21st Century Economy: A Beginner's Guide [NOOK Book]

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CHAPTER 1
WHAT IS THE FUSION ECONOMY?

The converging world economy has created a whole new paradigm for the 21st century. Global warming, credit crunches, currency meltdowns, food crises, and trade wars are just a few examples of how our everyday lives are being altered by a myriad of forces, many of which are economic in nature. And like nuclear fusion, which joins together hydrogen molecules and releases enormous amounts of energy in the process, the converging global economy is releasing a lot of new energy-we just need to figure out how to use it.

This new fusion economy brings together forces and reactions in ways that are impossible to understand using normal linear forms of approach. It used to be that we could follow a fairly simple path to arrive at an economic conclusion: A better product or a more efficient company meant more productivity, which meant a higher standard of living for all. But today, things aren't so simple. How can we say that economic growth in China or India is a good thing if it increases global pollution or leads to food scarcity? How can we say that increased access to mortgage financing is a good thing if it entices subprime borrowers to buy houses they can't afford to pay for, leading to failing banks in Europe and the United States, stock market crashes in Asia, and a worldwide credit crisis?

With hundreds of billions of dollars worth of mortgage-backed securities being traded annually, the market for subprime debt became, at one point, bigger than the entire market for U.S. Treasury bonds-the biggest bond market in the world. When banks and mortgage companies realized they could pass on the risk of the mortgages they were issuing, they became more concerned about increasing volume and less concerned about whether the borrowers could pay back their loans. Consequently, credit standards were relaxed and many poor and low-income borrowers were given mortgages to buy homes-leading to ever-increasing home prices. Many borrowers bought homes they knew they couldn't afford, but assumed that rising home prices would cover their loan commitments, allowing them to refinance at a later date, once the house's value had gone up.

When the housing market began to cool, many subprime borrowers were unable to refinance their loans and were unable to make the interest payments on their original loans. Delinquencies-borrowers' failure to make their mortgage payments-began to rise, and the value of the bonds that were based on subprime mortgages began to decline. When large numbers of these subprime borrowers started going bankrupt, the subprime mortgage securities had to be revalued downward.

In the end, the banks and investment houses around the world that had bought these mortgage-backed securities were forced to write off large portions of their debt-up to 80 percent of their original value in some cases-leading to a credit crisis that spread around the world as other banks and investment houses refused to provide the cash that the world's companies and financial institutions need to keep running. Banks around the world had to be rescued by cash-strapped governments. In the United States, Lehman Brothers, one of the largest investment banks in the country, was forced into bankruptcy, and another investment bank, Bear Stearns, had to be sold off with help from the U.S. Federal Reserve-for a fraction of its previous value. AIG, the largest insurance company in the world, also had to be bailed out by the Federal Reserve. Once the financial meltdown had started it was impossible to stop.

In addition to financial meltdowns, even cataclysmic events such as hurricanes and global warming are influenced by the expanding 21st-century economy, which is bringing forces to bear that are making it impossible to predict what will happen in the future. For example, the destruction of the Amazon rain forest, primarily for economic reasons, has led to a sharp increase in the release of carbon dioxide into the atmosphere. And industrial pollution in the United States, Europe, and China has contributed to the shrinking of the Arctic ice cap and an unprecedented melting of the permafrost, releasing even more carbon dioxide and methane gas into the atmosphere, leading to even more global warming. This greenhouse effect has led to ever higher temperatures-literally a “meltdown” in some parts of the world. And no one seems to know where it will all end.

Even efforts to reduce global warming, such as the promotion of biofuels, have led to unintended and unforeseen consequences. In addition to the use of massive amounts of water to produce sugar-or corn-based biofuels, the reduction of farmland for the production of food for human consumption led to rising shortages of rice, corn, and wheat on the world markets, resulting in riots in some countries and calls for increased protectionism in others.

The converging global economy is also shaking up traditional patterns of trade and investing. Before the 21st century, for example, people tended to limit their investments to purchases of domestic stocks and bonds. They then waited patiently for their investments to increase in value or provide a safe, fixed income over time. But in today's fusion economy, our money is being invested-whether we're aware of it or not-in pension funds, governments, and banks that buy an increasingly complex array of securities and investment vehicles.

The 21st-century economy has brought strange new correlations between investors and between markets. And the results can be catastrophic. Investors who are losing money in one sector tend to sell investments in another sector-or another part of the world-to pay their debts. When stocks fall sharply in the United States and Europe, for example, emerging-market funds from Brazil to Bangladesh can decline sharply as investors sell their shares abroad in order to raise cash to pay for losses at home. Currencies in previously healthy economies around the world often crash as speculators rush to safe haven currencies such as dollars and yen.

It has been said that a butterfly flapping its wings over Tokyo could cause a rainstorm over New York's Central Park several days later. The 21st-century economy has taken this linear correlation to another level. Causes and effects are converging, fusing together in a complex web that no one-not even the experts-are able to fully understand. Just as Metcalfe's Law, which says that the value of a network is proportional to the square of the number of its users, the expanding global economy is growing and expanding in ways we are unable to control.

And the speed of change is increasing exponentially. In today's modern economy, events have an almost immediate effect. If stocks fall sharply in China, markets around the world plunge instantly. Political events, such as an assassination or an unexpected election result-or even random events such as earthquakes or terrorist attacks-can cause the “invisible hand” of the marketplace to buy or sell precipitiously.

Like the aforementioned butterfly flapping its wings over Tokyo, even small investment decisions can affect the global marketplace. With China holding more than a trillion dollars of U.S. government securities, any sign that the dollar could lose value in the years ahead-a decision by the U.S. Federal Reserve to lower interest rates, for example, or a move in Congress to force China to revalue its currency-may set in motion political and economic changes that could end up dethroning the dollar as the world's preferred reserve currency.

