KH: I was in Montreal for a conference last week, landed in time for the coldest temperature in years. But the snow and the ice on the trees were pretty. Since I got back, it seems that the political climate is warming up in France. The Greeks have a responsive audience here. Everyone says there will be a big fight with Sarkozy in the spring. In the meantime, people have seized on his attempt to remove commercial ads from the public television stations. It’s funny really, the left combining for the right of public TV to sell advertising; but they see it rightly as Sarkozy paying off his chums in the private channels and weakening the revenue base of the public alternative. The whole mechanism of the decision has been exposed to view and the pretense of due procedure gets more ridiculous by the day.

AA: You mean people are going to take to the streets like the Greeks?

KH: Well, one scenario is that the railway men will strike and this will provoke a general strike, with or against the railway men. A passenger in Lyon tried to strangle a SNCF employee last night. Tempers are short. The universities are a powder keg, they have been messed about so much. The professors in some places have refused to hand in marks to the administration, while giving them to the students. Obviously they want the students out on the streets. I think the government knows this; certainly they have shown signs of caving in recently. We probably have the Greek to thank for that.

AA: It’s curious that the markets are bidding up the euro these days. It can’t be that they underestimate the weakness of the European economy. The Germans are going their own way, trading insults with the English. Not much solidarity there. Maybe they feel they gain by maximizing the volatility in exchange rates. This month it’s taking down the pound, after new year it will be the euro. Or are they really stupid enough to see nothing but the figures flashing before their eyes in a given moment?

KH: I always thought that the best way would be to keep a hard euro and let each country float its own politically managed currency. But to reverse Maastricht in that way would take so many deliberations that individual countries will seek their own solutions before it happens, like introducing exchange rate controls. I guess it would also destroy the illusion that Europe could achieve political union through adopting a single currency.

AA: How are you getting on as an international currency dealer?

KH: You’re joking, but I’ve been watching my small portfolio of currencies very closely. I got as much as I could out of sterling, ran down my euro holdings and parked it all in yen and dollars at the beginning of November. The pound has held steady against these in the last two weeks, but it lost 8 centimes against the euro in that time. Already the strong dollar and yen is showing up as reduced exports; and of course there is no knowing what the Fed’s latest monetary policy will do for the exchange rate.

AA: There are only two routes out of such a large credit bubble: hyperinflation and war. It looks like the USA is ready for either or both. Now that the Fed has taken interest rates down to near zero, the only tool it has left is to print money. And I guess you have noticed the warmongering noises over Pakistan. Brown goes out there to say that 75% of the domestic terror threats originate in Pakistan. Do they have no shame? 75%! Where do you get a figure like that from? It’s no different from saying how many minutes it would take Saddam to land a dirty bomb on London. You say that the European elites are worried about people taking to the streets. How many options do they have other than war? Well, hyperinflation would grab people’s attention too. I hope you have your wheelbarrow handy.

KH: I don’t, but I do have a billion Zimbabwean dollar note. But a case can still be made that deflation is the problem, not inflation. I would have thought you might recognize that now that OPEC has cut back on production and the oil price immediately fell! One thing for sure is that the Bank of England is deliberately running down the pound. They announced this week that they would not commit any Treasury funds to its defence. Between the Scylla and Charydis of inflation and deflation…

AA: We’ll see what happens to the dollar oil price. The chattering classes are talking about an early British election. Brown is morally and politically bankrupt and all the Tories can think of is to ape Angela Merkel as Thatcher’s true reincarnation, the angel of tight money. I tell you, the whole lot deserve to be flushed down the sewer. I would leave London, but my kids are doing well at school here.

KH: Same with me in Paris. The women who teach in the public primary schools here are the best on earth. My kid can’t get enough of it. The obvious route for Britain and France is to market their education systems, but the politicians think nuclear submarines and aerospace are more important. They see education as a threat to themselves and they are right to. If it isn’t that, it’s the immigration threat. Just when Asians are switching to British higher education because of the high dollar and euro, the authorities have introduced even more stringent financial controls over foreign students. We may not harass them so much at airports, like the Americans, but we make the bureaucracy a lot harder.

AA: There is no point in trying to discover the rationality of it all. The western ruling classes are going down and they know it. But, before they do, they are going to put out the lights for the rest of us.

KH: Well, I can see that some could be worried that this is a recycling of the same old Washington elite. Who speaks for the little people in this lot? I guess the answer is Obama himself. He does keep stressing that they are there to do the job he was elected for. He means to change things alright.

AA: Are you telling me he is a revolutionary?

KH: There have been four phases of the American revolution, if not four revolutions: Washington, Lincoln, Roosevelt and Obama. Obama thinks he is Lincoln on a world-scale, not just for the US. That means the modern equivalent of the civil war, a lot of bodies. His ‘security team’ reflects what he learnt from LBJ about pissing from inside and outside the tent. The criticism he is getting from the left reminds me of a hot argument I had with an American student after seeing Forrest Gump together. I liked it, she thought it was dissing everything she believed in. Obama really intends to get beyond the culture wars of the 60s that spawned his mother…and him.

AA: So he’s not a liberal in the standard American sense, despite his voting record as ‘the most liberal’ senator…

KH: I doubt if most American liberals are interested in much beyond what is between their own ears. I was in LA mid-September. The Hollywood liberals were in a panic about how ‘they’ (the Republicans and ‘small town Americans’) were going to steal the prize from them again. I said it was going to be a landslide because I don’t share their class prejudice. The same people are now banging on about how Obama has lost the plot and betrayed them. If he had listened to them instead of sticking to his strategy, he would have lost. They don’t understand about governing from the centre right in order to implement a progressive agenda.

