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US Economic Meltdown
|by Gaurang Bhatt, MD|
The seeds of stagflation were sown to undo the Herculean efforts of taming inflation by honest Volcker. The collapse of the tech bubble and the dastardly 9-11 terrorist attack brought the economy to its knees and one trick pony Greenspan, the enfant terrible, resorted to his favorite nefarious pastime by blowing another bubble (real estate). He kept the Fed Funds rate at 1% to jumpstart the economy and rescue banks from the Argentinean bankruptcy and default. He had done the same during the Russian default to help LTCM hedge fund and brokerages in the late nineties.
Kennedy and Johnson began the profligate spending of the Vietnam war that led to beginning of the demise of the Bretton Woods agreement and the dollar. Reagan with Alzheimer's and a monomaniacal paranoia about the already crumbling Soviet Union, increased the national debt by over a trillion dollars with his defense buildup and star wars fantasies. He cut taxes without fulfilling his promise to cut spending and American trade deficits with Japan ballooned to fifty billion dollars. Many Republicans because of their limited mental abilities have a single repertoire and obsession with increasing defense expenditures and cutting taxes with total disregard for fiscal responsibility as the idiotic statements of the current president, vice-president and many Republican contenders for the presidency in 2008 prove. Bush Sr. practiced the same voodoo economics despite condemning it.
Clinton, whose ambition overwhelmed his formidable intellect and meager behavior ethics, was a closet Republican who enacted NAFTA in betrayal of his labor support to enrich his business elite donors. Their greed for money and plan of enrichment by stock options to the detriment of working Americans' salaries and well being, led to factories and jobs moving to China and services to India. The above follies were topped by the current idiot in the White House by the same policies and invasion of Iraq under false pretexts of WMD, spreading democracy and other lies to capture Iraq's oil. Saddam was a despicable tyrant but a former ally and prot'g' whose overthrow could be camouflaged as humanitarian intervention to hide the oil grab.
The US Federal Reserve has two mandates, price stability and economic growth. It has been a Trojan horse for the financial behemoths. During the earlier irresponsible lending behavior of big banks to Latin America, it reduced the Fed funds rate low and long enough to make Citibank and others whole. Similar favors were done by Treasury Secretary Rubin in collusion with Greenspan in the Clinton era to bail out bad loans of US banks to Mexico and brokerage houses during the Reagan era in the 1987 market crash. Reagan who was a spokesman for GE had pushed through legislation to allow Savings and Loan Banks to indulge in reckless speculation and used 500 billion of taxpayer money to set up a Resolution Trust to rescue these institutions and enrich fat cat donors. US government policy is socialism for the rich and merciless capitalism for the poor. A similar policy is being proposed to bail out bond insurers, banks (crooked lenders) and irresponsible, ignorant and foolish borrowers. Bernanke is slashing interests again to rescue the stock markets and financial institutions to the detriment of the savers and taxpayers.
The sub-prime mess arose because Bush Jr. boasted about making America a homeowner's society. Financial institutions had learnt to securitize home mortgages, credit card and automobile loans receivables and sell them to high yield hungry investors like pension plans, hedge funds and European and Chinese banks and insurance companies with the connivance of equally greedy and irresponsible rating agencies (Moody's, S&P, Fitch etc. graded them as triple A) and monoline insurers (FGIC, MBIA, Ambac etc.) who insured them without setting up adequate reserves for loan losses. Mortgage brokers and lending institutions executives desiring large commissions and big year end bonuses encouraged borrowers to fudge or falsify income data and abandoned due diligence.
The borrowers wanting to be home owners and investors convinced that house prices were on a perpetual one way upward trajectory, cheered on by their irrational exuberance took the imprudent and false advice of Federal Reserve Chairman Greenspan to take out low adjustable rate mortgages without reading the fine print that the rates would skyrocket once the short teaser period was over. The unethical greed of CEOs (Enron, Worldcom, Tyco etc.) kept the American workers' earnings stagnant and job security poor. Two income couples mortgaged themselves to the hilt and could not meet payments if one lost a job (Read the book ' Two Income Trap) or if the interest rates rose. The repeal of the Glass Steagall act has erased the barriers between commercial banks and investment banks, setting the stage for a re-occurrence of the market crash of 1929.
