How the Economy Was Lost: The War of the Worlds (Counterpunch)

by Roberts, Paul Craig

  Each time the dollar price of oil rises, the U.S. trade deficit rises, requiring more foreign financing of U.S. energy use. Bush has managed to drive the U.S. oil import bill up from $106 billion in 2006 to approximately $500 billion 18 months later—every dollar of which has to be financed by foreigners.

  Without foreign money, the U.S. “superpower” cannot finance its imports or its government’s operation.

  When the oil price rises, Americans, who are increasingly poor, cannot pay their winter heating bills. Thus, the Senate’s military spending bill contains more heating subsidies for America’s growing legion of poor people.

  The rising price of energy drives up the price of producing and transporting all goods, but American incomes are not rising except for the extremely rich.

  The disappearing value of the U.S. dollar, which pushes up oil prices and raises the trade deficit, then pushes up heating subsidies and raises the budget deficit.

  If oil was the reason Bush invaded Iraq, the plan obviously backfired. Oil not merely doubled or tripled in price but quintupled.

  America’s political leaders either have no awareness that Bush’s wars are destroying our country’s economic position and permanently lowering the living standards of Americans or they do not care. John McCain says he can win the war in Iraq in five more years and in the meantime “challenge” Russia and China. Hillary Clinton says she will “obliterate” Iran. Obama can’t make up his mind if he is for war or against it.

  The Bush regime’s inability to pay the bills it is piling up for Americans means that future U.S. governments will cut promised benefits and further impoverish the people. Over a year ago The Nation reported that the Bush regime is shedding veteran costs by attributing consequences of serious war wounds to “personality disorders” in order to deny soldiers promised benefits.

  Previous presidents reduced promised Social Security benefits by taxing the benefits (a tax on a tax) and by rigging the cost of living adjustment to understate inflation. Future presidents will have to seize private pensions in order to make minimal Social Security payments.

  Currently the desperate Bush regime is trying to cut Medicaid health care for the poor and disabled.

  The Republican Party is willing to fund war, but sees everything else as an extravagance. The neoconized war party is destroying the economic prospects of American citizens. Is “war abroad and poverty at home” the Republican campaign slogan for the November election?

  May 23, 2008

  Chapter 27: When It’s a Clear Day and You Can’t See GM

  The prospects of a government rescue for the foundering American automakers dwindled Thursday as Democratic Congressional leaders conceded that they would face potentially insurmountable Republican opposition,” reported the New York Times last Friday.

  Wow! The entire country is steamed up over the Republicans bailing out a bunch of financial crooks who have paid themselves fortunes in bonuses for destroying America’s pensions. Why do Democrats want to protect Republicans from further ignominy by not giving them the opportunity to vote down a bailout for workers? Quick, someone enroll the Democratic Party in Politics 101.

  GM’s divisions in Canada and Germany are asking those governments for help. It will be something if Canada and Germany come through for the American automaker and the American government doesn’t.

  Conservative talking heads are saying GM is a “failed business model” unworthy of a $25 billion bailout. These are the same talking heads who favored pouring $700 billion into a failed financial model.

  The head of the FDIC is trying to get $25 billion—a measly 3.5 percent of the $700 billion for the banksters—with which to refinance the mortgages of 2 million of the banksters’ victims, and Bush’s Secretary of the Treasury Paulson says no. Why aren’t the Democrats all over this, too?

  Apparently, the Democrats still think they are the minority party or else their aim is to supplant the Republicans as the party of the rich.

  Any bailout has its downsides. But if America loses its auto industry, it will lose the suppliers as well and will cease to have a manufacturing sector. For years no-think economists have been writing off America’s manufacturing jobs, while deluding themselves and the public with propaganda about a New Economy based on finance.

  A country that doesn’t make anything doesn’t need a financial sector as there is nothing to finance.

  The financial crisis has had one good effect. It has cured Democratic economists like Robert Reich and Paul Krugman of their fear of budget deficits. During the Reagan years these two economists saw doom in the “Reagan deficits” despite the fact that OECD data showed that the U.S. at that time had one of the lowest ratios of general government debt to GDP in the industrialized world.

  Today Reich and Krugman are unfazed by their recommendations of budget deficits that are many multiples of Reagan’s. Moreover, neither economist has given the slightest thought as to how the massive budget deficit that they recommend can be financed.

  Both recommend large public spending programs. Krugman puts a price tag of $600 billion on his program. If it takes $700 billion to save the banks and only $600 billion to save the economy, it sounds like a good deal. But this $600 billion is on top of the $700 billion for the banks, the $200 billion for Fannie Mae and Freddie Mac, and the $185 billion for AIG. These figures add to $1.685 trillion, a sum that must be added to the budget deficit due to war and recession (or worse).

  What we are talking about here is a minimum budget deficit of $2 trillion. The U.S. has never had to finance a deficit of this magnitude. Where is the money coming from?

  The U.S. Treasury doesn’t have any money, and neither do Americans, who have lost up to half of their savings and retirement funds and are up to their eyeballs in mortgage and consumer debt. And unemployment is rising.