AA: Whatever. The war in Afghanistan/Pakistan/Kashmir is getting a lot hotter after the Mumbai massacre. It’s not quite “the gunshot heard around the world”, but I wonder if the next world war will be traced to this event. You can see the sides lining up already. Obama will go with India, abandoning Pakistan, but to whom? China and Russia? The Chinese are already feeling the economic pinch big time. The Japanese are worried that they may be the target of a nationalist distraction. But the Chinese can’t stay out of a Himalayas conflict, given their commitment to holding on to Tibet. So how about the US (with Britain as bag-carrier), a few Europeans, India and Japan as an Alliance for Democracy against the revived threat of the two Evil Empires and Muslim terror (that is, all of us, especially the Saudis who bankroll this stuff)?

KH: It’s hard to know about the Europeans. I see that they are going cool on getting Ukraine into NATO, forcing the Ukrainians to cosy up to the Russians again. One minute they are talking about reducing energy dependence on Russia, the next they are trying to make a deal. Putin doesn’t have a lot of room for manoeuvre with low commodity prices and an antiquated army. It’s fun to watch the oligarchs feeling the pinch. Abramovich is cutting costs at Chelsea, the poor dears. The world is turning upside down so quickly. I find it interesting how the different European countries are reverting to national type in this crisis. Angela Merkel refuses to have anything to do with the ‘financial stimulus’ packages being promoted in the US, France and Britain, preferring to stick with thrift and the traditional virtue of belt-tightening. The British Tories the same. The battle lines are hardening between what Krugman calls the advocates for ‘fiscal expansion’ and the ‘deficit hawks’. The line goes right down the middle of Europe.

AA: Time for another Orwell. Do you remember the lineup in 1984? Three power blocs: Eurasia (the Soviet Union and Europe), Eastasia (China and Japan) and Oceania (the Americas, Britain, Southern Africa and Australasia) fighting over a quadrilateral stretching from the Mediterranean and West-Central Africa through the Middle East to South Asia?

KH: Yes. It would be interesting to update that sketch. The main difference would be the weakening of Greater Europe and the rise of India. But then it has always been hard for the West to treat India seriously. I suppose British propaganda made them out to be pathetic, not to mention the original home of inequality. I have been watching the shift of power from Britain back to India for some time. The leadership of the Commonwealth, for instance. But the most glaring example is cricket, the Victorian symbol of how to reconcile democracy with empire. Suddenly the Indians are calling the shots worldwide. And what could be more pathetic than the England team running home for safety after losing all their games? Whether they go back again for the remaining test matches seems to be a matter of personal choice for each cricketer. Thomas Arnold’s team spirit it certainly ain’t.

AA: Remind me to look up ‘cricket’ in Wikipedia some time. I’m more concerned about them blaming us for financing the jihadists.

KH: Well, don’t you? OK, we’ll leave it for now. Another cup of tea?

AA: No, we can hardly expect anything else with the world economy heading for the next Great Deflation, if it isn’t already there. I just spent a week in Riyadh. You know, the world looks different from there — four or five hours flying time from London, Moscow, Nairobi and Mumbai. America seems almost as far away as Australia. It feels like the centre of the world, now that the North Atlantic is losing its grip over the rest of us.

KH: So that makes you sad?

AA: No, not in itself. It’s just that I can’t see the transfer of power eastwards being peaceful. The Americans have launched their new Africa military command from the Sahara to the Horn and Bush has turned Somalia into an inferno. The pirates hijacked a Saudi tanker and the Indian navy is steaming in, the Europeans want to send gunships to keep the Suez/Aden route open… They just blew up a village in order to claim the scalp of a terrorist born in Birmingham. Pakistan is a mess, the Taliban control Peshawar. And we are not even talking about the sixty nukes yet; but I did read Global Trends 2025,  put out by the ‘National Intelligence Council’. It has headlines like “The potential for conflict will increase owing partly to political turbulence in parts of the greater Middle East”; and we know where that is, Afghanistan/Pakistan, a place that just happens to have Russia, India and China as neighbours, not to mention the Islamic world. Langley is zeroing in on Obama’s top priority and the rest of us had better take cover.

KH: It’s funny you should say that, because I just posted my latest essay, where I reflect on Polanyi’s relevance as a prophet for these times. I got to thinking about the parallels between the last three decades and the similar period of financial capitalism that ended in 1914. By now everyone is drawing the parallel with the Great Depression of the 30s, but what if the end of the prewar boom in 1913 is a better analogy? That would mean a replay of the ‘Second thirty years war’ of 1914-45, the worst time ever, until the world picked itself up and tried serious improvement after 1945.

