How the Economy Was Lost: The War of the Worlds (Counterpunch) (4 page)

Chapter 6: The Bitter Fruits of Deregulation

R
emember 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.

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 3 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.

In the 21st century the U.S. 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.

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.

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.

The income gains of the 21st century have gone to corporate chief executives, shareholders of offshoring corporations, and financial corporations.

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.

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.

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 is 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.

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.

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.

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.

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 soon.

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 U.S. 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 being extended to money market funds.

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?

This crisis comes at the worst possible time. Gratuitous wars and military spending in pursuit of U.S. 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 U.S. export capability.

These large deficits are financed by foreigners, and foreign unease has resulted in a decline in the U.S. dollar’s value compared to other tradable currencies, precious metals, and oil.

The U.S. 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.

The dependency of Treasury Secretary Henry 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 U.S. is in a financially dependent position that is inconsistent with that of America’s “superpower” status.

The U.S. is not a superpower. The U.S. is a financially dependent country that foreign lenders can close down at will.

Washington 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.

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 ones. The Republicans, for the most part, and their media shills are doing their best to exclude the ordinary American from the rescue plan.

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 could mean, in effect, state capitalism or fascism.

If we add state capitalism to the Bush administration’s success in eroding both the U.S. Constitution and the power of Congress, we may be witnessing the death of accountable constitutional government.

The U.S. 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 U.S. 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 U.S. has no assets of its own with which to pursue its control over the world.

The U.S. cannot be a hegemonic power without foreign financing. All indications are that the rest of the world is tiring of U.S. arrogance.

If the U.S. Treasury’s assumption of bailout responsibilities becomes excessive, the U.S. 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 U.S. government would have to turn to the printing of paper money.

For now this pending problem is hidden from view, because in times of panic, the tradition is to flee into “safety,” that is, into U.S. Treasury debt obligations. The safety of Treasuries will be revealed by the extent of the bailout.

September 24, 2008

Chapter 7: Economic Treason

T
he June 2005 payroll jobs report did not receive much
attention due to the July 4 holiday, but the depressing 21st century job performance of the U.S. economy continues unabated.

•
Only 144,000 private sector jobs were created, each one of which was in domestic services.

•
56,000 jobs were created in professional and business services, about half of which are in administrative and waste services.

•
38,000 jobs were created in education and health services, almost all of which are in health care and social assistance.

•
19,000 jobs were created in leisure and hospitality, almost all of which are waitresses and bartenders.

•
Membership associations and organizations created 10,000 jobs and repair and maintenance created 4,000 jobs.

•
Financial activities created 16,000 jobs.

This most certainly is not the labor market profile of a First World country, much less a superpower.

Where are the jobs for this year’s crop of engineering and science graduates?

U.S. manufacturing lost another 24,000 jobs in June.

A country that doesn’t manufacture doesn’t need many engineers. And the few engineering jobs available go to foreigners.

Readers have sent me employment listings from U.S. software development firms. The listings are discriminatory against American citizens. One ad from a company in New Jersey that is a developer for many companies, including Oracle, specifies that the applicant must have a TN visa.

A TN or Trade NAFTA visa is what is given to Mexicans and Canadians who are willing to work in the U.S. at below prevailing wages.

Another ad from a software consulting company based in Omaha, Nebraska specifies it wants software engineers who are H-1B transferees. What this means is that the firm is advertising for foreigners already in the U.S. who have H-1B work visas.

The reason the U.S. firms specify that they have employment opportunities only for foreigners who hold work visas is because the foreigners will work for less than the prevailing U.S. salary.

Gentle reader, when you read allegations that there is a shortage of engineers in America, necessitating the importation of foreigners to do the work, you are reading a bald-faced lie. If there were a shortage of American engineers, employers would not word their job listings to read that no American need apply and that they are offering jobs only to foreigners holding work visas.

What kind of country gives preference to foreigners over its own engineering graduates?

What kind of country destroys the job market for its own citizens?

How much longer will parents shell out $100,000 for a college education for a son or daughter who ends up employed as a bartender, waitress, or temp?

