- Remember the good old days when the economic threat was
mere recession? The Federal Reserve would encourage the economy with low
interest rates until the economy overheated. Prices would rise, and unions
would strike for higher benefits. Then the Fed would put on the brakes
by raising interest rates. Money supply growth would fall. Inventories
would grow, and layoffs would result. When the economy cooled down, the
cycle would start over.
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- The nice thing about 20th century recessions was that
the jobs returned when the Federal Reserve lowered interest rates and consumer
demand increased. In the 21st century, the jobs that have been moved offshore
do not come back. More than three million U.S. manufacturing jobs have
been lost while Bush was in the White House. Those jobs represent consumer
income and career opportunities that America will never see again.
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- In the 21st century the US economy has produced net new
jobs only in low paid domestic services, such as waitresses, bartenders,
hospital orderlies, and retail clerks. The kind of jobs that provided ladders
of upward mobility into the middle class are being exported abroad or filled
by foreigners brought in on work visas. Today when you purchase an American
name brand, you are supporting economic growth and consumer incomes in
China and Indonesia, not in Detroit and Cincinnati.
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- In the 20th century, economic growth resulted from improved
technologies, new investment, and increases in labor productivity, which
raised consumers' incomes and purchasing power. In contrast, in the 21st
century, economic growth has resulted from debt expansion.
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- Most Americans have experienced little, if any, income
growth in the 21st century. Instead, consumers have kept the economy going
by maxing out their credit cards and refinancing their mortgages in order
to consume the equity in their homes.
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- The income gains of the 21st century have gone to corporate
chief executives, shareholders of offshoring corporations, and financial
corporations.
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- By replacing $20 an hour U.S. labor with $1 an hour Chinese
labor, the profits of U.S. offshoring corporations have boomed, thus driving
up share prices and "performance" bonuses for corporate CEOs.
With Bush/ Cheney, the Republicans have resurrected their policy of favoring
the rich over the poor. John McCain captured today's high income class
with his quip that you are middle class if you have an annual income less
than $5 million.
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- Financial companies have made enormous profits by securitizing
income flows from unknown risks and selling asset backed securities to
pension funds and investors at home and abroad.
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- Today recession is only a small part of the threat that
we face. Financial deregulation, Alan Greenspan's low interest rates, and
the belief that the market was the best regulator of risks, have created
a highly leveraged pyramid of risk without adequate capital or collateral
to back the risk. Consequently, a wide variety of financial institutions
are threatened with insolvency, threatening a collapse comparable to the
bank failures that shrank the supply of money and credit and produced the
Great Depression.
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- Washington has been slow to recognize the current problem.
A millstone around the neck of every financial institution is the mark-
to-market rule, an ill-advised "reform" from a previous crisis
that was blamed on fraudulent accounting that over-valued assets on the
books. As a result, today institutions have to value their assets at current
market value.
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- In the current crisis the rule has turned out to be a
curse. Asset backed securities, such as collateralized mortgage obligations,
faced their first market pricing in panicked circumstances. The owner of
a bond backed by 1,000 mortgages doesn't know how many of the mortgages
are good and how many are bad. The uncertainty erodes the value of the
bond.
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- If significant amounts of such untested securities are
on the balance sheet, insolvency rears its ugly head. The bonds get dumped
in order to realize some part of their value. Merrill Lynch sold its asset
backed securities for twenty cents on the dollar, although it is unlikely
that 80 percent of the instruments were worthless.
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- The mark to market rule, together with the suspect values
of the asset backed securities and collateral debt obligations and swaps,
allowed short sellers to make fortunes by driving down the share prices
of the investment banks, thus worsening the crisis. With their capitalization
shrinking, the investment banks could no longer borrow. The authorities
took their time in halting short-selling, and short-selling is set to resume
on October 3 or thereabout.
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- If the mark to market rule had been suspended and short-selling
prohibited, the crisis would have been mitigated. Instead, the crisis intensified,
provoking the US Treasury to propose to take responsibility for $700 billion
more in troubled financial instruments in addition to the Fannie Mae, Freddie
Mac, and AIG bailouts. Treasury guarantees are also apparently being extended
to money market funds.
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- All of this makes sense at a certain level. But what
if the $700 billion doesn't stem the tide and another $700 billion is needed?
At what point does the Treasury's assumption of liabilities erode its own
credit standing?
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- This crisis comes at the worst possible time. Gratuitous
wars and military spending in pursuit of US world hegemony have inflated
the federal budget deficit, which recession is further enlarging. Massive
trade deficits, magnified by the offshoring of goods and services, cannot
be eliminated by US export capability.
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- These large deficits are financed by foreigners, and
foreign unease has resulted in a decline in the US dollar's value compared
to other tradable currencies, precious metals, and oil.
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- The US Treasury does not have $700 billion on hand with
which to buy the troubled assets from the troubled institutions. The Treasury
will have to borrow the $700 billion from abroad.
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- The dependency of Treasury Secretary Paulson's bailout
scheme on foreign willingness to absorb more Treasury paper in order that
the Treasury has the money to bail out the troubled institutions is heavy
proof that the US is in a financially dependent position that is inconsistent
with that of America's "superpower" status.
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- The US is not a superpower. The US is a financially dependent
country that foreign lenders can close down at will.
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- Washingtonn still hasn't learned this. American hubris
can lead the administration and Congress into a bailout solution that the
rest of the world, which has to finance it, might not accept.
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- Currently, the fight between the administration and Congress
over the bailout is whether the bailout will include the Democrats' poor
constituencies as well as the Republicans' rich oness. The Republicans,
for the most part, and their media shills are doing their best to exclude
the ordinary American from the rescue plan.
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- A less appreciated feature of Paulson's bailout plan
is his demand for freedom from accountability. Congress balked at Paulson's
demand that the executive branch's conduct of the bailout be non-reviewable
by Congress or the courts: "Decisions by the Secretary pursuant to
the authority of this Act are non-reviewable and committed to agency discretion."
However, Congress substituted for its own authority a "board"
that possibly will consist of the bailed-out parties, by which I mean Republican
and Democratic constituencies. The control over the financial system that
the bailout would give to the executive branch would mean, in effect, state
capitalism or fascism.
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- If we add state capitalism to the Bush administration's
success in eroding both the US Constitution and the power of Congress,
we may be witnessing the final death of accountable constitutional government.
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- The US might also be on the verge of a decision by foreign
lenders to cease financing a country that claims to be a hegemonic power
with the right and the virtue to impose its will on the rest of the world.
The US is able to be at war in Iraq and Afghanistan and is able to pick
fights with Iran, Pakistan and Russia, because the Chinese, the Japanese
and the sovereign wealth funds of the oil kingdoms finance America's wars
and military budgets. Aside from nuclear weapons, which are also in the
hands of other countries, the US has no assets of its own with which to
pursue its control over the world.
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- The US cannot be a hegemonic power without foreign financing.
All indications are that the rest of the world is tiring of US arrogance.
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- If the US Treasury's assumption of bailout responsibilities
becomes excessive, the US dollar will lose its reserve currency role. The
minute that occurs, foreign financing of America's twin deficits will cease,
as will the bailout. The US government would have to turn to the printing
of paper money as did Weimar Germany.
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- For now this pending problem is hidden from view, because
in times of panic, the tradition is to flee into "safety", that
is, into US Treasury debt obligations. The safety of Treasuries will be
revealed by the extent of the bailout.
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- Paul Craig Roberts was Assistant Secretary of the Treasury.
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