AA: That’s not a bad idea. When Roosevelt came in, the US economy was down on its knees to a level that is impossible to imagine now. But it wouldn’t take much to spark another military conflagration these days. The fact is that Obama wants it. He knows that the US has to get actively engaged at the crossroads of Asia and that the Gulf will be a sideshow. Oil is so twentieth century. All those lefties (including his own campaign team) complaining about Hillary becoming Secretary of State don’t get it. He’s a hawk. I wouldn’t be surprised if he reintroduces the draft very soon. He’ll have to call its something else, of course, maybe international community service…

KH: Pity that ‘The Peace Corps’ is already taken. Do you know that story about William James having a recurrent dream of the end of the world that he couldn’t remember when he woke up? So he put a pencil and paper on the bedside table for the next time and wrote something down before falling asleep again. In the morning, it read “The Smell of Gasoline”. But I think you are wrong about Obama. The guys who write to nettime are obsessed with the notion that he’s just raring to go, can’t wait to bomb women and children in Third World villages. But that is because they don’t want to abandon the anti-American politics of a lifetime. I am more inclined to the line I heard from a Swiss friend last weekend: “People everywhere can’t help but be affected by Obama’s election”. The world has changed and Obama would be crazy to spend all that good will by invading Pakistan.

AA: Well, when he does launch his imperialist war, he won’t have to watch his back in the black ghettos this time round. I am sure the Pentagon is grateful to know that Michelle and the girls are insurance against inner city riots the next time the poor get hauled off to war.

KH: You’re just bitter because he’s serious about green economics and wants to make the US independent of Gulf oil.

AA: Not at all. We are just rentier capitalists now. We know that the black stuff will get a good price whenever we suck it up. Our main priority is to invest the money we already have. I care more about Obama making the wrong call on the financial bailout than about whether he can force GM to build green cars. I am talking about the fact that, when the balloon goes up, it will be in my region and good Muslims will die — the old, women and children. God knows what the Israelis will use the opportunity of a general war for… It means that the military will be in the driving seat again and us commercial types will just have to watch. Have you not seen all the articles reminding us that FDR didn’t sort out the Great Depression? It took the second world war to do that.

AA: India, Brazil and South Africa. You’ve heard of IBSA? We are looking to invest in South-South economic co-operation. I’ll tell you about it some time. So why are you so keen on a US election post-mortem?

KH: Well, I wanted to tell you that I won my bet. In the summer I put a thousand pounds with a London bookmaker at 5-1 on an Obama win by more than 150 electoral votes. It ended up with me wanting one of the last three states to declare — North Carolina, Indiana and Missouri. He won two of them and I was well clear.

AA: Why were you so sure he would win by a landslide?

KH: First, I think any Democrat would have beaten the Republicans big after eight years of Bush. The mid-term elections of 2006 showed that the tide had turned. It’s a simple matter of jobs, housing, the war, health, education, the greedy and uncaring rich. Unlike many American liberals, I actually believe in the good sense of most Americans. Then I appreciated the power of Obama’s machine for getting out the vote, the first really to take advantage of the internet; and his political team hardly put a foot wrong. I have been studying American politics for half a century now and I knew that the narrow Bush wins of 2000 and 2004 were exceptional. The electoral college system exaggerates differences in the popular vote: thus Obama won by a bit more than 5% of the vote, rather less than his lead in the tracking polls, but his electoral college margin is almost 200.

AA: So what are you going to do with the money?

KH: Go on a holiday with my family, maybe Spain, I’ve never been there and I always fancied Andalusia. But it’s never been about the money for me. I started betting on the horses when I was 12 years old and I financed my time at university that way. Now I think that it was all training to be a seer, an oracle, a prophet. I love second-guessing the future. In fact, I’ve been playing at writing a novel for years. It’s called “Futures”, a pastiche of the western novel — I call it a science fiction murder mystery, featuring elements of Cervantes, Goethe’s Faust, Mann’s ‘Magic Mountain’, Gibbon’s ‘Decline and Fall’ and Star Trek. Don’t ask me to summarize the plot… I’ve never been happier than during this economic catastrophe because it allows me to be a prophet. I have always been interested in Karl Polanyi’s ‘The Great Transformation’ as a work of prophecy that failed, since he didn’t foresee the postwar economic revival under US leadership. I’m giving a talk at a Montreal conference on Polanyi this December. I came up with the title long ago — “Economic revolutions are always monetary (Mauss). Karl Polanyi and the breakdown of the neoliberal world economy”. People write to me asking how I knew. But I’ve been waiting for this crash since 2004. The similarities with the 30s and what led up to it are so strong that Polanyi could be in for a big revival and I want to be part of that. I (almost) share a birthday with John the Baptist. I fancy being a warm-up act for the big-time politician. Maybe there was something of that in my bet on Obama.

AA: Well, the only crystal ball-gazing I was doing on election night was figuring out how to offload a bunch of sterling that came up when I found a buyer for a property in London’s West End. I put it all immediately into dollars and yen. I made 11% on the yen in ten days and 7.5% on the dollars. We are in for a rough ride on the currency exchange markets, especially now that the G-20 failed to come up with anything substantial to stabilize exchange rates. It’s funny how the media identify the Bretton Woods institutions with Keynes, when the IMF and World Bank were not his idea.

KH: Have you been following the political row about George Osborne talking down the pound?

AA: Yes, I can’t believe it. I read three articles yesterday and today. First Will Hutton says we have to join the euro since it’s the only viable reserve currency with the dollar and the UK is a ‘small country’ (like Iceland or Ireland). Then Anatole Kaletsky says the opposite and, when sterling gained a cent early today, they all piled in to say that Osborne is useless.

KH: For what it’s worth, I think Kaletsky is right. When I came to live in Paris over a decade ago, I wanted very much for Britain to join the euro, if only to minimize exchange transaction costs, but also because the idea of European union was attractive then. But when Blair and Brown stayed out, for whatever reason, it eventually dawned on me that they had stumbled onto a better alternative. No-one in Britain, especially businesses or tourists, has any problem using euros; but the continuing existence of sterling gives them two currencies to manipulate rather than just one. Maastricht was a huge mistake, insisting on countries replacing their national currency with the euro. They should have followed the route once advocated by the Tories, a hard ecu run by a European Central Bank along the lines of the Bundesbank and politically managed currencies floating alongside it to find their own level.