  There are only two sources of financing: foreign creditors and the printing press.

  I doubt that foreigners have $2 trillion to lend to the U.S. Thanks to the toxic U.S. financial instruments, they have their own bailouts to finance and economies to stimulate. Moreover, I doubt that foreigners think the U.S. can service a public debt that suddenly jumps by $2 trillion. At 5 percent interest, the additional debt would add $100 billion to the annual budget deficit. In order to pay interest to creditors, the U.S. would have to borrow more money from them.

  Economists and policy-makers are not thinking. This enormous financing need comes not to a well-managed economy that can take the additional debt in its stride. Instead, it comes to an economy so badly managed that there are no reserves.

  Massive U.S. trade deficits have been financed by giving up U.S. assets to foreigners, who now own the income flows as well. Budget deficits from years of pointless wars and from unsustainable levels of military spending have helped to flood the world with dollars and to drive down the dollar’s exchange value. Consumers themselves are drowning in debt and can provide no lift to the economy. Millions of the best jobs have been moved offshore, and research, design, and innovation have followed them. Considering America’s dependency on imports, part of any stimulus package that reaches the consumer will bleed off to foreign countries.

  Generally, when countries acquire more debt than they can service, they inflate away the debt. If foreign creditors do not save the Obama administration, the Treasury will print bonds and give them to the Federal Reserve, which will print money by creating checking accounts for the Treasury.

  The inflation will be severe, particularly as Americans will not be able to pay for the imports of manufactured goods from abroad on which they have become dependent. The exchange value of the dollar will decline with the domestic inflation. Once inflation is off and running, the printing press dollars will only have goods made in America to chase after. The real crisis has not yet begun.

  Paulson should rethink the automakers’ and FDIC’s proposals. A bank produc
es nothing but paper. Automakers produce real things that can be sold. Occupied homes are worth more then empty ones.

  Paulson’s inability to see this is the logical outcome of Wall Street thinking that highly values deals made over pieces of paper at the expense of the real economy.

  November 17, 2008

  Chapter 28: Why the Paulson Plan was a Fraud

  Is the Paulson bailout itself as big a fraud as the leveraged subprime mortgages?

  There will be more trouble to come if the bailout impairs the U.S. Treasury’s credit standing and/or the combination of mark-to-market and short-selling permits short-sellers to prosper by driving more financial institutions into bankruptcy.

  A reader’s comment and an article by Yale professors Jonathan Koppell and William Goetzmann raise precisely this question of the fraudulence of the Paulson package.

  As one reader put it, “We have debt at three different levels: personal household debt, financial sector debt and public debt. The first has swamped the second and now the second is being made to swamp the third. The attitude of our leaders is to do nothing about the first level of debt and to pretend that the third level of debt doesn’t matter at all.”

  The argument for the bailout is that the banks will be free of the troubled instruments and can resume lending and that the U.S. Treasury will recover most of the bailout costs, because only a small percentage of the underlying mortgages are bad. Let’s examine this argument.

  In actual fact, the Paulson bailout does not address the core problem. It only addresses the problem for the financial institutions that hold the troubled assets. Under the bailout plan, the troubled assets move from the banks’ books to the Treasury’s. But the underlying problem—the continuing diminishment of mortgage and home values—remains and continues to worsen.

  The origin of the crisis is at the homeowner level. Homeowners are defaulting on mortgages. Moving the financial instruments onto the Treasury’s books does not stop the rising default rate.

  The bailout is focused on the wrong end of the problem. The bailout should be focused on the origin of the problem, the defaulting homeowners. The bailout should indemnify defaulting homeowners and pay off the delinquent mortgages. As Koppell and Goetzmann point out, the financial instruments are troubled because of mortgage defaults. Stopping the problem at its origin would restore the value of the mortgage-based derivatives and put an end to the crisis.

  This approach has the further advantage of stopping the slide in housing prices and ending the erosion of local tax bases that result from foreclosures and houses being dumped on the market.

  What about the moral hazard of bailing out homeowners who over-leveraged themselves? Ask yourself: How does it differ from the moral hazard of bailing out the financial institutions that over-leveraged themselves, securitized questionable loans, insured them, and sold them as investment grade securities?

  Congress should focus the bailout on refinancing the troubled mortgages as the Home Owners’ Loan Corp. did in the 1930s, not on the troubled institutions holding the troubled instruments linked to the mortgages. Congress needs to back off, hold hearings, and talk with Koppell and Goetzmann. Congress must know the facts prior to taking action. The last thing Congress needs to do is to be panicked again into agreeing to a disastrous course.

  October 3, 2008

  Chapter 29: A Futile Bailout as Darkness Falls on America

  America has become a pretty discouraging place. Americans, for the most part, will never know what happened to them, because they no longer have a free and responsible press. They have Big Brother’s press. For example, on September 28, 2008, a New York Times editorial blamed the current financial crisis on “antiregulation disciples of the Reagan Revolution.”

  What utter nonsense. Every example of deregulation that the New York Times editorial provides is located in the Clinton administration and the George W. Bush administration. I was a member of the Reagan administration. We most certainly did not deregulate the financial system.

