New paradigm of world economy

Emzar Jgerenaia, TSU professor

Zbignev Bjezinski
“In 1945, the formula for the foundation of UNO has been discovered… that secretly proved the fact that national sovereignty was becoming an illusion for all the countries, apart from several strong countries (Security Council permanent member countries – Russia, China, USA, Great Britain, and France) that were the members of United Nations.”

Plato
Let us enquire how timocracy (the government of honor) arises out of aristocracy (the government of the best). Clearly, all political changes originate in divisions of the actual governing power; a government, which is united, however small, cannot be moved. (Plato, “The Republic”)

George Soros
History development is defined largely by erroneous point of views and faulty perception. The new Paradigm for Financial Markets, New York 2008

Neil Ferguson
We should understand that present crisis lasts long. Medicines that are used for curing economies are leading to new problems. Unfortunately, the economical boom that was observed in the beginning of the decade cannot be reiterated, in any event, in the nearest future.

The worldwide view is established that the reason of financial crisis is US economy and every calamity comes from there. Ex facte, this is obvious as the bubble originated there, but in reality, the beneficiary of the bubble was whole world. On one hand US is trying to find solution, but despite enormous injections made in the economy there is no way seen yet. On the contrary, it seems that they are plunging into marsh even more. At the first stage of crisis, USA ex-Secretary Paulson’s plan was considered as easy way out. As if, $700 billion could save economy and banking field. This was followed by second $838 billion plan. However, this is just a drop in a bucket as the volume of financial bubble or abyss accounts several trillion dollars.
On the second hand, simplistic approach to the problem and wrong perception exaggerates the situation even more. Unprecedented growth of Chinese and Asian economies, just like European and BRIC countries was the bubble and nothing more. Consequently, it is wrong to expect rescue from US and accept American rescue formulas without appeal. Their magic formulas are not justifying themselves. Absurd situation appears, when in central banks money is almost free, while banks do not lend credits. America is preparing for big banking crisis. Some new and important category is appearing in economy, such as confidence – in consumers, depositors, clients, banks and investors. “Invisible hand” has stolen away and new style state regulating system that gives steadiness to business and economy is not seen yet.
Economy regulation is more resembling socialism and planned economy. At the same time, China is becoming quite active as donor and leading economy. Chinese Minister of Trade together with 300 business groups invaded Europe and bought new technologies, factories, patents and businesses of thirteen billion dollars. China became rescuer for Europe and America. It takes away new technologies to China. It buys bonds in America and strengthens dollar that way or in other words, it finances US government. It is obvious that China is becoming second centre and US’s serious partner on world market. Some questions are becoming sharp: Are these world’s future outlines? How it happened that socialist China appeared to be more effective, state enterprises were able to overcome crisis and reach high capitalization level? Which is determinant factor – market with its huge volume, where the fixed costs’ volume is minimal or technologies and patents that are sources of strength? Where is the way out of crisis? What will be the fate of small developing countries such as Georgia, Armenia and Azerbaijan, or Bulgaria and Latvia? Where this crisis took a start? What was it, investable outcome of the boom of recent years or business fraud of few tens of capitalists, which sacrificed states and businesses? There are many questions, including the one: maybe some people consider it as profitable to have small war situations in the world or on the contrary?
After August war events (Russia-Georgia war), the situation in the world took rather dramatic tinge. This incites us to make a cause-effect connection between world economical crisis and current events in Georgia. It is obvious that crisis proceeded from banking sector to business! This wave soon crosses the ocean, first it spreads in Europe and in few months, it strikes eastern European countries and naturally Georgia with furious economical crisis. It is true that situation in banking sector of Georgia is not alarming yet. As some banks, for instance, “People’s Bank” is breathing only with respiratory apparatus, TBC Bank elaborated reorganization rescue plan that helped it to attract considerable sums. Some banks, for instance ProCredit Bank had no corresponding investment made in construction market and at present, it has some dirty assets. However, difficulties in Georgian banking sector are inevitable in summer and autumn. First, the crisis will last so long that almost stopped banks will face huge problems in meeting their own commitments. On the other hand, many assets that are not bad now will become problematic. Besides, world-banking crisis is just moving forward at a steady gate and it is impossible that crisis passes beyond such countries as Georgia. US number one bank Citigroup suffered big damages in February. It required additional help from government. The seven percent of preferred shares, which earlier Citi offered in exchange for state bailout, has been converted into equity shares and thus increased state stake in the bank up to 37 percent. Experts suppose that this won’t be a last injection and worse is to follow. Bank nationalization just took a start and this process is a new stage in banking sector that is the beginning of world banking system crisis.