AA: Yes, Brown would be crazy to join the euro now and get mired in the political collapse of the European Union. While I was visiting the South, we talked a lot about which parts of the world are most vulnerable at this time and the Indians and the Brazilians all picked Europe for the big fall. The South Africans, black and white, are different. They still haven’t weaned themselves from the old idea that they are an offshoot of western imperialism with closer connection to the North Atlantic than to anywhere nearer home.

KH: What do you mean, Europe is for the jump?

AA: Look at them all. They are worried sick about their precious little national sovereignty. They are growing old and they hate the young foreigners who come to do the work that pays for their pensions. They have depended on American muscle for so long, they have forgotten how to fight. They can’t fix a constitution to organize their economic union. They are going down, no question about it. I doubt if the euro will survive much longer. They will never agree on a common strategy. The only good thing about recent events is that the strong dollar has saved Europe from an overvalued exchange rate.

KH: So it looks as if sterling could make a comeback quite soon, if the euro becomes shaky and British exports can take advantage of the 30% devaluation. I read today that Asian students are already signing up in droves for British universities because of the relative price when compared with the US. We shouldn’t forget that services are still the fastest-growing sector of the world economy.

AA: So I guess Europe could get some benefit for tourism if they join the raise to the bottom of the currency charts.

AA: Yes, having a lot of spare cash in the Great Deflation is terrific for PR. We’ve been putting it around that we can help the Brits go green, some of our neighbours have bought a chunk of Barclays. It’s all go.

KH: Just run that thing about deflation past me again.

AA: In an inflation cash loses its value, but in a deflation, there’s not much money around, so prices fall and anyone who has cash can pick up stuff cheap. The people with cash right now are the exporters to the US, in particular Japan, China and countries like Korea. In order to keep the market for manufactures going, they paid for the US current account deficit by transferring their surpluses into T-bills, US Treasury paper, even though the fall of the dollar made that look unprofitable for a time. The oil exporters made huge windfall gains from the price rise this year and a lot of the money went the same way. Of course we have been looking for other outlets, like the euro, and we even floated the idea of an Islamic gold dinar. But, after the collapse of real estate and then the stock market, everyone rushed into dollars and US bonds. With all titles to property going South (houses, shares and now commodity futures too), this puts us and the other net exporters in pole position to call the shots in the next stage.

KH: So what do you think will be the response to Brown’s initiative?

AA: All the Gulf states have a long-term policy of trying to replace dependence on oil over the next 20 or 30 years. This means buying into blue-chip companies that we hope are going to last. Now the Europeans are worried that the West just doesn’t have the cash reserves to cope with the collapse of Eastern Europe and some of the other ‘emerging markets’ to which they are overexposed. The IMF has $250 billions in the kitty, which is peanuts compared with all that worthless paper out there, trillions of CDOs and CDSs. Brown has basically said that we and the Chinese have to come to the rescue. But that is a bit rich when the Americans and the Europeans have stitched up control of the Bretton Woods institutions between them. If they want our money, we will demand a new deal when it comes to voting rights on the IMF, World Bank and the rest. The Chinese are going to play harder ball than us because they have a real economy and we just have the western oil companies and a lot of sand. So we are going to talk nice, say we want to save the planet from global warming and all that.

KH: Barclays got a lot of stick for taking that Gulf money instead of the British government’s. Vince Cable said it was a rip-off (like the bonus payouts from the nationalized banks): they got a better deal than the existing shareholders and certainly better than what the British taxpayers would have. Why do you think they went that route?

AA: Because they still think they can come out of this mess as a fancy investment bank, rather than a semi-nationalized company with the newspapers making a fuss about bonuses and high salaries. That’s why they took a look at Lehman Bros and picked up some of the fire sale afterwards. Of course, with the shirt off their backs, they had to make some concessions.

KH: Did you see that one of the consortium that bought into Barclays was the guy from Abu Dhabi who bought Manchester City? Surely that can’t be represented as investment? The English premier league is massively indebted and footballers salaries have been one of the main beneficiaries of the credit bubble. Maybe he thinks he will soon be able to pick up some cut-price stars. But it still looks more like consumption to me.

AA: It’s all part of the same strategy: buying banks, football clubs, going green. We are moving in on the British economy at several levels. We need to get people used to the idea that New Labour turned it into a glorified hedge fund and, now that the hedge fund is broke, new owners are knocking on the door. It’s a mistake to distinguish too sharply between hard profits and soft symbolism.

KH: It’s curious how Brown has become a hero in New York and Washington, when he supervised the demise of the British economy. The Guardian’s Larry Elliott had a superb swipe at the whole pretension in an article on the economy as mutton dressed as lamb. I can’t resist quoting the opening paragraph: “Repossessions up 71%. Activity in the high street down for the seventh month in a row. Short-term working at Honda’s Swindon plant. An estimate by the Bank of England that losses from the financial turmoil now stand at $2.8 trillion. Just another normal day in the economy.” It takes some chutzpah for Gordon Brown to swan around the world as a saviour, when he didn’t see any of this coming.

