It will be interesting to see how the currency markets view the problem. The New York Times reported that “the dollar plunged about 3 percent against other major currencies” in response to the Fed’s announcement.
If the exchange value of the dollar works its way down, it will complicate the financing of the trade deficit and impact the decisions of foreigners who hold large stocks of U.S. dollar debt. The premier of China recently expressed his concern about the safety of his country’s large investment in U.S. dollar debt.
If the U.S. government is forced to print money to cover the high costs of its wars and bailouts, things could fall apart very quickly.
March 23, 2009
Chapter 37: How the Economy was Lost
The American economy has gone away. It is not coming back until free trade myths are buried six feet under.
America’s 20th century economic success was based on two things. Free trade was not one of them. America’s economic success was based on protectionism, which was ensured by the Union victory in the Civil War, and on British indebtedness, which destroyed the British pound as world reserve currency. Following World War II, the U.S. dollar took the role as reserve currency, a privilege that allows the U.S. to pay its international bills in its own currency.
World War II and socialism together ensured that the U.S. economy dominated the world at the mid-20th century. The economies of the rest of the world had been destroyed by war or were stifled by socialism.
The ascendant position of the U.S. economy caused the U.S. government to be relaxed about giving away American industries, such as textiles, as bribes to other countries for cooperating with America’s cold war and foreign policies. For example, Turkey’s U.S. textile quotas were increased in exchange for over-flight rights in the Gulf War, making lost U.S. textile jobs an off-budget war expense.
In contrast, countries such as Japan and Germany used industrial policy to plot their comebacks. By the late 1970s, Japanese auto makers had the once dominant American auto industry on the ropes. The first economic act of the “free market” Reagan administration in 1981 was to put quotas on the import of Japanese cars in order to protect Detroit and the United Auto Workers.
Eamonn Fingleton, Pat Choate, and others have described how negligence in Washington, D.C. aided and abetted the erosion of America’s economic position. What we didn’t give away, the United States let be taken away while preaching a “free trade” doctrine at which the rest of the world scoffed.
Fortunately, the U.S.’s adversaries at the time, the Soviet Union and China, had unworkable economic systems that posed no threat to America’s diminishing economic prowess.
This furlough from reality ended when Soviet, Chinese, and Indian socialism surrendered around 1990, to be followed shortly thereafter by the rise of the high speed Internet. Suddenly, American and other First World corporations discovered that a massive supply of foreign labor was available at practically free wages.
To get Wall Street analysts and shareholder advocacy groups off their backs, and to boost shareholder returns and management bonuses, American corporations began moving their production for American markets offshore. Products that were made in Peoria are now made in China.
As offshoring spread, American cities and states lost tax base, and families and communities lost jobs. The replacement jobs, such as selling the offshored products at Wal-Mart, brought home less pay.
“Free market economists” covered up the damage done to the U.S. economy by preaching a New Economy based on services and innovation. But it wasn’t long before corporations discovered that the high speed Internet let them offshore a wide range of professional service jobs. In America, the hardest hit have been software engineers and information technology (IT) workers.
The American corporations quickly learned that by declaring “shortages” of skilled Americans, they could get from Congress H-1B work visas for lower paid foreigners with whom to replace their American work force. Many U.S. corporations are known for forcing their U.S. employees to train their foreign replacements in exchange for severance pay.
Chasing after shareholder return and “performance bonuses,” U.S. corporations deserted their American workforce. The consequences can be seen everywhere. The loss of tax base has threatened the municipal bonds of cities and states and reduced the wealth of individuals who purchased the bonds. The lost jobs with good pay resulted in the expansion of consumer debt in order to maintain consumption. As the offshored goods and services are brought back to America to sell, the U.S. trade deficit has exploded to unimaginable heights, calling into question the U.S. dollar as reserve currency and America’s ability to finance its trade and budget deficits.
As the American economy eroded away bit by bit, “free market” ideologues produced endless reassurances that America had pulled a fast one on China, sending China dirty and grimy manufacturing jobs. Free of these “old economy” jobs, Americans were lulled with promises of riches. In place of dirty fingernails, American efforts would flow into innovation and entrepreneurship. In the meantime, the “service economy” of software and communications would provide a leg up for the work force.
Education was the answer to all challenges. This appeased the academics, and they produced no studies that would contradict the propaganda and, thus, curtail the flow of federal government and corporate grants.
The “free market” economists, who provided the propaganda and disinformation that hid the act of destroying the U.S. economy, were well paid. As Business Week noted, “outsourcing’s inner circle has deep roots in General Electric and McKinsey,” a consulting firm. Indeed, one of McKinsey’s main apologists for offshoring of U.S. jobs, Diane Farrell, is now a member of Obama’s White House National Economic Council.
The pressure on U.S. employment from jobs offshoring, together with vast imports, has destroyed the economic prospects for all Americans, except the CEOs who receive “performance” bonuses for moving American jobs offshore or giving them to H-1B work visa holders.
