 The Era of Fictitious Capitalism
by Addison
Wiggin
The
Daily Reckoning
8 December, 2003
The Daily
Reckoning PRESENTS: When 'real value' is no longer what seems to
matter... you can be sure it matters more than ever...
Perspective.
While doing
radio interviews this fall regarding themes in our book, the
question invariably arises: "France? Nice place to visit,
but why the heck do you live there?"
The short answer
is, of course, the wine is cheap and the woman are... um, elegant.
The long answer is, we gain perspective. It's the long answer,
because it requires an explanation. One could gain perspective
from just about anywhere, of course... but why not do it in a
place where the wine is cheap and the women pleasing to look
at?
An English
reader, who also lives in France, recently passed on an interesting
article written by a Chinese bureaucrat, published on a non-profit
website hosted in Italy, sponsored by the government of Singapore.
The aim of the site is to increase amicable relations between
Asia and Europe in a U.S.-centric world. The purpose of the article:
a strategic recommendation on how China ought to position itself
while the U.S. and Europe - as the major players in the two-bloc
international system the author predicts will eventually emerge
- gear up for eventual war.
If we were
writing our daily missives from our offices in Baltimore, would
such a site, and such an article, be interesting? Probably. But
we'd likely judge the origin of the site through Murdoch's lens
at Fox News, like so many TV-addled minds do, and dismiss it
out of hand. Away from influence, living as foreigners, in a
country where they don't pronounce words as they are spelled,
we take to the extraordinary like gnats to a sugar bowl. We are
addicted to the taste and go there often to get a buzz going.
But we are under no illusions that it has nutritional value.
What could
possibly interest us about a Chinese bureaucrat's white paper
on impending global war? First of all, his conclusion: "In
the last century," writes Wang Jian, "American people
were pioneers of system and technology innovation. However, the
interests of a few American financial monopolies now lead this
country to war. This is such a tragedy for the American people.
"Clouds
of war are gathering. Right now, the most important things to
do for China are:
1. Remain neutral
between two military groups while insisting on an anti-war attitude.
2. Stock up in strategic reserves
3. Get ready for a short supply of oil
4. Strengthen armament power
5. Speed up economic integration with Japan, Hong Kong, Korea
and Taiwan... "
It's a rather
unsettling idea. China as the neutral power in a war between
the United States and a united Europe. How did Wang get there?
That's the subject of the second part of the article, which we
find intriguing... and even more unnerving. Wang's view is disturbingly
similar to our own understanding of the way the global economy
works.
"War is
the extension of politics and politics is the extension of economic
interests," Wang asserts. "America's wars abroad have
always had a clear goal; however, such goals were never made
obvious to the public. We need to see through the surface and
reach the essence of the matters. In other words, we need to
figure out what the fundamental economic interests of America
are. Missing this point, we would be misled by American government's
shows and feints."
Wang's argument
in a nutshell: By the mid 1970s, the U.S., the U.K., France,
Germany, Italy, Japan and other major capitalist countries had
completed the industrialization process now underway in China.
In 1971, when Nixon closed the gold window, the Bretton Woods
system collapsed, and the dollar - the last major currency to
be tethered to gold - came unstuck. Economic growth as measured
by GDP was no longer restricted by the growth of material goods
production. Toss in a few financial innovations, like derivatives,
and the "fictitious" economy assumed the central role
in the global monetary system.
"Money
transactions related to material goods production," writes
Wang, "counted 80% of the total [global] transactions until
1970. However, only 5 years after the collapse of the Bretton
Woods the ratio turned upside down - only 20% of money transactions
were related material goods production and circulation. The ratio
dropped to .7% in 1997."
As we note
in our book, since Greenspan assumed the central role at the
most powerful central bank in the world, he has expanded the
money supply more than all other Fed chairmen combined. From
1985-2000, production of material goods in the U.S. has increased
only 50%, while the money supply has grown by a factor of 3.
Money has been growing more than six times as fast as the rate
of goods production. The results? Wang's research reveals that
in 1997 - before the top blew off in the U.S. stock market, mind
you - global "money" transactions totaled $600 trillion.
Goods production was a mere 1% of that.
"People
seem to take it for granted that financial values can be created
endlessly out of nowhere and pile up to the moon," our friend
Robert Prechter writes in his book, Conquer the Crash. "Turn
the direction around and mention that financial values can disappear
in into nowhere and they insist that it isn't possible. 'The
money has to go somewhere... It just moves from stocks to bonds
to money funds... it never goes away... For every buyer, there
is a seller, so the money just changes hands.' That is true of
money, just as it was all the way up, but it's not true of values,
which changed all the way up."
In the fictitious
economy, the values for paper assets are only derived from the
perceptions of the buyer and seller. A man may believe he is
worth a million dollars, because he holds stocks or bonds generally
agreed in the market to hold that value. When he presents his
net worth to a lender, a mortgage banker for example, and wishes
to use the financial assets as collateral for a loan, his million
dollars is now miraculously worth two. If the market drops, the
lender, now nervous about his own assets, calls in the note...
and the borrower once thought to be worth two million discovers
he is broke.
