The Code for Global Ethics:

"We do not want a PAX Americana enforced on the world by American weapons of war. Not the peace of the grave or the security of the slave. I am talking about genuine peace, the kind of peace that makes life on earth worth living, the kind that enables men and nations to grow and to hope and to build a better life for their children — not merely peace for Americans but peace for all men and women — not merely peace in our time but peace for all time."

President John F. Kennedy, 1963

"I will not hesitate to use force unilaterally, if necessary, to protect the American people or our vital interests wherever we are attacked or imminently threatened. ...

We must also consider using military force in circumstances beyond self-defense, in order to provide for the common security that underpins global stability — to support friends, participate in stability and reconstruction operations, or confront mass atrocities."

Sen. Barack Obama, Foreign Affairs (July/August 2007)

"Our interest in Afghanistan is to prevent it from becoming a haven for terrorists bent on attacking us. That does not require the scale of military operations that the incoming administration is contemplating. It does not require wholesale occupation. It does not require the endless funneling of human treasure and countless billions of taxpayer dollars to the Afghan government."

Bob Herbert, The New York Times, January 6, 2009

Those who thought that the election of Barack Obama as American President would mean a fundamental shift in U.S. foreign policy should have lost their illusions by now. Faces change but the system remains. When you want change, it's necessary to look beyond a single individual and evaluate the team he is working with ...or for. And the Obama team is what can be called a soft neoconservative team, all devoted to maintaining the military-industrial complex, and all sold out with the ideology of permanent wars rather than permanent human progress.

The truth is that during the last election, both candidate McCain and candidate Obama were favorable to the policy of permanent wars under the cover of fighting terrorism. That is the reason I had concluded then that candidate Obama was only marginally superior to candidate McCain, but not fundamentally different. In fact, I believe that as far as character goes, McCain was probably more his own man than Obama, who has demonstrated a tendency to align himself with powerful interests in order to bolster his political career.

There seems to have been a deal here: Obama will be kept busy shaking hands, traveling and delivering grand speeches or sermons, while Chief of cabinet Rahm Emanuel would run the White House. Everything then felt into place: Marine Corps General James Jones was named National Security Advisor (N.B.: The national security adviser heads the National Security Council, which is the part of the White House structure that deals with foreign policy), and Bush's Defense Secretary Robert Gates was asked to remain at his post. This alone should have persuaded most everyone that U.S. foreign policy would only change in tone, not in substance.

By enlarging and expanding the Afghanistan-Pakistan war just as U.S. troops reduce their unwelcomed presence in Iraq, Obama has de facto endorsed interventionism and militarism as the cornerstone of his foreign policy. This is a failed policy, besides being immoral, because it requires the pursuit of a contradiction, i.e. killing civilians and supporting authoritarian regimes while attempting to obtain the support of a foreign population in favor of democracy.

What is more, Obama is enlarging a war that has no clear rationale behind it and no clear objectives. If the main rationale is to build his political image as “commander-in-chief”, then Obama is falling into the same trap as George W. Bush. The Afghanistan-Pakistan war will be his war and it will be a quagmire. When he signed an order increasing U.S. troops by 17,000 combat and support personnel in Afghanistan, then newly sworn in President Barack Obama said the war in Afghanistan was “still winnable”. What did he mean? Does it mean that the U.S. will have troops over there for decades?

It seems that nothing is learned from history and that everything has to be relearned. —Such a policy failed miserably in Vietnam, and it is most likely to fail again in Afghanistan-Pakistan, two countries whose borders are highly artificial, having been imposed by imperial Great Britain in the nineteen century. It also failed for the Soviets who had to withdraw from Afghanistan after eight-and-a-half disastrous years. Soon after, the entire Soviet regime collapsed.

Indeed, by enlarging the Afghanistan-Pakistan War, President Obama is embarking on a course of action that could eventually destroy his presidency. It will be a repeat of President Lyndon B. Johnson who was destroyed politically with his Vietnam War, even though this was a war he had not started. As in Vietnam, the ill-conceived Afghanistan war will become a war of attrition that will drain public support and finances as the war becomes more and more americanized. This will be another tragedy.

If Obama listens to the military, as he obviously seems to do, he will be fed the deadly pablum that every problem in the world is a military problem. But this is false and counterproductive. In fact, bombing civilian populations will only enrage them against the invaders, just as bombing the United States would naturally enrage Americans. On that, Obama and his team are on the same wavelength and on the same path to disaster as Bush-Cheney and their neocon sycophants.

–This is too bad. President Barack Obama is quickly wasting his political capital and his political credibility. And once lost, it will be difficult to regain them.

Rodrigue Tremblay is professor emeritus of economics at the University of Montreal and can be reached at

rodrigue.tremblay@ yahoo.com.

He is the author of the book 'The New American Empire'.

Visit his blog site at www.thenewamericanempire.com/blog.

Author's Website: http://www.thenewamericanempire.com/

Check out Dr. Tremblay's coming book "The Code for Global Ethics" at: http://www.TheCodeForGlobalEthics.com/

*****The French version of the book is now available.

See: http://www.lecodepouruneethiqueglobale.com/

Or on Amazon Ca.