Lowly paid offshored employees, together with H-1B visas, have curtailed employment for new American graduates and for older and more experienced American workers. Older workers traditionally receive higher pay. However, when the determining factor is minimizing labor costs for the sake of shareholder returns and management bonuses, older workers are unaffordable. Doing a good job and providing a good service have ceased to be grounds for employment in corporations that no longer have any loyalty to employees. Instead, the goal is to minimize labor costs at all cost in order to please Wall Street and shareholders. In this way U.S. corporations become the benefactors of foreigners.
“Free trade” has destroyed the employment prospects of older workers. Forced out of their careers, they seek employment as shelf stockers for Wal-Mart where they are paid the minimum wage and no benefits.
I have read endless tributes to Wal-Mart from “libertarian economists,” who sing Wal-Mart’s praises for bringing low price goods, 70 percent of which are made in China, to the American consumer. What these “economists” do not factor into their analysis is the diminution of American family incomes and government tax base from the loss of the goods producing jobs to China. Ladders of upward mobility are being dismantled by offshoring, while California issues IOUs to pay its bills. The shift of production offshore reduces GDP. When the goods and services are brought back to America to be sold, they increase the trade deficit. As the trade deficit is financed by foreigners acquiring ownership of U.S. assets, this means that profits, dividends, capital gains, interest, rents, and tolls leave American pockets for foreign ones.
The demise of America’s productive economy left the U.S. economy dependent on finance, in which the U.S. remained dominant because the dollar is the reserve currency. With the departure of factories, finance went in new directions. Mortgages, which were once held in the portfolios of the issuer, were securitized and sold.<
br />
Individual mortgage debts were combined into a “security.” The next step was to strip out the interest payments to the mortgages and sell them as derivatives, thus creating a third debt instrument based on the original mortgages.
In pursuit of ever more profits, financial institutions began betting on the success and failure of various debt instruments and on firms. They bought and sold collateral debt obligations and credit default swaps. A buyer pays a premium to a seller for a swap to guarantee an asset’s value. If an asset “insured” by a swap falls in value, the seller of the swap is supposed to make the owner of the swap whole. The purchaser of a swap is not required to own the asset in order to contract for a guarantee of its value. Therefore, as many people could purchase as many swaps as they wished on the same asset. Thus, the total value of the swaps greatly exceeds the value of the assets.
The next step is for holders of the swaps to short the asset in order to drive down its value and collect the guarantee. As the issuers of swaps were not required to reserve against them, and as there is no limit to the number of swaps, the payouts could easily exceed the net worth of the issuer.
This was the most shameful and most mindless form of speculation. Gamblers were betting hands that could not be covered. The U.S. regulators fled their posts. The American financial institutions abandoned all integrity. As a consequence, American financial institutions and rating agencies are trusted nowhere on earth.
The U.S. government should never have used billions of taxpayers’ dollars to pay off swap bets as it did when it bailed out the insurance company AIG. This was a stunning waste of a vast sum of money. The federal government should declare all swap agreements to be fraudulent contracts, except for a single swap held by the owner of the asset. Simply wiping out these fraudulent contracts would remove the bulk of the vast overhang of “troubled” assets that threaten financial markets.
The billions of taxpayers’ dollars spent buying up subprime derivatives were also wasted. The government did not need to spend one dime. All government needed to do was to suspend the mark-to-market rule. This simple act would have removed the solvency threat to financial institutions by allowing them to keep the derivatives at book value until financial institutions could ascertain their true values and write them down over time.
Taxpayers, equity owners, and the credit standing of the U.S. government are being ruined by financial shysters who are manipulating to their own advantage the government’s commitments to mark-to-market and the “sanctity of contracts.” Multi-trillion dollar “bailouts” and bank nationalization are the result of the U.S. government’s inability to respond intelligently.
Two more simple acts would have completed the rescue without costing the taxpayers one dollar: an announcement from the Federal Reserve that it will be lender of last resort to all depository institutions including money market funds, and an announcement reinstating the uptick rule.
The Uptick rule was suspended or repealed a couple of years ago in order to permit hedge funds and shyster speculators to rip-off American equity owners. The rule prevented short-selling any stock that did not move up in price during the previous trade. In other words, speculators could not make money at others’ expense by ganging up on a stock and short-selling it trade after trade.
As a former Treasury official, I am amazed that the U.S. government, in the midst of the worst financial crises ever, is content for short-selling to drive down the asset prices that the government is trying to support. No bailout or stimulus plan has any hope until the Uptick rule is reinstated.
The bald fact is that the combination of ignorance, negligence, and ideology that permitted the crisis to happen still prevails and is blocking any remedy. Either the people in power in Washington and the financial community are total dimwits or they are manipulating an opportunity to redistribute wealth from taxpayers, equity owners, and pension funds to financial manipulators.