At the beginning of the 21st century, the euro had already begun supplanting the dollar as the world's currency of choice-there are now more euro notes and coins in circulation than dollars. And the international bond markets have begun issuing more euro-denominated securities than dollar-denominated securities. Many countries are now accounting for their purchases and sales of commodities and other goods on the international marketplace in euros instead of the almighty greenback-leading to an eventual decline in value of the dollar as countries sell the U.S. currency to buy others to use in the global marketplace.

In many ways, old paradigms have become obsolete and a new world order has been established. Asia's export boom at the beginning of the 21st century, for example, was mainly based on sales of products to U.S. consumers. Without them, it was assumed, the booming Asian economies would slow, engendering economic and political turmoil. In order to keep the U.S. economy afloat-and in part to ensure the safety of the foreign reserves sitting in Asian central banks' vaults-Asian nations became the United States' biggest creditor.

Trillions of dollars of U.S. government securities have been sold to mercantilist Asian and oil-rich Middle East nations, allowing the United States to fund its huge budget and trade deficits. The decision by foreign investment funds and central banks to subsidize the U.S. economy-providing the credit to fuel the U.S. housing bubble, leading eventually to a worldwide financial meltdown affecting even the cash-rich economies in Asia and the Middle East-shows how much the balance of power has shifted and how interconnected the world has become.

In one of the biggest economic revolutions in history, the expanding 21st-century economy has begun shifting power from the developed world to the developing world-with Brazil, Russia, India, and China, the so-called BRIC countries, leading the way. Adjusting for purchasing power, the economies of the emerging markets have surpassed the economic output of the developed world. Their economic machine is already consuming over half of the world's energy, and they have been responsible for 80 percent of the increase in oil consumption during the first years of the 21st century. The export-oriented powerhouses of the developing world have been able to acquire more than three-quarters of the world's foreign currency reserves and increase the stock market valuations of their companies enormously. This led fund managers to invest even more money in the emerging markets, leading to even more growth and even more consumption of the world's resources.

Where will it all end? With economic and political events occurring around the world at a dizzying pace-from credit meltdowns to terrorist attacks-the ability of any one country to control or significantly influence the maelstrom of forces buffeting the economic landscape will be increasingly limited in the years to come.

WHAT IS MACROECONOMICS?

Economics is an art as much as it is a science. And economics in the 21st century, the art form and the science, is being transformed significantly. It used to be that economists limited themselves to looking at the behavior of governments, firms, and individuals in a carefully defined framework. Inflation, unemployment, and interest rates-the traditional components of macroeconomics-were the main areas of interest, with very little else occupying the limelight.

Now there is a whole new horde of players clamoring to be center stage. Hedge funds, subprime mortgage securities, black markets, outsourcing, pollution rights, and carbon footprints are just as much a part of the world economy as the behavior of firms and individuals when interest rates rise or fall or when taxes are slashed.


The study of the global economy is essentially a macroeconomic survey, but there is a constant interplay between the world at large and the role we all play in it. When we go to the store and buy foreign-grown bananas, fill up our gas tank with imported oil, or watch a foreign-made music video on TV or on the Web, we're participating in the world economy. And it is not only as consumers of imported goods or services that we are part of the world economy. The money that our pension funds or college endowments invest in foreign markets helps pay for our retirement or for a new dormitory on campus. In fact, foreign investment in our home economy-and foreign purchases of our government debt-provide needed capital and jobs, making our lives better.

Unfortunately, it's not just the legal activities that make up the new 21st-century global economy. If we buy drugs-or if we join in the fight against illegal drugs by helping Latin American farmers substitute food crops for coca-we are also participating in the world of international trade and finance. Even economic sanctions against foreign regimes that abuse human rights or destroy the environment make us part of the world economy. Basically, buying anything that crosses an international border, from an illegal music download to imported hashish, integrates us into the ever-expanding global economy.

How do we size up a country's economy? Mainly, by putting a value on every good and service produced in an economy. Gross domestic product (GDP) and gross national product (GNP) are the terms economists use to describe the total amount of goods and services produced by a country in any given year.

Sometimes GNP is bigger than GDP and sometimes it's the other way around. Countries like Ireland, which have a large portion of domestic companies in foreigners' hands, have a smaller GNP than GDP because the payments to foreign stockholders are deducted from the GDP figures. On the other hand, British, U.S., and Swiss residents own a lot of companies abroad, so their GNP is usually larger than their GDP because it includes income from foreign production that is not included in the “domestic” summary.

How do you compare GDP among countries with different currencies? One way is to translate the various figures into a common currency, such as the U.S. dollar.

Unfortunately, official exchange rates give a skewed view of the size of a country's economy if the cost of goods and services isn't the same in every country. In India and China, for example, everything from meat to movie tickets is much cheaper than in wealthier countries like the United States and France-so the GDP often ends up looking much smaller than it really is. That is why economists have come up with a “real-world” exchange rate called purchasing power parity, or PPP. This is arrived at by using a basket of goods and services in each country that allows GDP to be compared across borders.

The way it works is simple: One country, such as the United States, is chosen as the base country. The GDP of the other countries is adjusted to take into account the comparable “real” value of the goods and services that make up the country's economy and not what the exchange rates provide. The cheap cost of haircuts or shoes in China, for example, would be adjusted upward to give them equivalent value to the haircuts and shoes in the United States. The “basket” of goods and services that is used to determine purchasing power parity includes a wide variety of everyday items such as rent, food, and transportation.


From the Trade Paperback edition.