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Problems of financial powers keep prices up

By Ding Yifan (China Daily)
Updated: 2008-08-29 11:12

According to some European and American analysts, nations of the world have been regrouped into a new "three-world fixture": developed countries have turned into financial powers while developing nations have become manufacturing powers and exporting powers of energy and materials resources.

Before the prices of production materials shot sky high, the opening up of the global market brought by the liberalization of international trade created an opportunity for manufacturing powers to develop further and they grew the fastes. That said, as the prices of production materials soared, the financial powers and energy- and materials-exporting powers seemed to be doing even better than manufacturing powers.

Financial powers and especially the US have a kind of currency hegemony. The US dollar is the leading currency in the world and the pricing currency for many bulk commodities such as oil. When the US dollar depreciated, the prices of such commodities went up. There is a mechanical co-relation between them.

The US is already the largest debtor nation in the world and needs to import a lot of foreign capital to keep its economy running. The depreciation of the US dollar has caused the prices of bulk commodities to rise and a tide of worldwide inflation, making the US a victim of the problem, too, though it has also lightened the debt burden on America's back.

The materials-exporting nations fared relatively well in the days of ballooning prices, because their income rose accordingly. But, there is a theory in economics called the "curse of resources", which says that resources-rich nations might form the (bad) habit of "depleting a big fortune by all consumption and no regeneration". Sometimes easy money lets nations forget about economic development and structural renovation and they end up lagging behind other countries.

The current hike in energy resource prices has been caused mainly by currency and financial policies of developed countries. The resources-exporting powers might have benefited from soaring prices, but how long this kind of situation lasts depends on the future development of financial powers and the result of manufacturing powers' response.

Compared with the past few years, manufacturing powers are faced with unprecedented difficulties. First of all, the cost of imported energy resources and production materials keep rising while the export market contracts, prices cannot go up and profits fall, pushing some medium- and small-sized enterprises to the brink of reorientation or shutdown. Second, Transportation cost goes up as oil price rises, making it difficult for manufacturing powers far away from export markets to stay afloat as some importers choose to buy from closer manufacturers. Third, manufacturing powers are being targeted by criticism from developed countries that their growing consumption of energy resources and production materials have driven prices up worldwide, while government subsidies have kept their own energy prices relatively low.

In fact, the reason why manufacturing powers subsidize their enterprises on energy price is that energy price is a complex political and social issue. If energy prices are allowed to soar freely, ordinary manufacturers will not be able to afford it and the economy will go into recession as a result.

Financial powers are already troubled by serious market instability. If developing nations also fall into recession, a great recession of global proportions will soon follow.

Financial powers are in an advantageous position, but the "deepening" of finance in past few years has created a plethora of risk-shy products, which ironically come with mounting systematic risks of their own.

Too many new financial products and growing debts of the US are making the US economy weaker while prompting foreign investors to lose confidence. Various financial derivatives have scattered the risks facing financial institutions, but those risks still exist - hidden in all kinds of debt packages thought to hedge risks. As debts changed hands those risks have been overlooked, hence immediate panic on the market whenever a certain problem pops up and investors become so nervous that they must dump the debt packages for cash, sending the whole financial system into crisis.

Truth be told, the financial crises of financial powers and their governments' market-relief measures are the real causes of the current hikes in resources price, though the foundation of the soaring prices is not so firm. If the financial situation in financial powers lingers on, resource prices will not be able to remain high for long, because manufacturing powers have long been relying mainly on exporting to financial powers and their productivity will shrink when their export markets lose appetite, which in turn causes demand for production materials to drop, too.

Therefore, both manufacturing and resource-exporting powers should give the situation another serious look and think about their future development strategies so as to prevent their development tracks from going astray because of external market changes.

The author is a researcher with the State Council Development Research Center