Posted, Sunday, June 14, 2009, at 5:30 am

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Friday, May 29, 2009

Trade Protectionism and Worldwide Economic Contraction

“I almost went down on my knees to beg [President] Herbert Hoover to veto the asinine Hawley-Smoot Tariff.”...“That Act intensified nationalism all over the world.”

Thomas Lamont, banker and economic adviser, June 1930

"Now is a time where we have to be very careful about any signals of protectionism."

President Barack Obama, February 19, 2009

“From the purely economic point of view nothing speaks against free trade and everything against protectionism.”

Ludwig von Mises (1881-1973), Austrian economist

When the economy is booming, foreign borrowings and imports of goods and services from other countries are most welcome. They allow for more spending without inflation and they raise living standards. It is a version of having your cake and eating it too. In an economic downturn, however, the political reflex of populist politicians is to turn protectionist and to become economic isolationists by raising trade barriers. In such an environment, foreign competition becomes a convenient scapegoat for the crisis, even though the causes of such crisis are most often purely domestic in nature.

Regarding trade, the Obama administration seems to have adopted the “good cop, bad cop” routine, extolling the virtues of free trade in presidential speeches while letting Congress pass protectionist measures in series. The fear here is a repetition of the 1930s when American politicians rushed to pass the infamous Smoot-Hawley Tariff act of 1930 that triggered an international trade war and which accelerated the worldwide economic downturn. World trade plummeted into a spiral downward and domestic production for exports contracted everywhere. Normal trade links were disrupted and intricate inter-country production arrangements were dismantled.

Indeed, in a misguided attempt to fight the economic downturn, governments all over the world rushed to adopt self-destructive “beggar-thy-neighbor” policies, in a futile attempt to devalue each other's currencies and to reduce their imports in retaliation, forgetting that one country's imports are the other country's exports. The consequence was that from 1929 to 1933, the value of world trade contracted by two-thirds, going from $5.3 billion to $1.8 billion.

The world economy went down with world trade and every country was worst off as a consequence. A severe recession was then turned into a worldwide economic depression. This is because trade protectionism in the modern world is the equivalent of “cutting off your nose to spite your face” and its main consequences are to spread poverty and economic dislocations.

Some seventy years later, the same mistakes risk being repeated. Most modern economies are interrelated and if politicians begin to unravel such an economic integration, the consequences may be even worst than in the 1930s, because economic integration is much more advanced and prevalent than it was then.

World trade is already contracting due to the current global financial crisis, a decline in commercial bank trade credits and a drop in private investments. According to the World Bank's projections, total world trade in goods and services this year is expected to fall 6.1 percent. The decline will particularly hurt large export-led economies such as Mexico, Germany and Japan.

The issue of protectionism is also particularly important for Canada, the U.S.'s most important trade partner. The United States and Canada not only share this continent, but they also have a mutually beneficial trading relationship that has been enhanced with the signing of the Canada-U.S. Free Trade Agreement on October 12, 1987. This treaty was enlarged in 1994 to include Mexico with the implementation of the North American Free Trade Agreement (NAFTA). As a consequence, there are no tariffs on most goods that pass between Canada and the United States.

In 2008, Canada's trade with the United States accounted for about 76 percent of its total international exports and 63 percent of its imports, while U.S. exports to Canada represented about 20 percent of total American exports. A lot of American jobs are tied to American exports to Canada. In fact, Canada is the leading export market for 36 of the 50 U.S. States and Canada is a larger market for U.S. goods than all 27 countries of the European Community combined.

Moreover, Canada is the single largest exporter of total petroleum to the United States, supplying the U.S. with more than 2.5 million barrels per day. What is more, this oil supply is guaranteed under Nafta. There is also an important and growing cross-border trade of electricity between Canada and the United States that links the two economies.

This does not mean, however, that trade frictions between Canada and the United States do not exist. Sometimes politicians behave as if the trade agreement between the two countries did not exist. A case in point is the routine inclusion of “buy American” provisions in spending bills voted by the U.S. Congress, which can be considered overt protectionist trade-distorting measures and contrary to the spirit and the letter of the free trade agreement.

If the lessons of the past have been learned, governments should resist the temptation to export their economic problems abroad and should work instead to stimulate their economies without resorting to protectionist measures. What is needed now is to avoid sending the world economy into a self-reinforcing contraction that would hurt everyone.

_____________________________________

Rodrigue Tremblay is professor emeritus of economics at the University

of Montreal and can be reached at

rodrigue.tremblay@ yahoo.com.

He is the author of the book The New American Empire.

Visit his blog site at www.thenewamericanempire.com/blog.

Author's Website: www.thenewamericanempire.com/

Check out Dr. Tremblay's coming book

The Code for Global Ethics at:

www.TheCodeForGlobalEthics.com/

*****The French version of the book is now available.

http://www.TheNewAmericanEmpire.com/tremblay=1111

_____________________________________

Posted, Friday, May 29, 2009, at 5:30 am

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COMMENTS (3)

Wednesday, April 29, 2009

The Mixed Economic Report Card on Obama's First 100 Days

"An election cannot give a country a firm sense of direction if it has two or more national parties which merely have different names but are as alike in their principles and aims as two peas in the same pod."