AA: Did you see that interview with the FT’s Gillian Tett? They are talking her up as a prophet because she predicted a crash two years ago.

KH: I predicted one four years ago, but it didn’t do me much good. When the boom kept roaring ahead, I lost my nerve and put half my cash from selling two houses into mutual funds. It’s all about timing or, as the man said, “In the long run we are all dead”. I taught Gillian a bit at Cambridge. She did a PhD in social anthropology. Smart woman.

AA: Yes, there’s a lot of that in the interview. She claims she beat the City boys to the draw because they were all stuck in their little groove and she had been taught to put it all together. Nice plug for your discipline, eh?

AA: Well, now we know that the world economy is going through a deep deflation, it would be crazy to do otherwise. I hope you noticed that we didn’t propose any cuts when the oil price started falling a month ago. That’s because we knew the commodities boom was an investor-driven bubble, successor to the dot com boom and  Greenspan’s housing bubble. Oil, gold, wheat — it was all hot money. I laughed when I read those newspaper reports about how increased demand in China and India had pushed these things to a new level of scarcity. Oil going to $200, global starvation, gold replacing the dollar, that sort of thing. The hedge funds took a ride on the bull market for commodities and look what has happened to them. But now is different. The money has gone up in smoke and the markets are starved of cash, not to mention credit. So how much oil are people going to be able to buy? The price will go through the floor unless we cut back production. It could go through the floor, as it is.

KH: The Norwegians say they are not going to cut back. I wonder why? It’s not as if they need the money. Or maybe it’s because all the money from the oil surplus that they put into their ‘national pension fund’ has just been blown on Wall Street. The S & P 500 lost 23% in the last month. Perhaps they want to get the stuff out of the ground while there’s still a market for oil.

AA: OPEC is trying to get Russia on board, but they could probably use as much hard currency as they can get, what with the implosion of their banks and stock market. They have the second or third highest currency reserves in the world, but Putin can’t be feeling comfortable enough to play hardball, right now. Funny, isn’t it, that just a short time ago, everyone was talking about the Axis of Diesel — Russia, Iran and Venezuela, the oil powers who stood against the US and were bound to be strengthened by the inexorable rise in the price of fuel. Chavez got it right when the price was in the $50s range and rising. He offered long-term contracts at $70 a barrel. I wonder if he got any takers? I bet he would grab that price now.

KH: Apart from Russia, I read that the most vulnerable economies in the world today are many of the countries formed after the break-up of the Soviet Empire, places like Kazakhstan and Bulgaria. They are in the same boat as Iceland, small countries who bought the idea that they could play the emerging market game, even when they had no internal economic backing for it. Apparently the worst hit is Hungary. They suspended trading there for four days last week.

AA: The problem is that they took out lots of hard currency loans. Not just the government and firms, but ordinary households for mortgages and the like. Japanese yen and Swiss francs were the currencies of choice, I believe. Now they have no way of finding that money. The story of what happened to the former communist bloc is one of the great tragedies of our time. Of course, we were all delighted that they got out from under the Stalinist jackboot. But look what happened when they did. They ran into neoliberalism in its full pomp: all they had to do was privatise everything and encourage the free flow of international capital. The gangsters bought up whatever was going and now, just when some of them had got up off their knees and were thinking they had an economic future, puff!

KH: I still don’t get why the Europeans haven’t woken up to the depth of the crisis on their own doorstep. A bunch of these countries are now in the EU. Ambrose Evans-Pritchard wrote an incendiary article today about the prospects for a European currency meltdown. It looks as if the second epicentre of the crisis will be Europe because their banks are much more exposed to emerging markets than the Americans and the Japanese. Austria is the most exposed and could trigger the European bank collapse, just as it did in 1931 with the failure of Credit-Anstalt. But I don’t get any sense of urgency about what the economic crisis will mean for Western Europe. It’s like they have grown so used to thinking of neoliberalism as an Anglo-Saxon disease, they don’t think it can happen to them. What happens to Germany, for example, now that, instead of being the natural centre for a strongly integrated European economy, it is neighbour to an economic disaster? They already took the biggest hit from the collapse of the Iceland banking system.

AA: Isn’t Ambrose the son of the godfather of your discipline in Britain?

KH: Yes, small world, isn’t it? He has a lot of beefs against Europe, so he’s prone to see the downside there. But I think he is right with this one. That’s why I’m as fast out of euros as I can.

AA: Talking about disaster, do you remember when, three years ago, the FT described the British economy as nothing more than a glorified hedge fund? Well, the hedge fund has well and truly tanked now. Sterling has already lost 27%, more than at any time since 1967, including Black Wednesday in 1992. One thing to be said for neoliberalism is that it is very easy to get your money in and out of currencies these days. My daughter asked me in January what my prediction was for the new year. She was impressed that I stopped her from buying a house in LA before the subprime crisis broke in early 2007. So I said, “Sell sterling!”. That put me in her good books even more. My main home is in London, so I need to keep some pounds for local use. But I am glad I got out of sterling and euros into dollars and yen.

KH: I see The People’s Daily has come out with an attack on the dollar to coincide with a meeting of European and Asian governments. The Chinese say the US has exploited the dollar’s hegemony to loot the world and the rest should agree to boycott its use, trading in euros, pounds, yen and yuan instead. They didn’t say how you can do that with yuan when it isn’t convertible on the capital account. But you can see how they would be mightily peeved at so much of their US investments getting blown away.