Structured Investment Vehicles which were off the books and balance sheets like the two trillion dollar cost of the Iraq and Afghanistan wars which don't figure in the national budget and its deficit will have to be put back on the balance sheet books of financial institutions. The losses they have taken so far (150 billion) are a mere tip of the iceberg. Eventually they may amount to half to one trillion. In addition the losses reduce bank capital and restrain commercial lending which is the lubricant of the economy. The US government is so much in hock that the top Federal employee (comptroller of the currency David Walker) has been shouting from rooftops that we are heading for bankruptcy and mortgaging our children's future. The unfunded government liabilities over the next 50+ years are 70 trillion dollars. The financial institutions have a derivative exposure of nearly 500 trillion dollars. No wonder the credit markets have clogged up and Bernanke is slashing rates every few days. He seems to have forgotten that no matter how much you flog a dead horse it won't get up and run.
The government, similar agencies and corporations have been funding their money needs with short term paper in the money market instead of long term bonds to keep their interest expense low. Last week the Port Authority of New York which owns bridges, ports and toll roads in New York and is not a credit risk, was compelled to pay an interest rate of 20% per annum to finance it short term money needs. Many municipalities and hospitals have lost access to borrowing money. The dollar is sinking and metals, oil and food prices soaring, thanks to Reagan, Clinton, the two Bushes, Greenspan and the corrupt, stupid and do nothing Congresses (House & Senate) of the last 30+years.
In life there is no free lunch and as the second law of thermodynamics states entropy or disorder inexorably increases with time. Any countervailing order has to be paid for by expending energy, a part of which is inefficiently wasted by generation of heat, which is dissipated and leads to increased entropy. There is no Maxwell's demon that can separate the high energy fast moving gas molecules from the slow moving ones without higher cost. Thus the diversion of corn harvests to fructose syrup and ethanol to mix with gasoline, rapeseed oil to artificial diesel fuel and water to clean burning hydrogen cells consumes more energy than it can generate. Not only are the costs prohibitive for a non-tropical country (Brazil can do it less inefficiently from a low input crop like sugarcane), but also as an unintended consequence, it accelerates food price inflation and shortages, as the riots and unrest in Jordan, Morocco and China prove. In nature the only free lunch is the invention of chlorophyll by primitive organisms to harness the abundance of sunlight and use it to synthesize all essential nutrients as plants do, with oxygen our lifeline as a by-product. Even this basis of our existence is not achieved energy efficiently.
Ludwig Von Mises and the Austrian school of economics believe that irresponsible inflation of money supply and resultant artificially low rates of short term interest eventually lead to a collapse of bubbles and a depression like in 1929, similar to a biological phenomenon called tachyphylaxis where excessive secretion of a hormone or enzyme leads to progressive diminution of effect due to exhaustion of the substrate responsible for generating the ultimate effect and the desensitizing of the receptor mediating it. This is what America is facing. Maximum opening of the money spigot and flooding the economy with money creation is not unclogging the bottleneck of a credit crunch due to the unreliability of and increase in counter-party risk between the contracting parties (lenders and borrowers or credit default swap traders) and the shrinkage of capital base of banks due to huge write offs of imprudent loans and investments.