The current crisis is financial structures’ crisis. The aim of analyze is to present the reason that gave the rise to crisis – financial market and institutions or hypothecary sector. Was the economy growth persistent demand virtual provocation of supply? (See article – Monaco System, Sakartvelos Ekonomika, edition No 2, 2008). Maybe financial market itself created hypothec or both of them were created by economy’s real sector in order to increase demand. The question is – is the originator of crisis USA or China and Europe (together with BRIC countries – Brazil, Russia, India and China)? Export from these countries was growing persistently due to increased demand. US financial market undertook artificially increased demand main line in order to create bonds afterwards, non-existent increased demand-supply and receive enormous margin by it. The idea of crisis was dictated by financial market that is clearly seen at this stage of development. It is essential whether the crisis proceeds into real economy sectors or goes to an end. Every condition points that crisis will reach real economy sectors. In the course of 2009, decreasing production, unemployment growth, decrease in consumption and price reduction will be observed in the world. The last will be followed by production decrease and due to infringing price demand-supply rule this deflation will be changed by inflation.

Outlines of crisis
First signs of financial crisis spreading on real economy sectors were revealed by emptied US cities (besides thet fact that it influenced automobile producing giants). Such cities were Las-Vegas – entertainment centre and Detroit – car producing centre. Ford and General Motors factories are closed in Europe. The same fate shared OPEL four factories in Germany, where were working 26 000 people. At the time of Angela Merkel election’s year and for whole Germany was a big strike. Including the family members of those who were working in these factories, the overall amount of people who were left without income is 200000. The number of unemployed people in US in creased by 40 000 in February. The main task is to understand crisis anatomy and history that was named as hypothecary crisis. According to George Soros, the crisis has started at the end 2000 by blowing the internet companies’ financial bubble. USA FRS (Federal Reserve System) in a course of few months decreased interest rate from 6.5 percent to 3.5 percent. This was followed by act of terrorism on 11 September, afterwards the FRS decreased interest rate to record-breaking 1 percent. In the same period, Alan Greenspan was leading US banking sector. He issued cheap money and thus encouraged origination of well-known bubble in construction business. At the expense of cheap money assets, purchasing was taking place. Moreover, it was possible to buy money free. Everybody was yielding to strong temptation of taking credit. This was profitable for banks and whole economy as they were in need of high pace growth. Everybody participated in this some kind of competition for GDP growth speed. Existing demand-supply growth on market wasn’t giving a hand to businesses and banks, as they were striving for high capitalization and income growth. While top management was greedy for high bonuses. They started to increase demand on market by creating special products. Permanently was decreasing standards of mortgaging. In the end, they even were lending money without pledge. So-called Alt-A, Lire Loans and NINJA Loans (No Income, No Job, and No Assets) types of credit became wide spread. In order to increase credit attractiveness was established so called ARM – adjustable rate mortgages, when during first two years interest rate was considerably lower than their market value. Management of those banks and hedge funds, that now are receiving help from budget, were taking bonuses then. Investment banks on Wall Street invented few methods of transferring pseudo-risks to other investors. Pension and inter-aid funds became scapegoats. Investment banks established SIV (Structured Investment Vehicles) – structured investment companies that together with other privileges were not showing balance on some of their assets. Any bank had its structured investment sub department, Daughter Company that was making operations on hypothecary market and thus the assets were not reflected in balance. Construction boom started and in 2000-2005 years (from 2003 in Georgia) the price of ready, ready-for-use estate increased by 50 percent in USA and by 40-42 percents in Europe. According to Merrill Lynch calculations, in 2005-2006 years the half of DGP growth was coming from construction market. According to Merrill Lynch exports’ information, in 1997-2006 years the amount of crediting was by $9 billion more than the pledges. Martin Feldstein, the head of famous consulting company -Council of Economics Advisers, proves this number. The demand on dwellings was ten times more than then real demand. Thus, the rest was speculative. The research conducted in 2005-2006 showed that 3 percent of consuming expenses of the US population were financed by crediting in 2000, while in 2005 this rate increased up to 20 percent. In 2005-07, consumers’ expenses and mortgage crediting was increased 30 times and amounted $4 billion.