The Bush and Obama plans total $1.6 trillion, every one of which will have to be borrowed, and no one knows from where. This huge sum will compromise the value of the U.S. dollar, its role as reserve currency, the ability of the U.S. government to service its debt, and the price level. These staggering costs are pointless and are to no avail, as not one step has been taken that would alleviate the crisis.
If we add to my simple menu of remedies a ban against short selling any national currency, the world can be rescued from the current crisis without years of suffering, violent upheavals, and, perhaps, wars.
According to its hopeful but economically ignorant proponents, globalism was supposed to balance risks across national economies and to offset downturns in one part of the world with upturns in other parts. A global portfolio was a protection against loss, claimed globalism’s purveyors. In fact, globalism has concentrated the risks, resulting in Wall Street’s greed endangering all the economies of the world. The greed of Wall Street and the negligence of the U.S. government have wrecked the prospects of many nations. Street riots are already occurring in parts of the world. On Sunday February 22, the right-wing TV station, Fox “News,” presented a program that predicted riots and disarray in the United States by 2014.
How long will Americans permit “their” government to rip them off for the sake of the financial interests that caused the problem? Obama’s cabinet and National Economic Council are filled with representatives of the interest groups that caused the problem. The Obama administration is not a government capable of preventing a worse catastrophe.
If truth be known, the “banking problem” is the least of our worries. Our economy faces two much more serious problems. One is that offshoring and H-1B visas have stopped the growth of family incomes, except, of course, for the super rich. To keep the economy going, consumers have gone deeper into debt, maxing out their credit cards and refinancing their homes and spending the equity. Consumers are now so indebted that they cannot increase their spending by taking on more debt. Thus, whether or not the banks resume lending is beside the point.
The other serious problem is the status of the U.S. dollar as reserve currency. This status has allowed the U.S., now a country heavily dependent on imports just like a Third World or lesser-developed country, to pay its international bills in its own currency. We are able to import $800 billion annually more than we produce, because the foreign countries from whom we import are willing to accept paper for their goods and services.
If the dollar loses its reserve currency role, foreigners will not accept dollars in exchange for real things. This event would be immensely disruptive to an economy dependent on imports for its energy, its clothes, its shoes, its manufactured products, and its advanced technology products.
If incompetence in Washington, the type of incompetence that produced the current economic crisis, destroys the dollar as reserve currency, the “unipower” will overnight become a Third World country, unable to pay for its imports or to sustain its standard of living.
How long can the U.S. government protect the dollar’s value by leasing its gold to bullion dealers who sell it, thereby holding down the gold price? Given the incompetence in Washington and on Wall Street, our best hope is that the rest of the world is even less competent and even in deeper trouble. In this event, the U.S. dollar might survive as the least valueless of the world’s fiat currencies.
February 24, 2009
Chapter 38: The Economy is a Lie, Too
Americans cannot get any truth out of their government about anything, the economy included. Americans are being driven into the ground economically, with one million school children now homeless, while Federal Reserve chairman Ben Bernanke announces that the recession is over.
The spin that masquerades as news is becoming more delusional. Consumer spending is 70 percent of the U.S. economy. It is the driving force, and it has been shut down. Except for the super rich, there has been no growth in consumer incomes in the 21st century. Statis
tician John Williams reports that real household income has never recovered its pre-2001 peak.
The U.S. economy has been kept going by substituting growth in consumer debt for growth in consumer income. When he was Federal Reserve chairman Alan Greenspan had encouraged consumer debt with low interest rates. The low interest rates pushed up home prices, enabling Americans to refinance their homes and spend the equity. Credit cards were maxed out in expectations of rising real estate and equity values to pay the accumulated debt. The binge was halted when the real estate and equity bubbles burst.
As consumers no longer can expand their indebtedness and their incomes are not rising, there is no basis for a growing consumer economy. Indeed, statistics indicate that consumers are paying down debt in their efforts to survive financially. In an economy in which the consumer is the driving force, that is bad news.
The banks, now investment banks thanks to greed-driven deregulation that repealed the learned lessons of the past, were even more reckless than consumers and took speculative leverage to new heights. At the urging of Larry Summers and Goldman Sachs’ CEO Henry Paulson, the Securities and Exchange Commission and the Bush administration went along with removing restrictions on debt leverage.
When the bubble burst, the extraordinary leverage threatened the financial system with collapse. The U.S. Treasury and the Federal Reserve stepped forward with no one knows how many trillions of dollars to “save the financial system,” which, of course, meant to save the greed-driven financial institutions that had caused the economic crisis that dispossessed ordinary Americans of half of their life savings.
The consumer has been chastened, but not the banks. Refreshed with the TARP $700 billion and the Federal Reserve’s expanded balance sheet, banks are again behaving like hedge funds. Leveraged speculation is producing another bubble with the current stock market rally, which is not a sign of economic recovery but is the final savaging of Americans’ wealth by a few investment banks and their Washington friends. Goldman Sachs, rolling in profits, announced six figure bonuses to employees.
How the Economy Was Lost: The War of the Worlds (Counterpunch) Page 16