America like Adam Smith's proverbial butcher, baker and candlestick maker has not handed out Marshall plans, sheltered the growth of Western Europe, Japan, the Asian tigers and recently China out of benevolence, but initially for selfish motives of maintaining its supreme hegemony and more recently for lulling to distraction its naive populace with cheap bread and circuses, to surreptitiously enrich its fat cats who fund the power lust of its crooked politicians. (China is doing the same in Africa and South America currently) The result is the depreciation of the dollar from 300 to 100 yen and from the Euro's nadir of 82 cents to 152 cents. Now the time has come to pay the piper. The sub-prime crisis is the last straw. The addiction to profligate spending has left consumers, corporations and governments, both state and federal, so burdened with debt and unfunded liabilities that mere band-aids like shenanigans of accounting fudges will not stem the bleeding from gaping wounds. Warren Buffett's recent annual letter to shareholders highlights the blatant lies and false assumptions of pension accounting by assuming unachievable high rates of returns on pension assets to increase reported annual earnings, merely to raise share prices to cash in on huge windfalls from options by greedy unethical executives.
Japan for its American nuclear umbrella, China for its hunger for technology and the desperate need to avoid unrest by its teeming masses needing employment, who may challenge the rule of its crooked and corrupt government and Europe because of its ethnic ties and gratitude for American rescue from two world wars, are accepting of America's eroding currency and mounting debt. A limit will soon be reached as the value and purchasing power of the former two's reserves has plummeted by nearly 50% (rise in price of gold, oil, wheat, corn, soybeans and other commodities) despite their currency manipulation and the skyrocketing Euro is decreasing Europe's exports, reducing the growth of its economy and increasing its unemployment and budget deficits due to its gold plated safety net. China's iron rice bowl has vanished and the crooked farmer land acquisition of its corrupt local leaders, which the equally crooked central government is unable to control, will morph into bigger problems in the future.
The problem is that to bring the global economy back into a stable state, America needs to generate trade, budget and current account surpluses. This can only occur if American consumers save instead of consuming, manufacturing returns to America and the dollar loses a further 25% of its value. This would lead to severe economic upheavals in Japan, China, the Asian tigers and even Europe which they are unwilling to tolerate. On the other hand accumulating dollars with rapidly shrinking value is equally unacceptable to them and even to the illegitimate tyrants of oil rich Middle East countries being tweaked further by Russia, Iran and Venezuela threatening to price energy resources in currencies other than the dollar.
The above facts explain the desperate gamble by Cheney and his dummy Bush to take over the energy assets of Iraq, threaten Iran, malign Russia, capture Afghanistan for access to Caspian energy, cozy up to the tyrants of Uzbekistan, Turkmenistan and Kazakhstan, give independence to Kosovo to guard pipelines from the Bondsteel base, court Azerbaijan, Georgia and Turkey, strengthen Israel as the local gendarme, persecute Sudan for Darfur, foment unrest in Chad, destabilize Angola in the past, while having ignored Rwanda and Congo genocides and supported the Khmer Rouge genocide in Cambodia (as China did) and creating a new Africa centric command force by the Pentagon. The control of energy resources gives America a stranglehold on the energy needs of Japan and Europe to keep them toeing its dictates. This is why it threatened India and Japan not to have energy ties with rebellious Iran by building the IPI pipeline or developing Iran's energy fields. America wants a fatal grip on the carotid arteries (energy) of major nations to make brain dead those countries that disobey its dictates and threaten its supremacy and hegemony (read Bush strategic doctrine and Quadrennial Defense Review of the last four years). Only China and Russia can stand up to it. Cuba, Venezuela and Iran do but they pay a formidable price. Do not expect any significant change in American foreign policy if McCain, Hillary Clinton or even Obama become the next president, though the last is least beholden to vested interests or the power elite (see my two year old articles 'Hobbesian Hell ' at www.atimes.com or 'A History of International Relations: Power & Hypocrisy).
One of the cardinal principles of economics is how changing supply and demand affect price. Ordinarily, decreased supply in relation to demand leads to increased price and reversed supply demand relationship leads to decreasing price. A decreased price by itself can on occasions increase demand just as price increases can decrease demand by making things less affordable to greater numbers of people. Supermarkets and retail stores advertise reduced price sales to attract buyers and get rid of inventories. Another gimmick they use is to reduce the price of one common item (potatoes) to lure buyers and jack up the prices of other essential items (onions) even more, which the shopper is likely to purchase at the same time to avoid two separate shopping trips.