Experts reckon that the main role in provoking the crisis was played by Alan Greenspan. It is well known that after resigning and delegating responsibilities to Ben Bernanke, he published quite interesting book, in which he called the world for taking active steps toward upcoming all-time financial crisis. His precaution was considered as stuff and nonsense of an old man that had nothing in common with reality. However, the curious thing is that when Alan Greenspan was ruling US banking system, he was often warned that his monetary-crediting policy was encouraging the growth of bubble. However, Alan Greenspan did nothing in order to suppress it. In 2005, Alan Greenspan (He was managing banking sector in 1987-2006) conducted a research that showed that 3 percent of consuming expenses of the US population were financed by crediting from banks, while in first quarter of 2006 when Alan Greenspan was still in the head, this rate increased up to 10 percent. In 2003, in Georgia, 8 percent of population’s consuming expenses were financed by crediting, while at the end of 2007 – 28 percent. The research showed that by 2005, 40 percent of the housing fund was an object for speculations. This rate in Georgia for 2007 is 60 percent. Actually, it served not the aim of improving housing conditions, but speculation. The main motivation was to increase the price of real estate for several times that was covering credit interest rate and gaining profit. Some newer forms of the crediting were being invented in USA. Housing construction was considered as an object for speculation and selling-buying, that developed into new form of business. This process started in 1725 with Tulips (See, magazine “Sakartvelos Ekonomika” No 1, 2009) and continued with housing fund.
Let’s return to Georgian banking system that was characterized by fixed interest rate of credit and high debt security. However, the security that was valued by $200 000, now is worth of $100 000 or less. It is doubtless that this problem certainly exists in Georgian banking sector. The sliding interest rate system was not presented in Georgia up to now and some banks only recently started to use it. Interest rate should be changed, but this will be quite problematic and dangerous tendency, as due to expensive credit recourses banks are trying to increased interest rate on already loaned credits. If National Bank of Georgia doesn’t knuckle down to this, it might become the detonator of the crisis.
US banks were trying to get rid of dirty assets and risky mortgage credits and they transformed these debts into Collateralized Debt Obligations (CDO). Synthetic product was uniting cash flows that consisted thousands of mortgage debts that were piled together and ensured bonds basis. Major Tranches had the privilege of cashable and thus they were evaluated with AAA rating. Their volume amounted 80 percent of the basket, while the rest 20 percent was taking the whole risk and the profit was higher. The aim of such diversification was the risk reduction. Actually, these toxic waste products were accumulating all over the world and this was the sign of the crisis that is raging now. After this scheme, brokers were lending out money and they were managing credit basket. They were selling them wholesale to investment banks that on their own were creating secured bonds (liabilities). CDO rating agencies were evaluating bonds and afterwards institutional investors were buying them. The more was the volume of such operations the more was the bonus. This is how Sub-prime zone and fraud originated. The securitization mania appeared. It wasn’t reflected on the balance of the banks and it is interesting that leading rating agencies rated such banks with A category. While assessing the banks, agencies didn’t take into account, what quality assets their daughter companies were holding, that created not only regulation, but audit problem also. Securitization mania wasn’t ended by hypothecary crediting; it covered derivatives and hedging process. Synthetic product CDS – Credit Default Swaps appeared.
Many banks in Georgia infringed insider coefficient and started some constructions and the financing of own constructions created problems for Georgian banks. When the capital is devaluated, this results devaluation of the firms and the assets are reinsured in the insurance companies established by the banks.
The mania of debt instruments securitization covered the whole world at the end of 2005 and in the beginning of 2006. The originator of this was USA. It was attracting investors of whole world with cheap money. Billion dollar investments were flowing in various companies. Nowadays everybody is asking a question – where is all this money gone? The answer is simple – the money is gone to the managers of those financial organizations that were working with this scheme.
Celebrated experts including George Soros were calling synthesized products CDS-Credit Default Swaps. This bubble had no value behind it.
In August 2007, when the financial crisis started actually, more than half of listed securities were synthetic product CDS-Credit Default Swaps. The speculation was not limited with hypothecary credits and it spread on other forms of crediting too.