"The dynamics
of value expansion and contraction explain why a bear market
can bankrupt millions of people," Prechter explains. "When
the market turns down, [value expansion] goes into reverse. Only
a very few owners of a collapsing financial asset trade it for
money at 90 percent of peak value. Some others may get out at
80 percent, 50 percent or 30 percent of peak value. In each case,
sellers are simply transforming the remaining future value losses
to someone else."
As we saw in
the 2000-2002 bear market, in such situations, most investors
act as if they were deer caught in the headlights of a speeding
truck at night. They do nothing. And get stuck holding financial
assets at lower - or worse, non-existant - values. Anyone suffering
glances at their pension statements over the past few years knows
their prior "value" was a figment of their imagination.
Back to Wang:
"In the era of fictitious capitalism, a fictitious capital
transaction itself can increase the 'book value' of monetary
capital; therefore monetary capital no longer has to go through
material goods production before it returns to more monetary
capital. Capitalists no longer need to do the 'painful' thing
- material goods production."
Real-life owners
of stocks, bonds, foreign currency and real estate have increasingly
taken advantage of historically low interest rates and applied
for mortgages backed by the value of these financial assets.
Especially since the rally began 8 months ago, they then turn
around and trade the new capital on the markets. "During
this process," writes Wang, "the demand of money no
longer comes from the expansion of material goods production,
instead it comes from the inflation of capital price. The process
repeats itself."
Derivatives
instruments, themselves a form of fictitious capital, help investors
bet on the direction of capital prices. And central banks, unfettered
by the tedious foundation set by the gold standard, can print
as much money as is required by the demands of the fictitious
economy. You can, of course, trade the marginal values of these
fictitious instruments and do quite well for yourself. [See:
22 Trading Rules For The Fictitious Economy http://www.dailyreckoning.com/body_headline.cfm?id=3589 ]
But Wang sees
a darker side to the equation. "Fictitious capital is no
more than a piece of paper, or an electric signal in a computer
disk. Theoretically, such capital cannot feed anyone no matter
how much its value increases in the marketplace. So why is it
so enthusiastically pursued by the major capitalist countries?"
The reason,
at least until recently, is that the "major capitalist countries"
have been using their fictitious capital to finance consumption
of "other countries'" material goods. Thus far, the
most major of the capitalist countries, the U.S., has been able
to profit from the system because since the establishment of
the Bretton Woods system, and increasingly since its demise,
the world has balanced its accounts in dollars.
"Until
now," writes Wang, "U.S. dollars [have counted] for
60-70% in settlement transactions and currency reserves. However,
before the 'fictitious capital' era, more exactly, before the
fictitious economy began inflating insanely in the 1990s, America
could not possibly capture surplus products from other countries
on such a large scale simply by taking advantage of the dollar's
special status in the world... Lured by the concept of the 'new
economy', international capital flew into the American securities
market and purchased American capital, thus resulting in the
great performance of U.S. dollar and abnormal exuberance in the
American security market."
And here we
arrive at the crux of Wang's argument that a war is brewing.
"While [fictitious capital] has been bringing to America
economic prosperity and hegemonic power over money," he
suggests, "it has its own inborn weakness. In order to sustain
such prosperity and hegemonic power, America has to keep unilateral
inflow of international capital to the American market... If
America loses its hegemonic power over money, its domestic consumption
level will plunge 30-40%. Such an outcome would be devastating
for the U.S. economy. It could be more harmful to the economy
than the Great Depression of 1929 to 1933."
Japan's example
suggests, as your editors have oft reminded you, that a collapse
in asset values in a fictitious economy can adversely affect
the real economy for a long time.
In the era
of fictitious capital, Wang surmises, America must keep its hegemonic
power over money in order to keep feeding the enormous yaw in
its consumerist belly. Hegemonic power over money requires that
international capital keep flowing into the market from all participating
economies. Should the financial market collapse, the economy
would sink into depression.
America's reigning
financial monopolies, he believes, (whoever they may be), would
not stand for it.
Addison
Wiggin
The
Daily Reckoning
P.S. Wang writes
that he was disturbed to draw these conclusions. And as noted
above, he recommends that the Chinese government plan accordingly.
He could not
be any more disturbed than your editors here in the Paris office.
We've grown to like the perspective we've developed while enjoying
carafes at the Paradis and watching passersby pass by.  Trouble is, if Wang's
conclusions are correct, then the currency most suited to challenge
the hegemony of the U.S. dollar has just this week closed at
a historic high of $1.20.
Addison Wiggin
is the Managing Editor of The Daily Reckoning, a daily e-mail
offering "erudite," "witty," and "sensible"
commentary on the day's stock news. Click here to sign up for a free
subscription.
He is also
the co-author, with Bill Bonner, of "Financial
Reckoning Day:
Surviving the Soft Depression of The 21st Century" (John
Wiley & Sons New York, London), available at Amazon.
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321gold Inc
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