Franklin D. Roosevelt, 32nd US President (1933-45)

“Behind the ostensible government sits enthroned an invisible government owing no allegiance and acknowledging no responsibility to the people.”

Theodore Roosevelt, 26th US president (1901-1909)

"I don't remember any time, maybe even in the Great Depression, when things went down quite so fast, quite so uniformly around the world."

Paul Volcker, former U. S. Fed Chairman

"Prosperity is just around the corner."

President Herbert Hoover, 1932

“This recession was not caused by a normal downturn in the business cycle. It was caused by a perfect storm of irresponsibility and poor decision-making that stretched from Wall Street to Washington to Main Street.”

President Barack Obama, April 14, 2009

On April 29, 2009, President Barack Obama completed his first 100 days in office, a symbolic milestone. In somewhat of a parallel to Franklin Delano Roosevelt, who succeeded the beleaguered administration of Herbert Hoover, Barack Obama took over from a most clumsy predecessor, George W. Bush.

And, just as for Roosevelt, Obama had a window of opportunity in his first 100 days in office to initiate new ways of doing things and new policies. He had all the incentive, mandate and leeway necessary to distance himself from the previous administration and profoundly change things for the future.

On the economic front, for example, facing a most urgent challenge then as of now, President Roosevelt immediately embarked upon a comprehensive program of fundamental reforms and of public works. For instance, he did not hesitate to close American banks, going as far as to declare a "bank holiday" from March 6, 1933 to March 14, 1933, in order to reorganize the banking system and to clean up the banks' books. The purpose, of course, was to renew public confidence in financial institutions and to reestablish the flow of credit and the level of spending in the economy.

Some seventy-six years later, it is fair to say that President Barack Obama was much less determined in dealing with a similar, serious banking crisis, firstly by reappointing or keeping officials close to the previous Bush administration (Timothy Geithner, Ben Bernanke, etc.) and secondly, by prolonging Bush's policies of subsidizing “too big-to-fail” and “too big-to-manage” mega-banks with a minimum of conditions, instead of restructuring them and changing their business model.

This applies to Fannie Mae, Freddie Mac, American International Group (AIG), and a host of large international investment banks (J.P. Morgan Chase, Goldman Sachs, Citibank, Wells Fargo, Sun Trust Bank, HSBC Bank USA, etc.) that have indulged in casino finance rather than concentrating on channeling stable capital into the economy. In so doing, and in contrast to what Franklin D. Roosevelt did, Obama did not confront and reverse the unhealthy and corrupt symbiosis between big business and big government, which most everybody knows to be the main cause of the current financial crisis; he prolonged it.

For example, no thorough investigation on the basic causes of the financial crisis has been launched, and no structural changes in the financial system have been advanced, above and beyond throwing trillions of public dollars to camouflage the problem. Consequently, mega-banks can still rely on casino finance through the derivative market, still package and collaterize long-term loans into risky short-term financial instruments. Similarly, gamblers can still buy Credit Default Swaps (CDS), even though they have no owned securities to protect, while simultaneously engaging in naked short selling of the stocks of companies, in the hope of depressing the price of their collaterized debt obligations (CDO). The derivative market is the greatest grand casino of all, and if left unregulated, it will come again to haunt the real economy in the future.

Another issue that the new administration failed to tackle is the practice of vulture or predatory capitalism, where financial operators are allowed to raid profitable companies and to saddle them with the debt incurred to take them over. Through such a process, prudently managed companies become the prey of unscrupulous financial operators who raid them while resorting to the practice of leveraged finance.

Most amazing of all, maybe, is the lack of concern about the repeal of the 1933 Glass-Steagall Act, and its replacement, in late 1999, by the pro-banks Gramm-Leach-Bliley Act (GLBA) that, in effect, removed most regulations of risk-taking investment banking. A similar issue is the lack of concern about the way the Securities and Exchange Commission (SEC) abandoned its role of protector of the public interest and became a cheerleader of the mega-banks.

All this leads to the observation that the structural financial problems of the American banking system have not been aggressively tackled and corrected, and that future financial crises and their attendant economic dislocations can be expected. The record will show that President Obama, in his first 100 days in office, has given the impression of being co-opted by Wall Street and its laissez-faire ideology, at a time when a clean break was necessary.

When there are flaws in the policies of a new administration, the responsibility may not rest with the President alone, but one must look at his entourage. For better or for worse, President Barack Obama has surrounded himself with close advisors who are cut from the same cloth: Rahm Emanuel as his Chief of Staff, David Axelrod, as his senior political adviser, and Lawrence Summers, director of the National Economic Council and his top economic adviser. Since these advisors have been known in the past to be opposed to the regulation of exotic financial instruments, this could explain why President Obama chose someone to head the strategic Commodity Futures Trading Commission (CFTC) who is also opposed to such regulation, Mr. Gary Gensler. Keep in mind that the CFTC is one of the outfits that regulate the trading in futures contracts on a host of derivative products that have magnified the subprime mortgage meltdown.