Synthetic, speculative product CDS – Credit Default Swaps was invented in the beginning of nineties in Europe. It was considerably reflected in Great Britain and Germany’s economies during the crash of Pound and Mark. Synthetic product defined the crisis in financial sector. According to scheme, bank sells SWAP or liability and agrees with another bank that during some specific years it pays agreed commission charges. If during the term of agreement, A bank suffers damage, B bank would compensate it. Before CDS, the bank desiring to diversify credit portfolio was obliged to sell part of the credits that was connected with various legal and financial difficulties. From the beginning, Credit Default Swaps became popular. The number of Swaps in 2000 reached billion dollars. This was the era of CDS development. Hedge funds appeared from 2000 that give the basis to the epic of current crisis. Hedge funds were created that were specialized on SWAP operations and they were acting as unlicensed insurance companies. Their income was CDO and CDS commission charges. Frequently such hedge funds were working fictitiously as (like Georgian banks) when commercial bank holds 100 percent stake of insurance company and it insures the loaned credit, risk is not distributed. In case of non-payment or mortgaged property destruction, the damage is compensated only by the bank or the money flows from its assets. Fictious was the existence of hedge funds, as the bank management itself was frequently establishing hedge funds because of gaining bonus from re-insurance. The real risk insurance was not taking place. The overall volume of such type contracts amounted $42.3 billion, while in USA stock market capitalization for the same period was $18.5 billion – almost 2.5 times less. For the mentioned period, the state debt of USA was $4.5 billion, nothing to say about the period when state debt amounted 10 billion. These circumstances caused the derivative boom on stock market. Some so called back appeared – margin level with 10 percent bonds. Bonds created on the basis of CBS were sold with 1.5% margin. Hedge funds were showing high-level income with this.
Such precedent has already taken place: in 1980, bonds market was developing successfully; bonds had hypothecary securing that was known as CMO – Collateralized Mortgage Obligation. This resulted in serious crisis in 1994, when hedge funds could not cover $2 billion security on devaluated stocks.
In spite of initial financial crisis expectation, Alan Greenspan and US equity market regulators were not trying to avoid the crisis. George Soros in one of his articles was stating that in 2000, US Federal Reserve System ex member Edward Gramlich warned Alan Greenspan about dangerous game played in sub-prime market. He warned Alan that equity market would blow up and it was necessary to take strict measures toward hedge funds. Gramlich discussed this issue in his book, in 2007. Another expert Charles Kindlberger warned financial fathers also. The research conducted by him showed the same result – the crisis would start in sub-prime market. One of the experts who were forecasting current crisis was ex head of USA Federal Reserve System Paul Walker, author of many well-known books. Top manager of one of the bad banks – Citibank Bill Roads expressed a suggestion about the bear trend and dangers that its influence on financial market could bring.
2007 is the year of crisis starting. On 22nd of February, HSBC management fired one of top managers of US department because he brought $10.8 billion loss to the banks. In the same period, US major construction company made a public warning about the problems anticipated in the sub-prime market and terminated employees. On 2 April, American company New Centre Financial declared of bankruptcy. After the failure of the last, the mass tendency of problem revealing and bankruptcies started. On 15 June, Bear Stearns declared the bankruptcy of its two hedge funds that was the pre conditions of the company’s bankruptcy itself. However, company opened $3.2 billion credit line and at the same time investors’ capitalization in amount of $1.5 billion disappeared.
On 20 July, Ben Bernanke declared that sub-prime losses concerning credits could be $100 billion. This was first confession of the official about huge loss. In July, Merrill Lynch and Citigroup wrote off huge flows of CBO and everybody thought that everything bad was in the past and black days were over. In addition, rating companies including Standard & Poor’s increased hedge funds and banks’ rating. However, this was only beginning of crisis.
In August, it appeared that everything that happened before was just prelude. Frequently people were talking about crisis in the past, but it is a current reality that took a start on 7 August 2007.
After devaluation of CDO and CDS equities, investment banks went back on obligation services. All they had left were bad assets in amount of $250 billion. All events that were taking place in previous years developed into financial crisis in 2008. Leading banks Citigroup, Merrill Lynch, Lehman Brothers and others declared about serious losses.
Current crisis differs from its antecedent one. It does not have so-called specialization. However, many scientists and economists call it hypothecary crisis. Somehow, synthetic instruments cause this crisis, but actually, this is the problem of whole world economy, as the financial resource that was synthesized from creativeness standpoint was used in real economy. The fact that crisis started in machine industry, construction, trading and manufacturing is just a logical result. 2009 is the year of crisis and it won’t have only financial character, it will include whole economy.