  The repeal of the Glass-Steagall Act, which separated commercial from investment banking, was the achievement of the Democratic Clinton administration. It happened in 1999, over a decade after Reagan left office.

  It was in 2000 that derivatives and credit default swaps were excluded from regulation.

  The greatest mistake was made in 2004, the year that Reagan died. That year the current Secretary of the Treasury, Henry M. Paulson Jr, was head of the investment bank Goldman Sachs. In the spring of 2004, the investment banks, led by Paulson, met with the Securities and Exchange Commission. At this meeting with the New Deal regulatory agency tasked with regulating the U.S. financial system, Paulson convinced the SEC Commissioners to exempt the investment banks from maintaining reserves to cover losses on investments. The exemption granted by the SEC allowed the investment banks to leverage financial instruments beyond any bounds of prudence.

  In place of time-proven standards of prudence, computer models engineered by hot shots determined acceptable risk. As one result Bear Stearns, for example, pushed its leverage ratio to 33 to 1. For every one dollar in equity, the investment bank had $33 of debt!

  It was computer models that led to the failure of Long-Term Capital Management in 1998, the first systemic threat to the financial system. Why the SEC went along with Paulson and set aside capital requirements after the scare of Long-Term Capital Management is inexplicable.

  The blame is headed toward SEC chairman Christopher Cox. This is more of Big Brother’s disinformation. Cox, like so many others, was a victim of a free market ideology that the market “always knows best.”

  The 20th century proves that the market is likely to know better than a central planning bureau. It was Soviet Communism that collapsed, not American capitalism. However, the market has to be protected from greed. It was greed, not the market, that was unleashed by deregulation during the Clinton and George W. Bush regimes.

  I remember when the deregulation of the financial sector began. One of the first inroads was the legislation, written by bankers, to permit national branch banking. George Champion, former chairman of Chase Manhattan Bank, testified against it. In columns I argued that national branch banking would focus banks away from local business needs.

  The deregulation of the financial sector was achieved by the Democratic Clinton administration and by Henry Paulson, Secretary of the Treasury in the George W. Bush administration, with the acquiescence of the Securities and Exchange Commission.

  The Paulson bailout saves his firm, Goldman Sachs. The Paulson bailout transfers the troubled financial instruments that the financial sector created from the books of the financial sector to the books of the taxpayers at the U.S. Treasury.

  This is all the bailout does. It rescues the guilty.

  The Paulson bailout does not address the problem, which is the defaulting home mortgages.

  The defaults will continue, because the economy is sinking into recession. Homeowners are losing their jobs, and homeowners are being hit with rising mortgage payments resulting from escalator interest rate clauses in their mortgages that make homeowners unable to service their debt.

  Shifting the troubled assets from the financial sectors’ books to the taxpayers’ books absolves the people who caused the problem from responsibility. As the economy declines and mortgage default rates rise, the U.S. Treasury and the American taxpayers could end up with a $700 billion loss.

  Initially, the House, but not the Senate, resisted the bailout of the financial institutions, whose executives had received millions of dollars in bonuses for wrecking the U.S. financial system. However, the people’s representatives could not withstand the vague hint of martial law and Great Depression with which Paulson and the Bush administration threatened them. The people’s representatives succumbed as they did during the New Deal.

  The impotence of Congress traces to the Great De
pression. As Theodore Lowi in his classic book, The End of Liberalism, makes clear, the New Deal stripped Congress of its law-making power and gave it to the executive agencies. Prior to the New Deal, Congress wrote the laws. After the New Deal, a bill is merely an authorization for executive agencies to create the law through regulations. The Paulson bailout has further diminished the legislative branch’s power.

  Since Paulson’s bailout of his firm and his financial friends does nothing to lessen the default rate on mortgages, how will the bailout play out?

  If the $700 billion bailout is based on an estimate of the current amount of bad mortgages, as the recession deepens and Americans lose their jobs, the default rate will rise. The $700 billion might not suffice. The Treasury would have to go hat in hand to its foreign creditors for more loans.

  As the U.S. Treasury has not got $7, much less $700 billion, it must borrow the bailout money from foreign creditors, already overloaded with U.S. paper. At what point do America’s foreign creditors decide that the additions to U.S. debt exceed what can be repaid?

  This question was ignored by the bailout. There were no hearings. No one consulted China, America’s principal banker, or the Japanese, or the OPEC sovereign wealth funds, or Europe.

  Does the world have a blank check for America’s mistakes?

  This is the same world that is faced with American demands that countries support with money and lives America’s quest for world hegemony. Europeans are dying in Afghanistan for American hegemony. Do Europeans want their banks, which hold U.S. dollars as their reserves, to help Paulson bail out his company and his friends?

  The U.S. dollar is the world’s reserve currency. It comprises the reserves of foreign central banks. Bush’s wars and economic policies are destroying the basis of the U.S. dollar as reserve currency. The day the dollar loses its reserve currency role, the U.S. government cannot pay its bills in its own currency. The result will be a dramatic reduction in U.S. living standards.