Stock markets, collectibles dealers, trendy merchandise retailers (including housing bubbles and tulip manias) use reverse psychology. They raise the price of an asset and this increases demand due to the greed of investors and speculators who pile on to the bandwagon. Prices go to irrational and unsustainable heights like 5000 Dutch Florins for a single tulip bulb during the tulip mania in the seventeenth century Holland, and presently millions of dollars for a small condo in Manhattan, Los Angeles, Shanghai, New Delhi or Mumbai or the astronomical values of Chinese, Indian and American stock markets. The mania leads to the greater fool price escalation until the greatest fool is left holding the house, stock or collectible, now with a much reduced market price. Greed and delusions of grandeur overcome caution, rationality and deliberation, and individuals, corporations and nations plunge in to face future disaster as in stocks and houses for the first, mergers and acquisitions for the second and wars like Iraq for nations.
US Congress and presidents have abandoned fiscal responsibility for the last 60+ years mostly to satisfy their lust for power and wealth and the Federal Reserve Chairmen and Governors have been their partners in crime at least since Arthur Burns (with the sole exception of Paul Volcker). The latter have run the printing presses to create excess money and slept on the job as regulators by permitting private financial institutions to create even more money and increase the money supply by means of leverage with Structured Investment Vehicles (CLOs, CDOs, CDOs squared, VIEs etc.). The sloshing flood of dollars inundated not only America, but became a proverbial Biblical flood the world over, and led to real estate bubbles in the UK, Ireland, Spain, US, Canada, China and even Australia.
China was willing to take a depreciating dollar to provide employment for its teeming displaced rural masses and laid off state employees. China also locked its currency and that of Hong Kong to a fixed parity with the dollar. This assured Chinese employment no matter how low the dollar fell, but has led to the current galloping inflation in China and resulting unrest. China intends to use it dollar reserves to blackmail America over Taiwan. It succeeded by causing the defeat of the separatist independence faction in the recent Taiwan elections. The newly wealthy Taiwanese have huge investments in the mainland and wish to avoid confrontation (like the Indians and few Chinese who stayed on in apartheid South Africa). Sooner or later China will now use its financial clout to force the US to abandon Taiwan. China has paid a hefty financial price as its 1.5 trillion dollar reserves have lost over a third of their purchasing power but Chinese leaders are not answerable to their population and though crooked and corrupt like those of India or America, they are not stupid or idiots like those of the last two.
The US claims to be the locomotive pulling the world economy at the cost of personal sacrifice of running huge trade deficits. It does so to numb its predominantly naive and ignorant population, to distract it while the thieving leaders and elite raid the national treasury. It set up the middle tier developing countries to be patsies holding depreciating dollars. During the Russian and Asian crises, it had brainwashed the Asian developing countries about the perils of not having adequately high dollar reserves to counter the wild gyrations of fleeing private capital in search of a quick profit. The US had used its Trojan horses, the World Bank and IMF to force developing countries to permit free capital flows while limiting the flow of people and labor itself to cause the financial catastrophe and now used it to impose the draconian measures of currency devaluation, elimination of subsidies to the poor and slashing of social spending on Thailand, Malaysia, South Korea, Indonesia and even Russia. This allowed US financial institutions to buy Asian assets for a pittance (Thai real estate, Korean banks, Indonesian mines etc.). Now that it is in a similar mess, it continues to run increasing deficits, asks other nations to revalue their currencies and puts obstacles to prevent them from buying US companies (China and Unocal, Dubai Ports and US ports management). Thus the Asian Central Banks buy dollars from their exporters and give them local currency which they have to sterilize by selling local currency bonds increasing the domestic national debt on which they pay a higher interest rate than they receive on their increasing dollar reserves rapidly depreciating in value and purchasing power. This stokes the fires of domestic inflation while the dollar reserves are invested in US treasuries keeping US interest rates and inflation lower than what they should be.