Sometimes the real influence of close advisors on policies and decisions can be stronger than that of the President himself, the latter being busy making speeches, appearing on TV shows and traveling around the world. The image that comes to mind is the boxer who is taking it on the chin in the ring, while the backroom managers run the shop. Obviously, President Obama's entourage seems to be most influential... for better or for worse. And they have a bias towards Wall Street rather than Main Street.

Rodrigue Tremblay is professor emeritus of economics at the University

of Montreal and can be reached at

rodrigue.tremblay@ yahoo.com.

He is the author of the book The New American Empire.

Visit his blog site at www.thenewamericanempire.com/blog.

Author's Website: www.thenewamericanempire.com/

Check out Dr. Tremblay's coming book

The Code for Global Ethics at:

www.TheCodeForGlobalEthics.com/

*****The French version of the book is now available.

http://www.TheNewAmericanEmpire.com/tremblay=1110

_____________________________________

Posted, Wednesday, April 29, 2009, at 5:30 am

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COMMENTS (3)

Thursday, March 26, 2009

The Dance of the Trillions to Shore up Banks, Bankers, and Gamblers

"Deficits in the, let's say, 5 percent of GDP range would lead to rising debt-to-GDP ratios that would ultimately not be sustainable."

Peter Orszag, Obama White House budget chief

“The [US] financial system is facing possible total losses of $7 trillion. ...With the banks 'effectively insolvent', we've concluded that the only viable solution is nationalization.”

Matthew Richardson and Nouriel Roubini, American economists

“China is worried that the U.S. may solve its problems by printing money, which will stoke inflation.”

Zhao Qingming, Chinese financial analyst

"Whoever controls the volume of money in any country is absolute master of all industry and commerce."

James A. Garfield, (1831-1881) 20th President of the United States

After ten years of wholesale financial deregulation, bad policies and unsound banking practices, and facing a worsening recession, over the last year and a half the U.S. government has been pumping trillions of dollars in order to deleverage and recapitalize banks that were on the brink of insolvency. But the banking crisis is of such a magnitude, and the damage done to the financial system so widespread, that each pumping of money into the system has never seemed to be enough. This is because numerous American financial institutions, and among the largest, have suffered multibillion-dollar losses, not only with subprime mortgages, but especially with large amounts of derivative products that have turned sour. Not the least of these are the famous gambling products called credit default swaps, (CDS), [which the Bank of International Settlements is reporting to be worth some $57 trillion.

For its part, ever since the collapse of the investment bank Bear Stearns on March 15, 2008, the Fed has pumped trillions of dollars, under various forms, into sick financial institutions in order to keep them afloat, or in order to merge them with other entities.

In the case of Bear Stearns, for example, the Fed guaranteed $29 billion so that the new owner of Bear Stearns (JP Morgan Chase) would not suffer losses on the most risky assets on the books of the acquired bank. The Fed has also been buying loads of financial assets from troubled institutions, thus issuing new “high-powered” money against such assets. On November 25, 2008, for example, the Federal Reserve Board launched its up-to-one-$ trillion Term Asset-Backed Securities Loan Facility (TALF) to support the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA).

As recently as March 17, 2009, the Fed has also announced that its purchases of Fannie Mae and Freddie Mac Mortgage Backed Securities (MBS) would be expanded from $500 billion to $1.25 trillion, and that it intends to double its purchases of Fannie Mae, Freddie Mac, and Federal Home Loan Bank bonds to $200 billion from the $100 billion intended initially.

Because the Fed stands ready to buy large amounts of the newly issued Treasury bonds to cover the large U.S. government's fiscal deficit, it can be said that the Fed is actively and effectively busy monetizing both the public debt and private financial debts. As a consequence, the Fed's balance sheet has ballooned to over $2 trillion now from less than $900 billion only one year ago. And it is likely to continue to expand in the coming months. Some of these loans will be repaid in the future and some of the new money will be retrieved, but if the Fed were to sell its portfolio of Treasury bonds to prevent an onset of inflation or to prevent the U.S. dollar from depreciating too fast, bond prices would drop significantly and interest rates would also rise quickly.

Similarly, the U.S. Treasury has been “investing”, guaranteeing and loaning hundreds of billions of dollars of public money to large American banks. It began on earnest last September, after the large investment bank Lehman Brothers($691 billion of assets at the end of 2007) failed and the large world insurance company American International Group (AIG) followed thereafter and became insolvent. Then, the U.S. Congress passed in a hurry the $700 billion Troubled Assets Relief Program (TARP), under the threat of a financial Armageddon.

It has been evaluated that all these public bailouts of the financial system amount together to a staggering $12.9 trillion, nearly as large as the U.S. economy (GDP) at some $14 trillion, and larger than the current U.S. national debt of $11 trillion. This includes, of course, the close to $800 billion Obama Economic Stimulus package that the new administration sent to Congress in February and that Congress passed with a minimum of Republican support (none in the House and three in the Senate).

That is where we stand.

