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***** To pre-order The Code for Global Ethics, by Rodrigue Tremblay, click: The
Code for Global Ethics, Ten Humanist Principles Thursday,
January 7, 2010 Economy 2010: From the Scandalous
Known Past to the Uncertain Future “Homes
rose markedly in value, especially in hot markets like Florida and New York
City. Borrowers believed that
home purchases were no-risk ventures certain to escalade, and they went out
on a limb to buy. Lenders who had once required large down payments now
permitted home purchasers to combine two and three loans to buy a home.
People took out what were called “buffet” loans, which were
interest-only loans that buyers were told they should refinance in three
years or five years. Lenders told home buyers not to worry; homes were rising
so fast in value that it would always be easy to refinance into another loan.
Developpers built larger houses. Why not? Borrowers wanted larger homes. They
needed the space to hold all the things they were buying.” —U. S.
Housing market in 1928-29, in Kristin Downey, The Woman Behind the New Deal
(Frances Perkins), 2009,
p. 106, from Gail Radford, Modern Housing for America: Policy Struggles in
the New Deal, 1996,
pp.10-22 "I
place economy (saving) among the first and most important virtues, and debt as
the greatest of dangers to be feared." Thomas
Jefferson: 3rd US President (1801-09) "America
is more communist than China is right now. You can see that this is welfare
of the rich, it is socialism for the rich -- it's just bailing out financial
institutions. This is madness; this is insanity; they have more than doubled
the American national debt in one weekend for a bunch of crooks and
incompetents." Jim Rogers,
American investor After a decade plus of unchecked greed by
money-changers, of the political dismantling of financial regulation, of
large “too-big-to-fail” banks made larger, of artificial easy
money by the central bank, of the risky securitization of all kinds of debt
instruments and of leveraged buy-outs of scores of companies with their own
debts by financial operators, it was no surprise that the financial house of
cards came crashing down in 2007-2008. It was like a pre-programmed financial
crisis. A perfect financial storm. What lessons can
be drawn from the recent unhealthy and unpalatable past? And, what is in store
for the near future, considering that hardly anything in the financial
environment has changed? A crisis caused by a near total absence of financial
regulation, by a too easy monetary policy and by too much debt, has been met
with no additional financial regulation, by an even easier monetary policy
and by even more debt. In fact, the U.S. ratio of total debt ($57
trillion) to the economy (GDP: $14.5 trillion in 2009) is even higher today
at 3.9, then it was before the onset of the crisis in 2007-08, when it stood
at 3.4. That is why we
will argue here that the problems of U.S. financial dysfunction have not been
solved. On the contrary, they have been swept under the large rug of even
easier money and of even larger debts, which is only postponing the day of
reckoning. For sure, the large Wall Street banks' bad debts have been
transferred to the public sector (the Treasury and the Fed) and to the quasi
public sector (Fannie Mae and Freddie Mac), but the overall debt load of the
U.S. economy has not been reduced; it has been increased. That is why the
U.S. is condemned to continue its foreign borrowing binge for some time to
come. In general, too much foreign
borrowing is bad for an economy, especially if it is done to finance an
excessive level of domestic consumption. When this happens, it is a sign that
total domestic expenditures (government, corporations, consumers) exceed
total incomes. The country lives beyond its means and the gap has to be
filled with net foreign borrowings.
The principal
indicator of this situation is the current account (a broader measure than the external
trade balance) of the country. When a country's current account turns
negative, more money for imports and interest payments is flowing out of the
country than is coming in through exports and investment income. Like any
individual, of course, a country can borrow abroad if its credit rating is
good. The question is how much and for how long. For countries that have fully convertible currencies or, better, for countries
like the United States whose national currency also serves as an international
key-currency, the situation can
endure for a longer period, but there is always a day of reckoning. In general, for
a normal economy, a negative current account that exceeds six (6) percent of
Gross Domestic Product (GDP), especially if this is due to a negative trade
balance, usually indicates a non sustainable situation of foreign borrowing
and foreign indebtedness that can lead to a financial crisis.