After the problems that started in summer 2007, European Central Bank was induced to assign aid to the banks in amount of 95 billion Euros. On 10 August, it additionally assigned 61 billion Euros; Central Bank’s third injection was made on 13 August in amount of 47.7 billion Euros. Just in few days Europe’s Central Bank made injection more than 200 billion Euros. On 13 August, Britain’s major bank Northern Rock, which was working on mortgages, appeared on the verge of bankruptcy that was followed by its nationalization. Similar precedent hasn’t taken place over 100 years. Crisis took a start in the whole world! We already know continuation, but we cannot see the future up to now. Darkest hour is just before dawn. History shows how the role of state is growing and its intervention in economy is exceeding any limits. At the end of February open discussion was held on this matter. Leading financiers gathered in the University of Columbia and discussed the issues like – Is capitalism dead or not? What future expects it? What will be the consequences of the strengthened regulation? IN the recent period, Keynes’ works became very actual and theses came up. Keynesianism became popular once again and some People even quote Marx and think about the correctness of his ideas. Alan Greenspan was managing US Central Bank for 19 years, despite the fact that he was democrat, he cooperated with republican presidents quite well. Many things depended on him: he determined whole American economy, employment, unemployment and many social matters. However, the situation has changed: there is quite easy approach toward crisis. Governments despite their concern with the current situation, think it easy to find a way out of crisis and reckon that additional injections are the solution to it. Good example to this is Bush’s $700 billion bailout and then Obama’s rescue plan in amount of $838 billion. Democrats were planning to create 5 million working place and overcome crisis. European bankers are strongly opposing this policy. The strictest attitude has Jan Clod Trice, president of European Central Bank – the most independent bank in the world that keeps interbank offered rate at 2%. He has a contrary viewpoint and reckons that crisis could be overcome by solving liquidity problems. Clod Trice calls such approach “Liquidity trap”.
First danger is that when credit interest rate is falling to zero point. Influence of traditional monetary policy on economic growth or on demand-supply balance is zero. Regulating instrument of the Central Bank is to impose interest rate on interbank credit movements. If this rate is zero, Trice reckons that central bank’s influence on economic growth and unemployment problem is zero either and bank is not carrying out its commitments.
Second danger is deflation. American experts forecast 5.5% deflation in the country. Deflation will reach its peak in 2012, when its rate will be 3.5%. With the start of deflation processes, it will be impossible to decrease interest rate with stimulating demand. This danger is characterized by crediting problem. Banks hold liquid funds (in Georgia either), but the los of confidence in population resulted complicated procedures and increased interest rates. Due to growing deflation, population prefers to spend money tomorrow and purchase cheap goods. This tendency originated consumer expectation problem that causes the market contraction.
When Keynes talks about similar processes that take place in leading capitalistic countries, he states that considerable increase in monetary aggregates within the population can result lost of confidence or in other words, they save funds and use them as insurance. State should have careful attitude toward injections. Injection doesn’t mean construction of bridges and roads. Keynes multiplier formula does not consider increasing market by spending money, as population might save the money due to existing vagueness.
Interbank offered rate in US almost equals zero. One might say that money is free that causes contrary processes. Macroeconomic specialists reckon that US Federal Reserve System should have offered rate at -6% in order to manage to use Tailor’s rule that considers coordinating coefficient on inflation. If FRS cannot have minus interest rate, it should purchase agency pass-throughs and thus balance the policy on real market, reckon specialists. European Central Bank doesn’t plan to purchase agency pass-throughs. On the contrary, Central Bank leaves more problems for national governments and that is a quite normal approach in this case.
At the end of February, on the meeting held in Berlin, heads of every leading countries declared that the times of free liberal economy are over and they support state regulation policy. This makes us to think that according to Marx scheme spirit of socialism is really strolling in Europe. European leaders are afraid of population unrest growth. Therefore, they use populist methods and declare that they are rescuing economy, artificially preserving working places. Moreover, they will bar bankruptcy of major companies. However, actually they do not see the way out of deep recession. England first showed that unlimited intervention in the economy could harm the country. The government’s policy brought the country to the disaster. Great Britain’s economy is in deep crisis. In February, the growth of GDP was -6.8%. Meeting of European leaders showed that the standpoint of crisis solution is wrong, just like their policy toward Russia and Georgia. Despite the fact that European Central Bank is standing on its feet quite well, Euro is losing its positions that it had in 200-2007. Euro exchange rate might have serious problems in 2009. Russia will have big influence on Angela Merkel’s election campaign that is not only big consumer of German product, but owner of several media houses also (For instance Deutsche Zeitungen). This is a powerful weapon in hand of Russia. What’s going on in western and central European countries? They were quite prospective countries not long ago and many specialists considered them the calm bays of investments. In the course of 20 years, after Soviet Union disintegration, so-called blowing development was observed in these countries. Many of them became the members of European Union and they were proud of own achievements. In February, agency “Reuters” published statement of World Bank executive Robert Zoelik statement that $106 billion injection is required to rescue western European banks. EBRD executive Tomas Mirou declares another number. According to his calculations, the mentioned banks require $200 billion injection. He also stated that if the recapitalization does not occur in the banks, their failure would be inevitable. He reckons that this would be the worst scenario of the event development that will be followed by the collapse of western and central European countries’ economies.