On Monday, March 23, Treasury Secretary Timothy Geithner announced that the Obama administration had decided to create a Public-Private Investment Program, and to pour $75 to $100 billion into it, the money coming from remnants of the old TARP program. The purpose, this time, is to rid American banks of the bad financial assets that are destroying their balance sheets, to the point of insolvency. What the new “Program” calls for is the purchase of as much as a half-trillion dollars of the American banks' so-called toxic assets, with the government providing 85 percent of the funds to willing private investors at low interest rates, and guaranteeing (through FDIC) any loss on the financial assets that banks will unload through public auctions. The political attractiveness of this measure is that it provides a public subsidy to the banks and other financial institutions without Congress having to debate and vote new funds. It can be done administratively.

What can be said is that finally the Obama administration is doing, through the back door, what I myself recommended last April 12, 2008. The Obama administration, in effect, has decided to create the equivalent of the old Resolution Trust Corp. to liquidate bad mortgage-backed assets and other bad financial bets made by the banks and large insurance companies, such as AIG. The way that it is being done, however, is questionable, because this may turn out to be very costly to the U.S. taxpayers and is less than transparent.

Indeed, the new entity to be created would be tailored somewhat along the lines of the 1980s' Resolution Trust Corp., which was established to dispose of the bad real estate assets of savings and loan institutions. However, and this may be a sign of the times, the new public-private program would be a mixed venture and would be far from having the same powers that the RTC had in managing the current troubled banks. Nevertheless, the new PPIP will fill essentially the same basic function as the RTC, i.e. selling bonds and borrowing in order to finance the purchase of bad “toxic” assets from insolvent or near insolvent institutions, in partnership with private investors and managers.

Financially, this is an operation that could be very profitable to the private firms that join the government in the operation, because the profit potential for them is high and the risks of losses are at a minimum, since such losses will be underwritten by the government. Therefore, most everybody in the private financial industry stands to win with the new policy: 1- the banks will rid themselves of bad assets at enhanced market prices (compared to what they are worth today); 2- banks' shareholders will see an appreciation in the value of their common shares; and, 3- private investment firms and hedged funds will buy some of these assets at prices lower than par, using low cost non-recourse government loans, and all the while being fully protected by government guarantees of no loss to themselves. The only losers in the operation could be the American taxpayers who are guaranteeing that there would be no loss to private investors. That is the reason Wall Street rallied 500 points after the announcement of the new banks' bailout. Cynics could say that this is American-styled capitalism at its best: no loser except possibly the government and the taxpayers who support it. How it is going to play politically is anybody's guess. It may be a good thing for the Obama administration that such a plan is not going to be debated in Congress.

When all is said and done, the Obama administration is essentially pursuing a policy similar to the one followed by the Bush administration, i.e. supplying public money to private banks and to private investors with a minimum of strings attached. Remember that last September, the Bush administration committed $400 billion to obtain a near 80 percent control in the world's two largest mortgage companies, Fannie Mae (Federal National Mortgage Association: FNM) and Freddie Mac, (Federal Home Loan Mortgage Corporation: FRE) which were close to insolvency. Instead of taking them over and placing them into administrative receivership, in order to change their business model and their lending practices, since the government was guaranteeing these two institutions' outstanding debts, (more than $ 5 trillion US), the Bush administration chose instead to keep up the appearance that these were still two privately run banks and only appointed a legal conservator for Fannie Mae and Freddie Mac. The rest was business as usual, including the payments of huge bonuses to the entrenched management.

Similarly, with the new Public-Private Investment Program, the Obama administration would have the authority to place a failed bank deemed 'too big to fail' in the equivalent of a conservatorship, while keeping its management more or less intact. One thing is different this time, however. Indeed, contrary to what happened after the U.S. government poured $185 billion into the large insurance company AIG, this time around the Treasury Secretary would have the power to limit payments to creditors and to break contracts governing executive compensation. The fact remains that there is still no intention of placing the most insolvent firms into administrative receivership and to change their business model or practices.

In conclusion, let us say that there will be consequences following from all this bailout money. In particular, what foreign lenders, especially the Chinese, do with their holdings of U.S. dollar-denominated debt, considering the risk of future interest rates hikes and future dollar depreciation. Already, China's Premier Wen Jiabao has publicly raised his government's concern about the safe value of the U.S. Treasury bonds and other dollar-denominated assets that they hold in huge quantities. —But, I guess, this is something for another day.

_____________________________________

Rodrigue Tremblay is professor emeritus of economics at the University

of Montreal and can be reached at

rodrigue.tremblay@ yahoo.com.

He is the author of the book The New American Empire.

Visit his blog site at www.thenewamericanempire.com/blog.

Author's Website: www.thenewamericanempire.com/

Check out Dr. Tremblay's coming book

The Code for Global Ethics at:

www.TheCodeForGlobalEthics.com/

*****The French version of the book is now available.

http://www.TheNewAmericanEmpire.com/tremblay=1109

_____________________________________

Posted, Thursday, March 26, 2009, at 5:30 am

Email to a friend:

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COMMENTS (7)

Friday, March 6, 2009

How Tinkering with Inflation Measurements May Have Led to the Current Financial Crisis

"There are three kinds of lies: lies, damned lies, and statistics."

Mark Twain, (1835 - 1910)

“The Cost of Living [has been] replaced by the Cost of Survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food, perhaps, after that.”

John Williams, private economist

“The consumer price index is being understated by at least 1 percent per year.”