AA: I don’t think the Europeans and the Japanese are going to boycott the dollar when so many of their investors have fled into US T-bonds out of the stock market. There was a time recently when the yields on treasury paper were negative, there were so many buyers trying to get in. In any case the Japanese are sitting pretty with over half of the outstanding value of US Treasury bonds. If in a great deflation cash is king, the Japanese will be able to buy everything up in the fire sale that starts soon. They began to do that when Mitsubishi put $9.5 billion into Morgan Stanley. That’s one of the reasons why I think the yen could be a major reserve currency. The Chinese have a lot of US bonds too of course, less than the Japanese. But what they are worried about is losing the market for their cheap manufactures and they hope to set up an anti-US cartel. I doubt if it will come off, especially when Obama turns up in January as the world’s new great hope!

KH: I’m supposed to getting my lump sum for retirement soon, but it’s in sterling and I’ve already lost a big chunk of it. Mervyn King, the Governor of the Bank of England, got a lot of stick for saying the UK was going into recession (only a few days before the figures were published!) and the markets took sterling down as a result.

AA: Well, think about what happened in the Great Depression. Countries went in for competitive devaluations in order to grab a share of a shrinking world market; and that was what pushed the global economy over the cliff. If we look at this crisis in the long run, the first big devaluation was the long decline of the dollar under Bush/Cheney. It is now recovering rapidly, actually the fastest move in exchange rates since the Bretton Woods system went down in 1971. Then sterling followed over a rather shorter period and it looks as if the euro could be next. As long as everyone else doesn’t devalue, this has got to encourage a shift back from financial services to export production in each of these currency areas. It’s already happened in the US. So maybe King was encouraging a devaluation for that reason. Remember not long ago — it seems an age now — when the dollar/euro exchange rate was $1.70 and people were talking about $2 soon? At that sort of level, Europe’s aerospace, nuclear and other heavy export industries would have been priced out of the world market. I couldn’t see Sarkozy putting up with that. So there is an upside to devaluation. The people who lose are the bankers who just trade money for money and get stuck with a currency nobody wants.

KH: Maybe I will write an article, Deflation: what is there to like (if you are not already rich)? Talking of which, what’s been happening to gold? I thought that everyone was supposed to rush into gold in a deflation, but gold stocks and futures have lost 16% in the last month.

AA: It’s what I was saying about the commodities bubble being the last dying gasp of the credit boom. People are still buying physical gold in Asia. You can’t find bullion anywhere. But a lot of the gold price came from the same investors who pushed up oil. Gold went from $250 in April 2001 to over $1000 in March 2008. Some of that was Asians getting a bit richer and saving the stuff; some of it was the gold bugs looking for an escape from paper money; but a lot of it was just speculation. Imagine what losing a sixth of its value in a month will do for the imagine of gold as the ultimate safe haven!

AA: I’m with Warren Buffet. I love that guy. Did you see his oped piece in the New York Times today, ‘Buy American. I am‘? It’s not just that I agree with his prediction that US stocks are going to bounce back soon, he has discovered a mother lode of pithy sayings: Be fearful when others are greedy, and be greedy when others are fearful. If you wait for the robins, spring will be over. Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.” I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” On top of which, he has such a good grasp of the economic history of the twentieth century. Maybe if Obama is going to be the next FDR, Buffet can do the fireside chats. He’d be wonderful at it. That way, he can be his own self-fulfilling prophecy, just like he always has been.

KH: I came across his Berkshire Hathaway annual report for 2002 not long ago. It’s got a sensational expose of derivatives, written in such clear language. But that’s enough of a puff for Warren B. I wanted to ask you, if you are bullish on America, how you think this economic crisis will affect the balance of power between the leading countries of the world and some of the smaller ones?

AA: Well, let’s start with the BRIC countries. Russia has had a financial meltdown of its own and all those dodgy banks relying on international credit are going to the wall. Putin has fortunately built up huge foreign exchange reserves from the commodities boom, so the state will be able to bail some of them out. But the whole of the former Soviet empire is going to be in deep trouble when the recession bites, since their economies have never known global conditions other than the neoliberal boom. I read somewhere that the Baltic states, Bulgaria and Kazakhstan are particularly vulnerable. None of the Eastern European governments have the resources to do anything comparable to what the major economies have done. But that raises the issue of what the European Union will do for the Eastern countries they let in.

KH: Europe hasn’t come out of all this very well, has it? There has been almost no evidence of political coordination, beyond the occasional press release of Merkel and Sarkozy holding hands and Gordon Brown leering on the fringes of some Brussels meeting. The performance of the common economic institutions, especially of the ECB, has been sluggish and inappropriate. What strikes me, living in Paris, is how slow they have been to recognize that a big slump is coming everywhere. It’s like they believe they were immune to the Anglo-Saxon liberal disease and will escape lightly now. There is no sign yet that the housing markets in France or Switzerland are feeling the effects of the credit crunch, but they surely will. It’s worth pointing out that all the big European countries have conservative governments (and I include New Labour!), without any prospect of electing an alternative soon. How ironic that the Americans are about to elect their most left-wing government since the 30s. So much for Europe’s claim to being the heartland of social democracy.

