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ing, 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 involv-
ing 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
Web of Debt

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 gov-
ernment 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
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
Chapter 27 - Waking the Sleeping Giant

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
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

Web of Debt

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 man-
aged 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 neo-
liberal 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 foreign-
currency debts and their impact on currency exchange rates.
For this reason, any government that takes on foreign debt is recklessly
Chapter 27 - Waking the Sleeping Giant

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 debt-
ridden 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 . . . .

Web of Debt

Chapter 28

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”

I ndia 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.
Chapter 28 - Recovering the Jewel of the British Empire

Gandhi™s economic ideal was a simple India of self-sufficient villages;
but Pandhit Nehru, the country™s first prime minister, wanted to
industrialize and combine British parliamentary democracy with
Soviet-style central planning. In the prototype that resulted, all areas
of heavy industry “ steel, coal, machine tools, capital goods “ were
government-owned; but India added a democratically-elected
government with a Parliament and a prime minister. The country
became the model of economic development for newly independent
nations everywhere, the leader for the Third World in planning,
government ownership, and control.1
Helping to shape the economics of Nehru and his successor Indira
Gandhi in the 1960s was celebrated American economist John Ken-
neth Galbraith, who was appointed ambassador to India by President
John F. Kennedy. Galbraith believed that the government had an ac-
tive role to play in stimulating the economy through public spending.
He wrote and advised on public sector institutions and recommended
the nationalization of banks, airlines and other industries. India™s banks
were nationalized in 1969.
Disillusionment with the promise of Indian independence set in,
however, as the private interests that had controlled colonial India
continued to pull the strings of the new Indian State. In 1973, the
country had a positive trade balance; but that was before OPEC entered
into an agreement to sell oil only in U.S. dollars. In 1974, the price of
oil suddenly quadrupled. India had total foreign exchange reserves of
only $629 million to pay an annual oil import bill of $1,241 million,
almost double its available reserves. It therefore had to get U.S. dollars,
and to do that it had to incur foreign debt and divert farming and
other industry to products that would sell on foreign markets. In 1977,


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