; but Professor Liu warns that it has been engaged in a dangerous flirtation with foreign investors, who are continually leaning on it to bring its policies in line with the West’s. China is “hoping to reap the euphoria of market fundamentalism without succumbing to this narcotic addiction,” Liu writes, but “every addict begins with the confidence that he/she can handle the drug without falling into addiction.”15 He observes:

After two and a half decades of economic reform toward neoliberal market economy, China is still unable to accomplish in economic reconstruction what Nazi Germany managed in four years after coming to power, i.e., full employment with a vibrant economy financed with sovereign credit without the need to export, which would challenge that of Britain, the then superpower. This is because China made the mistake of relying on foreign investment instead of using its own sovereign credit. The penalty for China is that it has to export the resultant wealth to pay for the foreign capital it did not need in the first place. The result after more than two decades is that while China has become a creditor to the US to the tune of nearing China’s own gross domestic product (GDP), it continues to have to beg the US for investment capital.16

Liu’s proposed solution to the international debt crisis is what he calls “sovereign credit” and what Henry Carey called “national credit”: sovereign nations should pay their debts in their own currencies, issued by their own governments. Liu writes:

Sovereign debts in local currency usually do not carry any default risk since the issuing government has the authority to issue money in domestic currency to repay its domestic debts. . . .

[S]overeign debts’ default risks are exclusively linked to foreigncurrency debts and their impact on currency exchange rates. For this reason, any government that takes on foreign debt is recklessly

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exposing its economy to unnecessary risk from external sources.17

Although Liu says “the issuing government has the authority to issue money in domestic currency to repay its domestic debts,” in the United States today, newly-created dollars are not issued by the U.S. Treasury. They originate with the privately-owned Federal Reserve or private commercial banks, which create the money in the form of loans. Like those governments that “take on foreign debt,” the U.S. government will therefore never be able to cure its mounting debt crisis under the current system. The only way out may be the sort of Copernican revolution envisioned by Professor Liu, a Chinese American economist with his feet in two worlds.

The Dragon and the Eagle

Although China has been flirting with foreign capital investment, it has so far managed to retain the power to issue its own national currency. It has reportedly been using that sovereign power to print up renminbi and exchange them with Chinese companies for U.S. dollars, which are then used to buy U.S. securities, U.S. technology, and oil.18 Washington can hardly complain, because the Chinese have been instrumental in helping the U.S. government bankroll its debt. The Japanese have also engaged in these maneuvers, evidently with U.S. encouragement. (See Chapter 40.) The problem with funding U.S. deficit spending with fiat money issued by foreign central banks is the leverage this affords America’s competitors. According to a January 2005 Asia Times article, “All Beijing has to do is to mention the possibility of a sell order going down the wires. It would devastate the U.S. economy more than a nuclear strike.”19 If someone is going to be buying U.S. securities with money created with accounting entries, it should be the U.S. government itself. Why this would actually be less inflationary than what is going on now is discussed in Chapter 39.

Ironically, the Dragon has risen to challenge the Eagle’s hegemony by adopting a monetary scheme that was made in America. For the United States to get back the chips it has lost in the global casino, it may need to return to its roots and adopt the financial cornerstone the builders rejected. It may need to do this for another reason: its debtridden economy could be on the brink of collapse. Like for Lincoln in the 1860s, the only way out may be the Greenback solution. We’ll look at that challenge in Section IV, after considering one more interesting Asian phenomenon . . . .

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Chapter 28

RECOVERING THE JEWEL

OF THE BRITISH EMPIRE:

A PEOPLE’S MOVEMENT

TAKES BACK INDIA

Of course the truck was a thousand times bigger than any of the mice who were to draw it. But when all the mice had been harnessed, they were able to pull it quite easily.

– The Wonderful Wizard of Oz,

“The Queen of the Field Mice”

India is a second sleeping giant that is shaking off its ancient slumber. Once called the jewel in the crown of the British Empire, it was the very symbol of imperialism. Today India and China together

are called the twin engines of economic growth for the twenty-first century. Combined, they represent two-fifths of the world’s population. Mahatma Gandhi unleashed the collective power of the Indian people in the 1940s, when he helped bring about the country’s independence by leading a mass non-violent resistance movement against the British. India celebrated its freedom in 1947. But in the next half century, the entrenched moneyed interests managed to regain their dominance by other means.

According to a PBS documentary called “Commanding Heights,” in the 1950s India was a Mecca for economists, who poured in from all over the world to advise the Indian government on how to set up the model economy. Their advice was generally that it should have a state-led model of industrial growth, in which the public or government sector would occupy the “commanding heights” of the economy.

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