AA: Before we get into all that again, let’s go back to the other BRIC countries. Brazil has suffered the same kind of stock market crash as elsewhere, but it seems to be in better shape than Russia, because its underlying production, especially in agriculture, is sound and it has depended less on an extractive windfall. The stories coming out of the rest of Latin America are pretty horrendous, though. The big question is how China and India are weathering the storm and I guess we can add Japan. I should say that I have transferred a good chunk of my euros into dollars and yen, partly because I think European monetary union will become more unstable as this thing develops, partly because I like the US’s chances, as I said. Japan is by far the principal owner of US Treasury paper, much larger than the Chinese holdings we hear more about. If the world economy is heading for depression, that means that cash is king and the Japanese have a lot of it they can use to buy up cheap assets, like Mitsubishi’s capital injection into Morgan Stanley this week. Second, they had their financial collapse in the 90s and ought to be more robust now. And they are in the right part of the world if India and China really survive this period as strongly as some people seem to think.

KH: I have always thought that China’s political economy was more likely to come unhinged in a crisis than India’s. But I was in Manchester last weekend, eating in a huge Cantonese restaurant with 90% Chinese clientele. The atmosphere was so cheerful! It was hard not to be infected by the happy noise all around. For a moment I felt that I was witnessing the global revival of China, the optimism that comes from riding a wave to the top. The contrast with European gloom is hard to miss.

AA: Well, I do think that the trend towards Asia as the epicenter of the world economy will be strengthened in the long run and I am pessimistic about Europe’s prospects of finding the energy to respond creatively to the crisis. But the US was already a third of the world economy before and it could end up having an even higher share soon. So European fantasies of American decline are premature, to say the least. China’s manufactures are more vulnerable to a global recession and market fragmentation than India’s internet services. I can’t say I have a clear view of either’s prospects.

KH: We need to talk about Africa and the Middle East.

AA: Next time. More tea?

AA: That reminds me of Keynes’s great piece in Essays in Persuasion (1931) about who wins and who loses as a result of inflation and deflation. In the first case, creditors and people on fixed incomes lose and debtors win; in the second, property holders (shares, real estate) lose and anyone with cash can pick things up cheaply. What is interesting about this crisis is that until very recently the central banks were worried at least as much about inflation as deflation. This was because of the temporary bubble in commodities after the housing market crashed. The Europeans kept interest rates up for too long and now it may be too late. That’s because economic policy has been driven by the banks for three decades and they worry most about inflation. It still seems like the banks are calling the shots. The Wall Street bailout was at first intended just to redeem their bad paper without any consideration of homeowners, for example. Now the story is all about which bank is going to fold next and will they all be nationalised? Krugman has a fairly technical paper where he argues that the issue is one of capital shortage, not liquidity (buying and selling). Several commentators have been saying something similar, that what is needed is a major injection of capital.

KH: Of course that leads us to the people who have the surplus capital, the Asians and the Gulf oil exporters. What are they going to do with the money and how does that bear on shifts in relations between the US, Europe and China? Did you see that piece by Thaksin in the FT, “An Asian bond could save us from the dollar”? Brian Holmes posted it to nettime with a sharp commentary:

“Here is a simple and ingenious scheme which gives you a hint of what may emerge in the future. It involves creating a regional Asian bond as an “offshore dollar” intended at once to prop up the Asian credit markets, help stabilize the American dollar in which all the Asian countries are heavily invested, and slowly displace control over the international reserve currency from Washington to an as-yet inexistent pan-Asian capital market, which the bond would create by its very existence.

“Recall how both the Bretton Woods institutions and the European Community were created as highly technical economic and monetary arrangements whose immense historical significance was hidden, for decades, by a veil of technical complexity. A proposal like Thaksin’s does not say anything about an Asian monetary fund, a common currency, or anything that would shock people with the thought that an immense new financial power is emerging. Yet it would have the same effect. I am not saying Thaksin’s proposal will go anywhere. But just such a proposal could have immense significance. Watch the news for any major innovation in the current structure of Asian economic relations. The future may be hiding exactly there.”

AA: They’re talking about an emergency new G8 to come up with a second Bretton Woods (really the third, if you buy the “Bretton Woods II” argument.) Bretton Woods II is supposed to be the US-China deal after the dot com bust. The story goes that Greenspan was so freaked out at the prospect of Clinton’s trillion dollar budget surpluses creating de facto socialism (a sentiment he openly expressed) that he pushed for the tax cuts with the effect ultimately of placing the US in hock to China, on the understanding that East Asian currencies would be kept artificially low and the dollar artificially high to allow cheap Asian imports to make up for the stagnation or decline in US real wages under Bush. The arrangement couldn’t last forever and is now going up in smoke. Hence the European push to convene the G8, effectively for a Bretton Woods III.

KH: I understand the need for shortcuts when we’re talking about relations between the US, Europe and Asia. But I don’t personally go for the Greenspan as Machiavelli line. The neocons (and that includes Bush, I don’t subscribe to the notion that he and his pals are too dumb) genuinely thought that pushing for capital accumulation and a new military phase of imperialism would establish a US third reich for a thousand years. That included undermining the eurozone where possible (with an overpriced exchange rate) and exchanging treasury paper for Asian imports fuelled by a cheap money housing boom. They have also been printing dollars like there’s no tomorrow for two years now. It was a game of Texas hold ‘em, assuming that the Asians (the Japanese have three times the bonds that the Chinese do) have nowhere else to go but the dollar.