July 16, 2005

Chapter 8: How Inflation Works (or Why I Can’t Buy an Old Ferrari)

A
nyone who has been alive very long is aware that the
U.S. government has failed on the inflation front. Soft drink machines that once delivered a bottled drink for a nickel now charge a dollar, a 20-fold increase in price.

Until the Reagan administration indexed the income tax, inflation was a boon to government, because by pushing up wages and salaries inflation pushed taxpayers into higher brackets. This allowed the real tax burden on labor to rise without politicians having to raise the tax rates. Inflation also destroyed the value of depreciation allowances, thus raising the tax rate on capital as well.

It is not easy to make the young aware of the long-term rise in prices. The inflation indices are periodically re-based, resulting in measures over time with different years as the base. The Clinton administration further destroyed comparability by substituting a variable basket of goods for the fixed assortment that had previously prevailed. With the Boskin Commission “reform” adopted by the Clinton administration, the Consumer Price Index (CPI) no longer compares apples to apples. If the price of apples rises, the CPI assumes that consumers switch to a cheaper substitute. The “substitution effect” thus underestimates the rate of inflation and destroys the comparability of the inflation rate from one period to the next.

Inflation is inherent in a fractional reserve banking system based on fiat money. Fiat money is not subject to limits on its supply, and fractional reserve banking permits the banking system to create money by expanding loans.

Aware of the ever present threat of inflation from such a system, Milton Friedman advocated a monetary rule that would limit the growth of the money supply to the long-term growth rate of the economy. For example, if the money supply grew 2 to 3 percent annually in keeping with the increase in real output, prices would remain stable. Perhaps it wasn’t a perfect solution, but at least Friedman thought about the problem.

In the post-WW II period, the U.S. has experienced dramatic increases in the growth of money and credit. One way to demonstrate the erosion of the purchasing power of money is to look at the change in the behavior of the prices of used Ferraris. In the 1950s, 1960s, and even the 1970s, Ferraris depreciated rapidly. Well-to-do playboys attracted by the unique cars wanted the latest model, and few other people wanted the maintenance expense associated with the high-performance machines. It was not out of the question for a person with an ordinary income to become the second owner of a Ferrari.

Excepting a few models of high volume and undistinguished performance, today it is totally out of the question that a person lacking an out-sized income or a large inheritance could acquire a previously owned Ferrari.

For example, in 1973 when I left Stanford University I had an opportunity to purchase a 1967 Ferrari 330 GTS. It was a low mileage car in new condition. The asking price was $10,000 and could have been negotiated down. Unfortunately, the Scottish part of my ancestry prevailed, and I did not purchase the Ferrari. Recently at the Monterey auction a 330 GTS sold for $671,000, 67 times its 1973 used car price.

As an assistant professor of economics in 1967, I cut a road test out of
Road & Track
magazine and filed it. The test was one of a 1967 Ferrari 275 GTB/4. The new price was $14,500. I intended to find one in a few years at a substantially depreciated price. At a recent Monetary auction, a 1967 GTB/4 sold for $1,925,000.

What has happened to money that causes a 41-year-old used car to sell for 133 times its new car price?

The abundance of money from a fiat money/fractional reserve banking system raises the price of scarce items that are beautiful and unique, such as Ferraris and antiques. Few Ferrari models were produced in numbers greater than several hundred cars. Perhaps the most famous Ferrari is the 250 GTO. Less than 40 were produced. The GTO, which is street legal, dominated racing and won the World Manufacturers Championship in 1962, 1963, and 1964. The new car price was $18,000. In 1989 one sold for $13 million. This year one sold for $28 million. I have a friend who bought a used GTO in Europe in the mid-1960s for $9,000 and sold it six months later for the same price.

Ferraris became collectibles, a store of value, a role that the dollar no longer performs. Today collectible cars have become items for speculation. They are flipped in auctions with bids rising several hundred thousand dollars from auction to auction, just as real estate speculators bid up waterfront condo prices and hedge funds bid up oil futures contracts.

The cars are worth so much now that you will never see one on the road, not even in the playgrounds of the rich and famous. The more than 1,500-fold rise in the price of the GTO over the last 45 years makes gold’s 28-fold price rise seem insignificant. But both prices show the ruin inflicted on the dollar by our fiat money/fractional reserve system.

October 21, 2008