The asset bubbles created by sloshing liquidity have pushed house prices the world over higher than affordable income and they have begun crashing in Ireland, Spain, UK, Australia and America. There is a glut of housing in America and no shortage of land. Just like in Japan in the nineties, house prices will fall by 25% or more. Japan at that time had a trade and current account surplus and no inflation so it could run huge budget deficits and keep interest rates at half a percent for a decade and is still not fully out of a deflationary quagmire. The US with its current account, trade and budget deficits, a high inflation and drastic cuts of rates by the Fed has no ammunition left to counter a recession or economic meltdown. The huge losses of capital by financial institutions reduce their lending ability by twice or thrice their losses. The secretive lack of transparency leads to mistrust and fear reducing lending and transactions due to counter-party risk. This clogs up the credit markets and increases credit default swap prices, which the Fed printing money cannot remedy.
Sovereign Wealth Funds like those of Abu Dhabi, China, Singapore have already seen their first foolish investments in Western Banks lose a third or more in value in six weeks and are presently reluctant to throw good money after bad. Thus America faces a decade or more of privation, stagnation, inflation in commodities and deflation in assets if it does nothing, a marked reduction in status and hegemony if it can successfully beg the Sovereign Wealth Funds to recapitalize its banks (unlikely because China will need over a trillion dollars to recapitalize its own bankrupt state banks with corrupt lending and humongous non-performing assets or demand Taiwan, and oil rich Gulf States may ask for a pound of flesh from the Israelis). The last alternative is a Federal bailout like what the RTC did for Savings and Loan Banks in the Reagan era. This may save the domestic economy somewhat, but will increase inflation and pressure the dollar further. A final alternative more in keeping with the temperament of the nation is to use its military might to capture new wealth and resources and compel creditors to wipe out the debt of America. All choices like those for Iraq are bad.
Three important truths must never be forgotten.
The lies of the current UPA government of India regarding the civilian nuclear deal and the changing lies of the current US president regarding the elective preemptive Iraq war are perfect examples. The Indian Constitution unfortunately has no clause for ratification of treaties by parliament. The US Constitution was framed by a wiser Madison who foresaw the benefits of war for the president and thus gave the power to the Congress which over the last hundred years has mostly been composed of rubber stamping morons and sycophants without integrity, honesty or intelligence.
'War is in fact the true nurse of executive aggrandizement. In war, a physical force is to be created; and it is the executive will, which is to direct it. In war, the public treasures are to be unlocked; and it is the executive hand which is to dispense them. In war, the honors and emoluments of office are to be multiplied; and it is the executive patronage under which they are to be enjoyed. It is in war, finally, that laurels are to be gathered, and it is the executive brow they are to encircle.'
Thus spake and wrote Madison, but in the hope of adding Canada to the Union while the British were occupied with the threat of Napoleon of France, he went to war in 1812 with disastrous consequences.
There is little hope of America having a decent and responsible Congress or President, so like Plato's draconian prescription for 'The Guardians', the people of the US need to pass a national referendum by which, those presidents and Congress who authorize an elective, unprovoked, preemptive and offensive war must immediately go for active combat duty on the front line as soon as the war starts, instead of sending the children of the common or poor people to become cannon fodder. A second referendum needed to pass is that the salaries of all elected officials be decreased every year by the rate of inflation and omitted altogether including their perks, privileges and pension benefits, every year that the budget is in a deficit. The leaders with all their cries of patriotism should loudly proclaim that they regret that they have but one life and one salary to offer in the service of their nation. Their failure to do so would make the truth obvious that patriotism is the last refuge of scoundrels.