Let’s remember what Bretton Woods was: a meeting between Keynes and Harry Dexter White which White won hands down. OK there were all the other signatories, but this was a US show and the postwar institutions were designed and controlled by the US. I think talk of BW II is fanciful for the US-China deal after 2001. I would imagine that the next round will be US and Asia, not just China, with the Europeans left out. They are too disorganized to count and both the other parties have an interest in sending them to the wall or at least ignoring them. The Middle East sovereign wealth funds have enough cash to get a place at the table. Basically the next round will be based on the US with less control by them. When the rubble has been sorted out, the US will still have a third or more of the world economy and Asian capital still has nowhere else to go. Obama will offer himself as a new deal for the others from a position of strength not weakness. We have yet to see how the Chinese cope with a savage downturn. It will come.

AA: What does it tell you about the future that the non-Western rich want to buy up English football clubs? Thaksin is only banging on about an Asian bond because he lost Manchester City to the Emirates.

The deepening financial crisis of late September 2008 persuaded KH to publish extracts from this conversation as a blog.

KH: George Soros called the present crisis the end of a 60 year cycle of credit expansion. So is this the end of the American empire? The implosion of Wall Street comes on top of giant fiscal and trade deficits, two wars running with no end in sight and a deep neglect of public infrastructure. Now, by taking on massive amounts of debt, the federal government will further reduce the resources which it could use to get things on track. Furthermore, the international institutions which embodied the values of the US — the UN, the Worldbank/IMF — have been severely weakened.

AA: Well, it is certainly the end of Bush’s attempt to control the world by military force and of him, of course. But I think the US economy is better placed to come out of this crisis strongly than its competitors. I recall reading about the replacement of the USA by Germany and Japan in the 80s (Paul Kennedy’s blockbuster, remember him?). There are other perspectives on our moment in history than the one about America’s inevitable and precipitous decline.

KH: Such as?

AA: The restructuring of the financial institutions there is more radical than could be contemplated anywhere else and so far its impact on the real economy has been less than expected. The prospects for the latter have been greatly improved by the dollar’s devaluation; and exports, particularly of internet-related products, where the US is still world leader, are rising strongly. The US took a big hit on housing and finance earlier than elsewhere and might already have absorbed the worst of it. My bet is that the US economy has the best chance of recovering strongly from this crisis. The OECD said so only last week when they revised their growth forecast for the US. The dollar will improve dramatically against the euro.

KH: Yes, in Europe, Britain, Ireland and Spain have been going the same way as the US but with a time lag; and the Eurozone in general has not yet felt the full brunt of the crisis. The euro has not had to survive a massive downturn before and, when it does, the institutional rigidity of the single currency and the political paralysis of the EU will be severe handicaps. Yesterday several financial institutions went to the wall there and this is only the beginning. I can’t imagine the French government abiding by European monetary rules if its large state industries (aerospace, nuclear, trains) need protection.

AA: What may save the euro is a massive devaluation like the dollar’s. When the dust settles after the current drama, I imagine the dollar/euro exchange rate will go down to $1.20 or less. But it will soon become apparent that the EU has no administrative or political basis to manage this crisis and the pressure to do something about the single currency will grow.

KH: I always liked that old Tory idea of the ‘hard ecu’, that Europe should have an inflation-resistant central currency modeled on the Bundesbank and each country could retain its own politically managed currency. Maastricht was a mistake. There is no way you can manage the economy of two dozen countries and even more regions with one currency.

AA: Blair and Brown stumbled into that recipe for Britain by failing to join the euro. British businesses and tourists have the benefit of both the euro and sterling; and this has given the UK a temporary edge in the current economic crisis. The pound’s devaluation has already begun to show up as improved exports. But New Labour colluded in a catastrophic shift in the economy to London and financial services. The FT said three years ago that Britain’s economy had become nothing more than a glorified hedge fund. So the UK’s chances of economic recovery are less than America’s, both in terms of the underlying strength of the US’s real economy and the democratic vitality of its political institutions.

KH: So do you think Obama is going to win?

AA: I made a large bet on him winning by a landslide a year ago, but what has happened this week makes it even more certain. It is not just that Obama and McCain are in a war between the forces for change and the forces of reaction, but that their political methods are similarly placed between the old and the new society: one trying to manipulate the TV news, the other trying to mobilise from the ground up. The announcement that Obama raised $66 millions in August, as opposed to the $84 millions McCain got from the Fed for the whole campaign shows the stakes of this war between methods and social visions.

KH: What interests me is how many of my liberal friends in America (I was in California recently) are still afraid that the Republicans will get in. 80% of Americans say they want something better than they have had and they have already lost a lot in the way of houses, jobs, income equality, education, health and the costs of war. People who think they would vote in a doddering curmudgeon and an untried icon of the religious right prefer their Americans to be stupid and bellicose.

AA: It’s the American people’s intrinsic sense of democracy that prevented Bush and Paulson rolling over Congress with a a proposal out of the Mussolini playbook. I stayed up for the debate last Friday. I thought Obama was so much more impressive than McCain, but the liberal press called it as a tie. Later the polls showed that the audience had a different opinion. It doesn’t pay to underestimate the American people, whatever Mencken said.

KH: Yes, three cheers for Tocqueville! I noticed that the hot money is now going into gold and short-term bonds, while the oil price took a bite yesterday. Where do you think the oil price is going?

AA: Down. To $70 or less. People don’t realise how big a deflation the world economy is entering. When credit dries up after thirty years of unlimited credit expansion, the money to buy commodities becomes scarce. That is why we (the Saudis) will not reduce production in order to keep the oil price up. If the world economy collapses, the demand for oil collapses too. Of course, it is good for us if much lower prices reduce talk about alternative sources of energy.

(To be continued)