Bill Gross, professional investor

"... The development of credit derivatives has contributed to the stability of the banking system by allowing banks, especially the largest, systemically important banks, to measure and manage their credit risks more effectively. In particular, the largest banks have found single-name credit default swaps a highly attractive mechanism for reducing exposure concentrations in their loan books...."

Alan Greenspan, Fed Chairman, May 5, 2005

Last February 20th, the U.S. Department Of Labor Bureau of Labor Statistics announced that, on a seasonally adjusted basis, the U. S. Consumer Price Index (CPI) increased by 0.3 percent during the month of January (on a yearly basis). Some independent economists, however, think that the real inflation rate is much higher, possibly as high as 7.52 percent (on a yearly basis). Why is that so?

The CPI is a measure of how much the price level of a basket of representative consumer goods and services, adjusted for predictable seasonal shifts, is supposed to have varied during a month or a year. Such a measure has been provided by the Bureau of Labor Statistics since 1919, covering the period between 1913 and today.

For many people, the CPI is less a measure of inflation than an imperfect measure for adjusting cost of living allowances. It is a technique that plays a central role in computing increases in the Cost Of Living Allowances (COLAs) of various money disbursements, incomes and wages. Some incomes, for example, such as Social Security payments and other entitlements, are statutarily adjusted upwards when the CPI goes up, and such adjustments have a direct influence on one's standard of living.

Economists have long debated the best methods of measuring inflation, especially as it affects the cost of living of various categories of consumers. This is a complex issue that involves statistical methods in calculating price indices, economic principles and notions of social justice. Moreover, not everyone is impacted equally by a rise in the overall level of consumer prices, depending on one's economic and financial situation. For example, for people living in a city and who are renters, a rise in the price of cars or of houses would not have the same predictable effect on them as it would on folks living in a rural area and who own their own homes. And it is not everyone who can deflect the negative impact of a rise in the price of consumer goods on their standard of living by substituting less costly items.

For the period between 1913 and 1982, the formula for measuring consumer inflation in the U. S. was pretty much straightforward. Government statisticians would periodically collect prices in certain identified areas with which the Bureau of Labor Statistics would then construct price indexes. Over time, surveys of consumer expenditures were conducted and the weight of different goods in the index would be adjusted accordingly to reflect people's new buying habits.

In the early 1980s, the Reagan administration feared that the standard CPI index overstated the impact of overall inflation on the cost of living of many recipients of government payments, the most important ones being Social Security outlays. The decision was then made to move away from the objective of having a general consumer price index measuring overall consumer inflation and adopt instead the policy of constructing a cost-of-living index that more closely reflected the true impact of inflation on different categories of consumers. That is why, since 1982, the CPI measurements that the Bureau of Labor Statistics publishes relates more to the cost of living, as defined and periodically revised, than to providing accurate information about the level of general inflation. [As a matter of fact, another government agency, the Bureau of Economic Analysis (BEA), has the responsibility to calculate a price deflator for consumption expenditures and other expenditures as part of the National Income and Product Accounts (NIPA).]

Indeed, in the mid-1990s, substantial changes were made to the CPI index which had the net result of lowering the official measure of consumer inflation. First, increases in asset prices, such as in housing, were only indirectly taken into account. For example, the 2002-2006 real estate bubble hardly registered at all in the CPI because only ‘imputed’ home rents for home owners were used in the index. At that time, rents were virtually stagnant in many cities due to overbuilding. Secondly, arbitrary downward adjustments were made in the prices of certain goods to reflect their enhanced quality. It is true that cars, TV sets or cellular phones are more performing today than their alternatives in the past, and this raises people's standard of living. However, such goods cost more, and the higher prices are not fully recorded in the CPI. Thirdly, and maybe more debatably, in order to concentrate on the impact of price increases on the true cost of living, it was assumed that consumers adjust to higher prices of certain items by substituting relatively less costly goods when relative prices change. For instance, buyers would be assumed to switch from steaks to hamburgers or from beef to chicken when the price of steaks or beef increases. Similarly, people would tend to switch from high-priced stores to discount stores when their incomes do not follow inflation. It can also be assumed that such forced substitutions are not without inconveniences or hardships for the consumers, and thus could indicate a lowering in their standard of living. Nevertheless, these modifications that lowered the official measure of the CPI were incorporated into new statistics from 1982 on.

Consequently, it has become somewhat risky to rely on official CPI figures to obtain a true assessment of inflation. Because of all the changes made in the CPI index since 1982, the CPI has become less and less a true measure of consumer inflation, even though it may or may not more closely reflect the true impact of inflation on people's cost of living. For the overall economy, it is fair to assume that the true inflation rate is substantially higher than what is reflected in official CPI announcements, and this has a compounding effect overtime.

For its part, since February 17, 2000, the Fed uses a “core” chain-type price index for personal consumption expenditures (CTPIPCE), i.e. a price measure for all items less price increases in food and energy. What is at stake here is the danger that government officials may begin to believe their own official inflation figures which are understated, maybe for good reasons as far as cost of living issues are concerned, but nevertheless severely understated as far as the true inflation rate is concerned. This has the potential for disastrous consequences, not only for the public in correctly judging inflation pressures for investment purposes, but also for public officials in framing policy, especially monetary policy.