Let me illustrate why the above are essential. A foolish Bush by his burning desire for war has raised the price of oil from $25 to $110 thus raising our oil import bill to nearly 500 billion dollars which go to some OPEC members who are not our friends and may even be financing terrorists. The war, according to Nobel Prize winning economist Joseph Stiglitz, will cost us an additional three trillion dollars. As I predicted in 'Federal Reserve has a Sophie's Choice', Bernanke like Greenspan has flooded the markets with money, shunned transparency and used his position to buy junk mortgage bonds to keep the crooked banks afloat and on Friday gave a non-recourse (not required to be repaid) loan to JP Morgan Chase Bank to pass the money on to Bear Stearns to rescue it. Bear Stearns was one of the offending culprits that securitized, packaged and sold this weapon of mass destruction to other banks, insurance companies, pension funds and individuals blinded by greed and ignorance. The securities were created by duping naive, ignorant people desperate to own a home. One might as well give the Nobel Prize for Medicine to Typhoid Mary who began an epidemic of typhoid in America a century or so ago.
The facile argument used is that the collapse of Bear Stearns would be contagious and other big avaricious institutions with highly leveraged bets would be sucked in to the whirlpool of counter-party credit default risk, leading to a cascade of defaults. Nobody mentions the fact that lack of due diligence by the rating agencies (Moddy's, S&P, Fitch etc.), unthinking greed and absence of caution and prudence by the mono-line insurers (MBIA, Ambac, FGIC etc.) and absent supervision and regulation by the Fed, Bank examiners etc. led to the burgeoning 500+ trillion dollar unregulated derivative market that will ruin the US economy. Greenspan encouraged irresponsible behavior by consumers by recommending the use of adjustable rate mortgages, without prohibiting the institutions from luring home buyers with teaser ARM rates that jumped exponentially on resetting in a year or two. The gullible sub-prime borrowers never read the fine print and the Fed's job is only to protect the big boys, not common folk. No such grand plan has been put into effect for the payment delinquent home buyers. The taxpayer will foot the bill just like in the S&L debacle of the Reagan era and the institutions will do their mea culpa like Reagan, by saying 'mistakes were made', but we are not responsible.
History and geography bear witness to governments' debasement of currency. The Roman emperors reduced the gold and silver content of their coins and replaced them with lead. The US government and the Fed are sinking the dollar by deficits and making the dollar a fiat currency. From Argentina to Zimbabwe hyperinflation devalued the national currency. One needed billions of Reichsmarks to buy a pack of cigarettes in Weimar Germany. The lust for bigger kingdoms of tyrants and CEOs leads to economically destructive wars and takeovers, and the lust for re-election to power in democracies leads to earmarks, COLA increases in Social Security and deficit spending to please voters. They eventually lead to national ruin.
Look at the nation destroying policies of puppet Manmohan Singh and his fiscally irresponsible Finance Minister Chidambaram. To avoid losing in state elections, the central government did not raise the price of gasoline, continued the cooking gas subsidy causing severe losses to PSEs (to be subsidized from the national exchequer), started a rural employment program laden with corruption to enrich crooked and corrupt local party leaders and bureaucrats and caused heavy losses to nationalized banks by forgiving farmer loans. This last bribe for votes will be ineffective as most poor farmers do not qualify for bank loans and borrow from moneylenders at exorbitant rates. They will not be saved and nor will the US sub-prime borrowers. The profligate deficit spending increases the national debt, a burden to be borne by future generations. It is this same malfeasance that allows Bernanke and Blunder Bush to make whole the fat cats who finance the latter's election and the political parties, while leaving a staggering burden on future generations. The previous nation destroyer Greenspan now travels from state to state and country to country giving speeches at I don't know how many thousands of bucks a speech and gets handsome advances for his memoirs like Bush Sr., Clintons (Bill & Hillary)
The life of politicians is like the passage of food through the human alimentary canal. No matter how appealing to taste, smell and vision, the food maybe at the beginning prior to intake and passage (winning elected office), politicians ultimately (after winning elected office) become visually disgusting, foul smelling waste of little use and possibly great hazard. At best they can only be used as fertilizer and that also after appropriate treatment, so as not to be a threat to public health.
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