Countries like Mexico (1994-95)
and Thailand (1997-98) experienced such a financial crisis in
the 1990's. Such was the case also with Argentina at the turn
of the century. Since 2000, and
coinciding with the arrival of the George W. Bush Republican administration,
the United States has also embarked upon a policy of excessive domestic
spending, resulting in larger and larger and persistent current account
deficits and huge foreign borrowings. Indeed, the adoption of an imperial
foreign policy of permanent war throughout the world, financed
on credit, and an ideological preference for large fiscal deficits, have
translated into large American current account deficits. In 2006, the
U.S. (external) current account deficit reached 6.5 percent of GDP. This was
the apex of external debt sustainability and a harbinger of economic troubles
to come for the U.S. economy. As a matter of fact, this induced me to write
an article on October 16, 2006 entitled “Headwinds for the US
Economy”, in which I warned that it was a "matter
of months, not years",
before the U.S. economy and the U.S. dollar begin to experience some downward
pressures. I repeated the warning a few months later when I wrote on May 5, 2007, (A Slowdown or a
Recession in the U.S. in 2008?), that we could expect "the
collapse of one and possibly several major financial institutions under the
pressures of bad loans and record foreclosures... The rate of foreclosure is
bound to spike in the coming months, possibly culminating in the next two
years into a financial hurricane." This was said many
months before the onset of the 2008-09 recession and the September 15, 2008
failure of the large investment bank Lehman Brothers. In 2008, in the midst of the economic recession, the U.S.
current account deficit was still estimated at –$706 billion (nearly
all caused by a –$707.8 billion trade deficit) for a $14,441 U. S. GDP,
that translated into a 4.9 percent current account deficit relative to the
economy. With the 2008–09 economic crisis and recession, the
US current account deficit has since been somewhat reduced due to a drop in
incomes and in imports, and partly due to a sharp decline in oil prices, but
it is expected to remain above four percent of GDP. In the coming years, this
ratio is likely to increase again as the long-term U.S. fiscal deficit is
expected to remain at 10 percent of GDP for years to come. The Fed's Role
in Creating Asset Price Bubbles The causes of a
financial crisis are complex and can vary from one country to the next. In
general, however, they usually stem from the central bank becoming
subservient to the government when the latter decides to embark upon a policy
of large fiscal deficits. If the central government opts in favor of
monetizing the public deficits and keeping interest rates low, an asset
bubble is bound to emerge. Unfortunately,
that's pretty much what the Greenspan Fed elected to do in maintaining an
easy money policy for too long and in keeping interest rates too low, for too
long, in the late 1990s and in the first part of the 2000 decade. Indeed,
most economists agree that in 2003-04, the U.S. Fed should have raised
short-term interest rates (pushed down to 1 percent in June 2003 from 6.5
percent in December 2000). But the then Greenspan Fed (current Fed Chairman
Ben S. Bernanke has been a Fed Board member since 2002) was deeply embroiled
in the Bush political agenda. Chairman Alan Greenspan publicly acknowledged
this fact when he declared on September 17, 2007,
in an interview with the Financial Times, that “raising interest
rates sooner and faster (before the
2004 presidential election) would not have been acceptable to the
political establishment given the very low
(official) rate of inflation”.
In financial matters, the American central bank (the Fed or the Federal
Reserve System) is a curious animal. It is an institution that
is entrusted to regulate banks and other financial institutions, but it is
partly owned by the large money center banks. It is in a perpetual conflict
of interests. In fact, it can be said that the Fed is the banks' own private
government. In good times, large Wall Street banks, bank holding companies
and other large integrated financial groups, such as AIG (American
International Group), are pretty much left alone and allowed to build
profitable but risky and shaky financial pyramids, with scant supervision.