The most recent example is provided by the pronouncements that Fed officials made during the crucial 2003-2005 period, when a dangerous housing bubble was building up speed and when financial firms were embarking upon riskier and riskier financial schemes. To a man, Fed officials denied there was any risk of inflation and, contrary to what everybody could see, declared that there was no housing bubble going on.

For instance, on March 1, 2003, the No. 2 man at the Federal Reserve, Fed Gov. Donald Kohn insisted that the extremely low short-term interest rates that the Fed was keeping down had not created a speculative bubble in real estate.

In 2004 and in 2005, Fed Chairman Alan Greenspan himself echoed Mr. Kohn and repeated many times that there was no inflation and that he was in no hurry to raise short-term interest rates from their 46-year low level of 1 percent. In April 2004, for example, in remarks on the economic outlook to the Joint Economic Committee, Greenspan remained unconcerned about inflation, declaring that "as yet, the protracted period of monetary accommodation has not fostered an environment in which broad-based inflation pressures appear to be building", just at a time when the housing bubble was but one year from its final top.

At that time, the old pre-1982 CPI formula, as calculated by private economists, indicated that U.S. consumer inflation was above 8 percent and that a housing bubble and a concomitant stock market bubble were in full swing. Future Fed Chairman Ben Bernanke, then a Fed Board member, echoed his mentor in late 2005 by saying that there was no housing bubble to go bust and that the fact that U.S. house prices were rising four times faster than the economy was "largely [a reflection of] strong economic fundamentals."

But, it is now generally agreed that from 2002 to 2004, the American central bank pursued a monetary policy that was too expansionary and that—plus the lack of government regulation of the credit derivative market—contributed greatly to create the conditions for a major financial crisis. Let us keep in mind that in 2004, the Fed Chairman was publicly recommending that people buy adjustable rate mortgages (ARMs), especially interest-only adjustable-rate mortgages, and other subprime loans instead of safer fixed rate loans.

As a matter of fact, most economists agree that interest rates should have been raised as early as 2002. But Mr. Greenspan implied later that he was forced to play politics with his monetary policy, when he declared on September 17, 2007, in an interview with the Financial Times, that “raising interest rates sooner and faster would not have been acceptable to the political establishment given the very low [official] rate of inflation”.

There you have it. What is suggested here is that the push to reelect President George W. Bush, in the fall of 2004, may have played an important role in letting the housing bubble become bigger, thus paving the way for a housing bubble burst in 2005-2006. This is, by the way, on top of the confession that Mr. Greenspan made in interviews promoting his Memoirs (The Age of Turbulence) that he had personally lobbied the Bush-Cheney administration in favor of the unprovoked 2003 U.S. war against Iraq, and that consequently, he was personally tied to the overall political agenda of the Bush-Cheney administration.

When the history of this financial and economic crisis is written, it shall be recorded that the Fed and other government agencies, such as the Securities and Exchange Commission (SEC), did little or nothing to prevent the debt pyramid from reaching the dangerous levels it attained and which is now crashing down, dragging down with it the entire U.S economy and most of the world economies.

Rodrigue Tremblay is professor emeritus of economics at the University

of Montreal and can be reached at rodrigue.tremblay@ yahoo.com.

He is the author of the book The New American Empire.

Visit his blog site at www.thenewamericanempire.com/blog.

Author's Website: www.thenewamericanempire.com/

Check out Dr. Tremblay's coming book

The Code for Global Ethics at: www.TheCodeForGlobalEthics.com/

*****The French version of the book is now available.

http://www.TheNewAmericanEmpire.com/tremblay=1108

_____________________________________

Posted, Friday, March 6, 2009, at 5:30 am

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COMMENTS (5)

Friday, February 13, 2009

Obama, like Bush, is Throwing Public Money into a Black Hole

“The [financial] crisis was not a failure of the free market system and the answer is not to try to reinvent that system. ...Government intervention is not a cure-all."

President George W. Bush, Thursday November 13, 2008

"There is no cause to worry. The high tide of prosperity will continue."

Andrew W. Mellon, Hoover's Secretary of the Treasury. September 1929

"While the crash only took place six months ago, I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover. There is one certainty of the future of a people of the resources, intelligence and character of the people of the United States - that is, prosperity."

President Herbert Hoover, May 1, 1930

Tuesday, February 10, may be the date when the U.S. economy officially entered into an economic depression. This was when President Obama's Treasury Secretary, Timothy Geithner, announced that the Obama administration was about to expand Bush's Secretary Paulson's $700-billion plan to rescue large U.S. banks from insolvency, euphemistically called the Troubled Assets Relief Program (TARP). The purpose now, as it was previously, is to use public capital, loans and guarantees to remove toxic financial assets from private banks' balance sheets and to transfer them to the Government and/or to willing private investors (hedge funds, private equity firms and other investors). One must keep in mind that Mr. Paulson and Mr. Geithner were the principal architects of last October's original plan. This was then, and it is now, a plan designed primarily to use hundreds of billions of taxpayer dollars to prevent banks from declaring bankruptcy, while in fact doing little to accomplish its presumed primary objective of getting banks to resume normal lending. Such a cure has failed in the past and is likely to fail now. Saving insolvent banks is not the same as fixing them and making them viable.