Experts call Western Europe to help these countries, in order to avoid new seats of financial crisis. There is a deep recession in Bulgaria, Czech, Hungary and Latvia. Some complicated processes are started in Lithuania, Estonia and Poland. Therefore, EBRD together with World Bank created banks’ aid program that amounts $500 million. Experts reckon that this is a drop in the bucket – only 15% of demand.
Everybody is concerned by the question – who is in fault? According to BBC, World Bank’s ex leader, Paul Volfovich declares that we do not fully understand the reasons of crisis, nobody knows how ling will it last and nobody knows how to fight it. However, one thing is obvious – everybody is in fault, those who participated in this process. The worse is still to follow. Yes, America was consumer more than it could afford, but Europe and China were exporting more that this country could consume and thus all the countries should seek the solution together. You might hear often (in Georgia too) that we will close borders and take care of our country, citizens, production ourselves. We will increase customs rates and protect market. However, Paul Volfovich reckons that in this case everybody will be perished, as this is the way leading nowhere. His statements once more prove the idea that crisis is carrying financial character and it is quite scaled. The crisis hasn’t spread in the sectors of real economy and it will reach its peak in Spring-Summer.
Grave situation is emerging is Bulgaria. It depends on Russian market in large extent and due to recession, Russian economy’s negative influence is felt. The main macroeconomic indicators are worsened. The reduction of production growth pace, trading deficit growth, currency exchange rate slump and banking system crisis caused collapse in Latvia. The similar processes are observed in Estonia. Merrill Lynch experts reckon that Bulgaria, Baltic countries such as Ukraine won’t be able to recover the state that they had before the recession. Recession processes are starting in Poland either. The industry growth has decreased by 15%, the salaries are reduced in a high pace. Poland’s National Bank published the plan of adopting Euro, but its realization is rather pessimistic. In our neighbor Turkey, the only positive events are price reduction and inflation slowdown. On the other hand, this country has the high risk of deep recession. The deficit in liquid assets in banks and investments creates huge problems for Lira exchange rate. Merrill Lynch experts think that country needs Monetary Fund aid for recovering it from crisis.
The situation is complicated in Armenia and Azerbaijan also. Annual income from oil production amounted $52 billion that was 95 percent of budget incomes. According to 2009 prognoses, this rate will fall to 6-7 billion dollars. Azerbaijani government is induced to recalculate budget that was adopted considering the oil price at $70, while the current oil price fluctuates between 40-45 dollars. Therefore, Azerbaijani government will have to define the social priorities of the budget again. The growth of economy is reduced considerably. Naturally, inflation rate is quite high. It was 22 percent last year. Due to price reduction on many commodities, inflation rate decrease is expected. However, this won’t have effect on production and consumption increase. Approximately $2 billion foreign funds were in Azerbaijani banking sector. There is a serious danger of new Manati exchange rate slump that is artificially preserved by Central Bank. All these events create fever expectation. Population tries to avoid using bank and thus the less and less money movement is in the banks. There are some Kazakh, Russian and Iranian banks, but active operations are not made in the market. Banks just stopped crediting.
As regards Armenia, immigrants were creating serious structures in the country’s economy. Transfers they were making as investments, ordinary transfers or aid were the driving force of Armenian economy. However, the crisis reduced these transfers considerably. The leading business in Armenian economy, such as mining business is almost stopped that of course seriously harms country’s budget and the harness of the currency.
The last 15 years can be called managers’ diktat era. The problem of relationship between proprietors and non-proprietors is standing quite sharply. There is a huge army of non-proprietors, while proprietors are the minority in the society. There is big confrontation between them. Stock or public companies are trying to overcome this confrontation by creating business forums. Any person can buy shares in an open stock society and became owner somehow. The mechanisms that are put in equities gives the right to ordinary person to participate in the management of the company. For years, this form might seem the way out of this confrontation. As from the point of social stability, capital attraction this from has huge advantage and its transparent form.