When things go bad, however, the Fed stands ready to bail them out with
automatic discounting, zero-interest loans and other goodies, the overall
cost being transferred to the general public through an inflation tax and a
debased currency. We know since 2008 that the U.S. Treasury also stands ready
with public money to bailout the large Wall Street banks when their gambles
go sour. The $700 billion Troubled
Assets Relief Program (TARP) is testimony to that effect. A central bank can always print new money. But this is
hardly a magic recipe for prosperity. If it were so, many Third World
countries could claim to have discovered this magic potion. The current
Bernanke Fed is tragically wrong in its belief that it can reverse the
current over-indebtedness situation in the economy and its mismanagement of
the financial crisis by printing money. It is not true that the real economy
always respond positively to heavy doses of monetary stimulus. In fact, the
contrary is usually the case. If it were true, Zimbabwe,
which is an African economic basket case with an uncontrolled bout of
hyperinflation, would be prosperous. The U.S. economy is not exempt from
fundamental economic laws. A few years down the road, people will see why. It is my feeling
that the U.S. economy is presently in the eye of a powerful financial
hurricane of debt liquidation.
Such systemic crisis happens no more than twice in a century and it takes at
least a decade to work itself out. In this environment, one should be wary of
the stock market as a barometer of the real economy. There could be
artificially created short-term “liquidity” rallies, when all the
while the real economy remains in the doldrums. The 2009 liquidity-driven
stock market rally has all the appearances of such a bear market rally
destined to fail and trap many unwary investors. In fact, this rally looks
like a mirror repeat of the 1930 stock market rally that saw stocks retrace
some fifty percent of their initial 1929 losses. We know now that this was
only a mirage, and that the worst was still to come. In my last July 10 blog,
I stated that there is likely to be a prolonged 2007-2017 economic stagnation
period in the U.S. —I reconfirm this assessment, which is reinforced by
my conviction that the Bernanke Fed is making matters worse by its unlimited
printing press so-called “solution” of discounting everything but
the kitchen sink. It is my contention that this imprudent Fed is paving the
way for the mother load of bubble and subsequent crash. This is because, as
alluded to above, they seem to have forgotten that the credit
cycle and the process of debt build-up, and the subsequent
debt liquidation that follows, are the primary driving forces in the
underlying economic cycle.
This time the
crash will be initiated in the huge bond market, will spread to the
commercial loan market and ultimately to the stock market, and then will
further crush the real economy in a way that few understand today but will
learn the hard way in the coming years. Let us keep in mind that in the recent past, the Fed and
the U.S. Treasury did not see the subprime and housing crises coming. They
were completely taken off-guard. In 2005, according to then Fed member Ben
Bernanke, “there was no housing bubble”, even though
everybody and his uncle could see that the real estate bubble was about to
burst. And now, let us look at the figures. At the end of 2009, reflecting a
binge of printing new money by the Fed, the U.S. monetary base, i.e. money circulating
through the public and banking reserves on deposit with the Federal Reserve,
stood at more than $2,016,136,000,000, after having increased 146 percent in
three years. This is unprecedented. —Even if one subtracts the inactive
excess bank reserves at the Fed, worth more than $1 trillion (and earning
interest!), the U.S.'s monetary base has grown 22 percent in three years,
from a starting point of $818 billion in early 2006. Nevertheless, Fed Chairman Ben Bernanke said in 2009, that
he does not fear inflation and that, in fact, inflation could even go down
from then on. He could be right for the next few months, but how about the
next few years? Those who listened to Chairman B. B. in 2005, and kept
buying leveraged real estate, lost their shirt. I am of the feeling that
those who believed Chairman B.B in 2009, and kept buying long-term U.S.
Treasury bonds, are also going to lose their shirt. Because of the huge
federal deficits and Fed policy to monetize a big chunk of them, U.S. long-term rates are bound to increase in the coming
years, whether the real economy grows or not. That would be the next
Fed-created bubble bursting, the bubble of artificially low interest rates,
excessive money creation and artificially high asset prices for long-term
Treasury bonds. In the past, the big losers of this policy
were the millions of people who lost their homes through mortgage
foreclosures, the millions of people who lost their jobs through bankruptcies
and the millions of retirees who saw their
retirement incomes plummet with near zero interest rates. In the future, the
principal losers will still be middle class families who will continue being
the victims of a massive spoliation and will still have trouble making ends
meet, plus retirees whose retirement capital will be further eroded. Where is
AARP when we need it? __________________________________ 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 coming book "The Code for Global
Ethics" at: www.TheCodeForGlobalEthics.com/
You
can reserve a copy of the book on Amazon
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