Indeed, when Mr. Geithner announced on Tuesday, February 10, that he was expanding the Paulson plan to make it a $1.5 trillion bailout plan, financial markets saw it as simply rearranging the chairs on the deck of the Titanic, and they sold off. I believe the markets are right and the Obama-Geithner plan only makes the Bush-Paulsen plan worse. Both are misguided and do little to address the root cause of the financial crisis, which is a mountain of unsustainable bad debts that was allowed to expand recklessly over the last ten years, and which is now crumbling down, dragging the entire economy down with it.

With more public money thrown at the problem with little strings attached, large U.S. banks will only use the new cash to de-leverage themselves and pay off their debts, buyout smaller banks and find a way to reward their incompetent executives with large bonuses, but little will trickle down to the real economy. We are back to the discredited Reagan era's economic trickle-down theory, the rich helping themselves first and the poor getting the crumbs.

Let's look coldly at the situation. The ratio of total debt to the U.S. Gross Domestic Product (GDP) is now higher than it was in 1933, when it reached the lofty and unsustainable level of 299.8 percent. It took nearly twenty years to bring down the debt/GDP ratio to below 140 in 1952. In the second quarter of 2008, all debt records were broken when the total debt ratio in the U.S. registered at 356,7 percent of GDP. If the same process of unwinding of excessive debt level plays itself out this time, this could translate into a debt deflation process lasting possibly until 2027!

It all depends on the problem being recognized for what it is, that is to say a mountain of unsustainable and insolvable debts and bets that have to be cancelled and erased from the books. Transferring such bad debts from the banks and other entities to the government will not solve the problem. It will only displace the it from one place to another and potentially create new and even more serious problems, such as horrendous future tax increases or an onset of hyperinflation down the road.

There exists a state of denial in Washington D.C. regarding the excessive debt problem, essentially because the same people who are responsible for creating the mess are in power. It doesn't matter whether a Republican or a Democratic administration is in place, they remain in charge and they rely on the same failed economic policies. The Geithner plan is the son of the Paulson plan. Both are destined to fail because they are based on a flawed diagnosis.

To deflate the mountain of bad debts and unclog the credit system in an orderly fashion, and to prevent a deflationary spiral from taking hold, the Obama administration should take the advice of L. William Seidman, chairman of the S&L Resolution Trust Corp. (RTC), the agency created in the 1990s to manage hundreds of insolvent thrifts. At that time, the RTC seized the assets of troubled savings and loans and resold them to bargain-seeking investors. The Obama administration should bite the bullet and create a similar Banking Restructuring Trust to temporarily take over the large insolvent American banks, streamline their operations, liquidate their bad debts and bets, and reorganize them on a firmer financial basis. I myself proposed such a restructuring trust last September. This would be more efficient and less costly than throwing trillions of dollars down a black hole without even solving the structural problem at hand.

The creation of such a Trust to unify government intervention has also been proposed by former Federal Reserve Chairman Paul A. Volcker and by former Treasury Secretary Nicholas F. Brady. This would entail, of course, that many of the banks' illiquid assets in CDOs ("Collateralized Debt Obligations") and in CDS (“Credit Default Swaps”) and other shaky assets, would have to be written off or cancelled in a chapter 11-like process. Such a process would cleanse the banks from the excesses accumulated in previous years and prepare them to meet credit demand as the economy recovers. But, above all, it would mark an end to incremental, complicated and improvised 'ad hoc' government interventions to solve the banking crisis. I would bet that there would be a powerful rally of financial markets if such a take-charge and decisive approach were to be adopted.

The Geithner bank bailout plan must not be confused with the close to $800 billion fiscal stimulus plan for the entire economy that Congress has adopted. The latter, contrary to the former, is designed to cushion the fall of real spending in the economy and is likely to have a net positive impact. Indeed, as households increase their savings rate and curtail their discretionary spending to compensate for the loss of housing and financial wealth, government spending has to take up the slack.

However, it should be realized that the multiplier effect on aggregate spending of each dollar of fresh public spending is not very high because national economies nowadays are globalized. Indeed, as domestic spending is being sustained, imports increase but exports may decline as world demand contracts. It is only if all governments adopt expansionary fiscal policies that all economic boats can be lifted. With European and Chinese economies weakening, this may take some time before world demand stops contracting.

All this is to say that while the Geithner bank rescue plan is misguided and should be reengineered, Obama's fiscal stimulus package is most likely too timid and should be enlarged, considering the scope of the problem at hand. All in all, let us hope that a prolonged economic depression can be avoided.

Rodrigue Tremblay is professor emeritus of economics at the University of Montreal and can be reached at rodrigue.tremblay@ yahoo.com.

He is the author of the book The New American Empire.

Visit his blog site at www.thenewamericanempire.com/blog.

Author's Website: www.thenewamericanempire.com/

Check out Dr. Tremblay's coming book

The Code for Global Ethics at: www.TheCodeForGlobalEthics.com/

*****The French version of the book is now available.