The practice of big companies showed that management, managerial bureaucratic mechanism totally manages stock company. The total dividend received by stock company might be considerably lower than the payment received by the top management. Why? Because management creates some bureaucratic apparatus that might be named as some type of corruption. Bank CEOs have quite high incomes in Georgia either. Their salaries are much higher than those of other ordinary employees’ are. The fact is worth of emphasis. This crisis revealed that bank manager is not taking risk appropriate to own salary. This is the caste of people, who oppress stakeholders. Their major income is developed by the rate of stocks. Their motivation is to have maximally high turnover rate. They create unprecedented artificial demand-supply and receive corresponding bonuses. The effectiveness of credit mechanism became of second quality and preference is given to the volume that gives bonuses. The decision made in the banks and the products they offered were the result of greediness for bonuses. Thus, the unjustified system was created. The last scandal is proving this that took place in USA. New York’s prosecutor Andrew Cuomo opened a file against the executives of Merrill Lynch. The sense of the matter is the following: crisis period was followed by factual bankruptcy of Merrill Lynch. With the Senate approved bailout money Bank of America purchased Merrill Lynch. From 1st of January, Merrill Lynch officially became part of Bank of America. The process was preceded by assigning to Merrill Lynch top management $3.5 billion as a bonus. Unimaginable situation when the bank is at the edge of bankruptcy, it has problems in liquid assets, it is united with another bank, that on its part is buying failed bank via bailout received from state and top managers of the failed bank receive huge bonus from this sum! This fact the clear proof that 21st century is the era of bureaucratic management and managerial corruption. The main reason of crisis is managers careless motivation, greedy striving for more money. This is not only banking sector illness, the same could be said about every major corporation, whose top management lives wasteful life and in most cases has it has more income than the proprietor does. What is the situation in Georgia? There are two extremes in our country – in some cases, managers are not valued and he company’s owner thinks that he/she is almighty and all-knowing that is reflected on the salaries of the managers and in the other cases managers have extremely high salaries. Whole world is responsible for the problem created by bonus-eaters and the crisis. The question arises – was the state involved in these new super-schemes? This is doubtless – state first received taxes, political organizations were financed and second many of the officials were directly involved in business. Politicians were receiving dividends from artificially blown employment rate.
World is in the agony. I explained this simply, as the bullock cart has turned over and one can see clearly, what has happened, but it is unknown what will happen.
Monetary fund is making another sharp prognosis for 2009. Agency Reuters published the statement of Monetary Fund first secretary John Lypski that economical crisis will last up to 2010 and economical growth shouldn’t be expected afterwards either. According to Montary Fund calculations, in the fourth quarter of 2008 and first quarter of 2009, the pace of economic slump was unprecedentedly high. Lypski highly glamorized pound devaluation decision that was made due to crisis aggravation and fall in pound exchange rate. He emphasized that he will support British economy reconstruction. Inter alia, the same Monetary Fund was making positive forecast that in fourth quarter of 2009 world would start to recover gradually from crisis. George Soros analysis is interesting also. Soros declares that he cannot see the light at the end of the tunnel. He cannot imagine that the crisis will be ended some times. He compares the current situation with gin depression period and says that current crisis will be more disastrous than big depression. Barak Obama’s economic advisor, Nobel prize laureate Paul Walker declares that production in the world is falling with more high paces than in America. He says that even in times of big depression the production was not falling with such high paces.
On the conference held in the University of Columbia in February, George Soros declared that current depression is more scaled and big than that of thirties. World economy system is breathing with respiratory apparatus and there are no symptoms giving a chance to change this state. Naturally, he meant those injections that national governments made in order to cure economy and which gave no results so far. Soros reckons that disintegration of world finances and protectionism era flourishing are starting. Hillary Clinton’s visit in China was very important for the aim of searching way out of crisis and new financial order establishment. She supposed that America and China would find the solution to world crisis together. Clinton thanked China for active financing of USA. Therefore, China is holding modest second position in the leader countries. Tight cooperation of these two countries is very important. Despite political differences, experts make correct emphasis – maybe some two poled world ruling scheme with two leaders is outlining. During the meeting, the statement of Hillary considered this new scheme. During February, many were requesting increase of Monetary Fund capitalization. China and India were the supporters of this idea. One of the ministers of South African Republic declared that before the crisis the participation rate of developing countries in the market was $980 billion that could have been increased up to one trillion. However, now this sum has decreased to 165 billion dollars. If in the period of economical growth, many countries, including Georgia were looking with some doubts to the mission of Monetary Fund. They reckoned that this was punishing organization with small bureaucrats, often with some dubious demands. Today many recognize that Monetary Fund should have not only the function of supporting developing countries, but it should play the role of strict player in the world markets also. The major western banks left the market and monetary fund should replace them with its mechanisms.
On 2 April, in London, during the meeting of great twenty, I suppose they will discuss the increase of monetary fund’s role in managing developing countries, as the monetary fund was always representing Europe, while World Bank was representing USA. Such tandems shouldn’t exists and the role of international financial organization in the regulation of national economies and markets should be increased.
