Since late 2007 Federal Authorities have spent well over three trillion dollars (half borrowed and half printed) to rescue the banking system and rev up the economy. That is equivalent to a full year federal budget only a few years ago.

Other governments have implemented similar policies. China’s “stimulus” is proportionately much larger than our own.

This unprecedented tide of money has produced some results. In the U.S. GDP has increased and corporate profits and the stock markets are up despite persistent unemployment and weakness in housing.  But this “fragile” recovery might now be faltering. The Brookings-Financial Times Index, designed to provide a “snapshot” of the global economy, has nose-dived since March. If it continues on the present course, we will be back in recession mode by Labor Day.

This begs the question: Are we dealing with a stubborn but still conventional cyclical downturn, or is there something more fundamentally wrong with the global economy as well as our own?

We are inclined to answer in the affirmative.

Just as the current downturn might be unprecedented, the two decades leading to it have seen a similarly novel development: globalization. There is likely to be a connection.

Globalization has occurred on two levels, financial and commercial. On the financial side all restrictions on the movement of currency and capital have been removed. This has led to a huge increase in financial activity amplified by global-scale leverage. Much of this activity has been of the speculative kind.

On the commercial or industrial side, national tariff barriers have been removed, allowing production to migrate to the lowest cost locations. Just as financial activity is amplified by leverage, this transfer of economic activity has been accelerated by mercantilist practices, of which China and its neighbors are the principal practitioners.

While this process has temporarily lifted profits for multi-national corporations, it has a dark side: it destroys wealth.

Consider a U.S. manufacturing plant worth $ 20 million. If production is moved to Mexico, the equivalent plant might be worth 15 million, due to less automation, fewer amenities, and looser environmental regulations. If production then moves to China, the plant might be worth $ 10 million, and even that is not sure, because the price will depend on government policy and possible intervention by local and national authorities.

The same will apply to all production-related expenses and accessory investments: wages, benefits, employee housing and enterprises servicing the plant. Only profit might be higher, but that will not compensate for the reductions listed above. It is likely to increase income inequality, which carries a social cost. So does the lower energy efficiency and increased environmental impact.

Ultimately, less new wealth will be created in the recipient country than has been lost in the U.S. China temporarily gains at the expense of the U.S., but it gains a piece of a shrinking global pie, because value has been lost in the transfer. In addition the resulting social (unemployment and the loss of accessory services) cost has to be borne by the U.S. taxpayers still employed, reducing the capital pool available to fund new industries.

On the whole, the world gets poorer, since globalization is by definition a race to the bottom. While there is development in some areas, the global asset base shrinks.  This has been, to a degree and for a limited period, compensated for by consumer indebtedness and government deficit spending. Both of these have reached their limits.

This global reduction in asset value probably contributes to the increasingly speculative character of finance. Money has to find returns somewhere. If opportunities for “real” investment disappear, new financial “instruments” will be created to fill the gap. The more widespread the use of such instruments, the higher financial volatility will be, with bubbles increasing in intensity and frequency of occurrence. Regulation might slow or mask this process, but cannot eliminate it.

In other words, the longer a policy of commercial globalization is maintained, the greater the likelihood of another financial implosion.

More ominous, in the short term, will be the deflationary effect, which is likely to defeat all current efforts to restart economic growth. Because globalization simultaneously lowers wages and prices, it introduces a deflationary bias against consumer spending, based on the expectation that well-paid jobs will continue to get scarcer while prices will stay stable or drop.

We are in the deepest recession since the thirties, and heading for the second dip. Globalized finance and “free trade” got us there. It is time to take a second look at their real effects.

This entry was posted on Wednesday, July 21st, 2010 at 11:46 am and is filed under Our Money, The People's Business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.