Many economists say that USA economy slump is rather slow. Despite the fact that the in fourth quarter of 2008, equity market became active, 2008 still was the hardest year of the crisis. Investors were panic-stricken, they were selling bonds and equities on the market, including so-called secured from inflation TIPS. If one should believe Swiss bank UBS experts, the gradual disappearance of panic in capital market caused some boom. The danger of deflation threatened America and Europe might have the same fate. Deflation problem will be one of the leading issues of 2009.
Barclay’s one of the leading experts Michele Bond analyzed bottom point of stocks income, in case of spread between the incomes of agency pass-throughs and TIPS deflation is anticipated in the market. He reckons that agency pass-throughs and TIPS correction in the market is positive information. In the course of next few years, deflation will be 5.5%, while average inflation will be zero. TO his mind, deflation will be 2-3.5% in 2009 and this rate will remain up to 2014. (Based on – The Economist).
It is interesting how the developing countries share the deflation future? Government of every country and its central bank tries to make injection that might be resulted in the change of deflation process. However, two things should be taken into account: market and demand contraction, price reduction on raw materials and preparing strong basis for deflation by this. Experts suppose that due to deflation and increased budgetary deficit, US agency pass-throughs emission will be approximately $1.8 trillion that exceeds the total amount of the pass-throughs that were issued during last 27 years.
Analysis showed that even today, there is a high demand on US agency pass-throughs and it remains an interesting investment for the investors. We can assume one thing, despite the crisis US economy, together with Chinese one, is still most interesting, leading economy and dollar is the hardest currency. In the neighboring Russia there are currency income problems. Ministry of finances tries to declare de-capitalization of leading banks and state intends to purchase holding of stock of VTB Bank, Alfa Bank, and Gazprom Bank. It is obvious that crisis is taking a start in Russian banking sector. According to recent data, capitalization slump is observed in Russia. First ten of rich Russians lost $221 billion, $80 billion investment is gone from the country. State spent $250 billion in order to support Ruble in vane. Due to oil price reduction, budgetary incomes are decreasing rapidly. It becomes more and more difficult to maintain social stability. Southern Caucasus conflict and hostilities with Georgia caused increase in military expenses.
Leading countries of Europe support the policy of increased regulation of economy by the state. Some signs of socialism rising like phoenix are appearing and at the same time, capitalism is on its deathbed. Nobody cares of sorting out relations between Russia and Georgia, nobody has the time to protect Georgia and punish Russia. This tendency will continue in 2009 and if we do not manage solve economical, and political problems with our Southern neighbor by optimal policymaking, in 2011 oil prices start to increase again and at that time, it will be unnecessary even to talk about regulation of relations with Russia.
Allow me to say as a conclusion:
World crisis will reach its peak in 2009. However, nobody knows what will be the outcome and what metamorphosis it can take. It is obvious that unprecedented contraction of market demand will be observed in 2009. Naturally, Georgia’s export decreases and unemployment rate gets higher. Despite the promise, this international aid will be considerably reduced in this year for Georgia. Due to insufficient financial resources west will be unable to take strict measures toward Russia. Supposedly, in the Gtwenty summit in London, country leaders will shape the outlines of future world. Solution of Georgian economical and political problems depends on Russia-USA relation and new world order. Europeans position is becoming vaguer. If they were worrying for us before, to my mind the time has come us to worry about them as the existing political and economical situation is rather disturbing. New member became a heavy burden for Europe, they make no contribution, on the contrary they are taking quite big funds that weakens Europe in the end. Creation of new economy offers new opportunities to the countries like Georgia. Let’s recall the after depression period, when new liberation era started in Asia and Africa. However, the Second World War followed big depression Maybe war is the discharging power and this is favorable both for the west and for the east. This might be a origination of the new world order.
Has the free capitalistic market collapsed? Are the Marx’s words coming true – we are standing at the socialism gates? The system that will be created in 2010-11 shows us. Every precondition points that state’s role in the market is increasing that is the precondition for Marxists ideas. Future is offering different free market, financial and capitalistic system. Nowadays current question is – How far the artificial intervention and disregarding of market requirements would be taken into account in the rules of future market architecture. ON the one hand, Plato’s free market has no alternative so far and myths about Marx and Keynes rising is just an illusion. However, on the other hand, what kind of new free market do we have? – This question is to be answered in the course of next three years, including Georgia either. New world economy system is developing. This is the destruction of old shapes and formation of new content. Countries with leading economies understand the fatality of old form, but they still find it difficult to adopt these processes, as it is hard to adopt anything new. Naturally, the system will be changed in Georgia also. But how?! Our freedom and future depends on these processes! Where is our place on the world map?