Today’s deepening financial and economic crisis cannot be alleviated without addressing a number of problems that the public does not really want to hear about. Even to cite them raises a wall of cognitive dissonance.
For starters, today’s debt problem is not marginal, but has become structural – and structural problems cannot be solved with merely marginal palliatives. What Alan Greenspan called “wealth creation” turned out to be asset-price inflation – bidding up property values and the stock market on credit. The Bubble Economy loaded down households, real estate and entire companies with debt, while the Bush tax cuts for the higher tax brackets forced federal, state and local budgets much more deeply into debt.
This policy could continue as long as debt inflated property prices at a faster rate than the interest rate that had to be paid. But paying interest and amortization charges diverted consumer and business spending away from consumption and production. This is what the term “debt deflation” means. The financial and property sectors received the income formerly spent on goods and services. Debt service is not available to be spent on consumer goods (for homeowners) or for capital investment (for debt-leveraged companies). The effect is to slow sales and business income, and hence the commercial rental and real estate market.
By 2006 a point was reached where debt service grew to exceed operating income or the ability of many homeowners to carry – especially when interest rates jumped. The Fed’s bailout idea is to lend debtors enough to pay their bankers and other creditors, subsidizing their insolvency with enough to keep current on obligations they cannot otherwise afford. The alternative is negative equity: the sale of homes, office buildings and companies pledged as collateral and sold at prices below the mortgage or loan value. Such subsidy merely buys time for the debt problem to become even more deeply engrained.
The reality is that the existing level of debts cannot be paid. The problem is by no means confined to the bottom of the economic pyramid, but is concentrated at the top. The U.S. Government itself turns out to be the world’s largest subprime debtor. Its $2.5 trillion debt to foreign central banks – and even larger private-sector debt to other foreigners – cannot be paid, given the nation’s heavy military and trade deficits. Recognition of this political fact at the core of the international financial system has led foreign governments and investors to dump dollar-denominated bonds and stock. This has driven down the dollar’s exchange rate, raising dollarized prices for oil and other raw materials.
The larger the U.S. trade deficits and foreign military spending grow, the more of these dollars are turned over to foreign central banks by foreign exporters and other recipients of U.S. funds. Central banks then find themselves with little to spend their money on, except to buy U.S. Treasury securities. They have bought so many that Americans have not had to bear the cost the U.S. federal budget deficit by buying the bonds to finance it. Foreigners have bought them. In effect they have loaned the U.S. Government the dollars and foreign exchange to wage its war in the Near East – a war that most foreign voters do not support. To fund the U.S. payments deficit and federal budget deficit is to subsidize this war.
In the last few years, foreign governments have sought some alternative to buying U.S. Treasury bills. But when the Chinese sought to buy Union Oil assets, Congress vetoed the deal, accusing government ownership of leading down the road to serfdom. For China to buy into U.S. privatizations, it would have to believe that the U.S. Congress would let it raise road tolls and other infrastructure access fees by enough to compensate it for the dollar’s decline. The more likely response would be new complaints against the Yellow Peril. So foreign governments are finding themselves stuck with dollars they cannot use to buy real U.S. assets, and also cannot spend on U.S. exports now that the country is de-industrializing. All they can do is lend money to the U.S. Government.
This is the road that drove the Medici bankers bankrupt a few centuries ago. By 1776, Adam Smith was led to conclude that no government ever had repaid its foreign debt. No private sector has reduced its debt level for long either – except through bankruptcy, moratorium and repudiation. These are the options that face us today. But they are not politically acceptable for public discussion. The last time the economics profession addressed the global debt problem was in the 1920s, in response to the unpayably high level of German reparations and Inter-Ally arms debts to the United States. Since that time there has been much talk of monetary theory, but little attention to measuring the ability of economies to carry their domestic and foreign debt overhead.
This week the Fed tried to reverse the plunge in asset prices by flooding the banking system with $200 billion of credit. Banks were allowed to turn their bad mortgage loans and other loans over to the Federal Reserve at par value (rather at just 20% “mark to market” prices). The Fed’s cover story is that this infusion will enable the banks to resume lending to “get the economy moving again.” But the banks are using the money to bet against the dollar. They are borrowing from the Fed at a low interest rate, and buying foreign euro-denominated bonds yielding a higher interest rate – and in the process, making a currency gain as the euro rises against dollar-denominated assets. The Fed thus is subsidizing capital flight, exacerbating inflation by making the price of imports (headed by oil and other raw materials) more expensive. These commodities are not more expensive to European buyers, but only to buyers paying in depreciated dollars. (This also squeezes Latin America and other countries in the dollar area.)
The Fed’s behavior (not only under Alan Greenspan) raises the question of whether central banks really are necessary. Their idea always has been to sponsor creditor-oriented rules, financial deregulation, and to bail out to the financial sector at public expense, painting the economy into a debt corner. But having done so, the Federal Reserve cannot solve the problems it has created under the Greenspan regime. Its role – and indeed, that of central banks in general – is to pursue precisely the kind of policies that have created today’s financial quandary.
Ever since the Bank of England was founded in 1694, central banks throughout the world have represented the interests of the commercial banking system. Unfortunately, the financial time frame always has been short-term. Banks make money by finding more and more clients to borrow funds, while investment bankers and brokerage houses take their commissions and run. Their interest is in promoting a Bubble Economy that will induce real estate buyers and corporate raiders to borrow so as to ride the wave of asset-price inflation. This borrowing seems at first to be self-sustaining as borrowers bid up prices for property, stocks and bonds. These assets then can be pledged as collateral for even larger loans as prices and debts rise together.
This is the kind of “wealth creation” for which Mr. Greenspan sought to take credit. But alas, it is not a process that provides stability for the economy at large. As the financial sector’s interests have come to be opposed to those of the “real” economy of consumers and producers, Federal Reserve policy seeks to solve the debt problem with yet more debt, in the form of bailouts to banks that have made bad loans. The bailout is designed to enable banks to lend money to support asset prices and preserve the market price of collateral pledged to back their mortgage loans and lending to highly leveraged companies and hedge funds. In bailing out banks to increase their loans to achieve these ends, the Fed has become an active player in a financial war to indebt real estate, labor and industry all the more.
The result is an unprecedented intrusion of Big Government, not in a socialist manner but one that uses the public purse to protect finance and property at the top of the economic pyramid. This is done by leading down a uniquely financial road to serfdom, by promoting a regime of debt peonage. Via the Federal Reserve system, the government is “solving” the ending of the Bubble Economy by providing enough loans to indebt industry and agriculture, labor and tangible capital as it borrows the money to pay debt service on loans that otherwise would fall into default.
But as noted above, the most problematic debt is foreign debt, and the major subprime international debtor is the U.S. Government. It is now indebted to foreign governments (via their central bank holdings of $2.5 trillion in dollar reserves) and to private investors (another few trillion) beyond the nation’s ability to pay, not to mention beyond its political willingness to do so. That is why foreigners no longer are accepting the dollars being thrown off by U.S. consumers, U.S. investors buying foreign enterprises, and the U.S. military extending its bases abroad.
As the dollar falls, import prices rise, headed by fuels and minerals. Something has to give. How can homeowners and businesses pay their debts, if their operating costs for heating, electricity and transport are absorbing their income?
The only way to stop this hemorrhaging is to negotiate a debt writeoff, starting with the U.S. Treasury bonds held by foreign central banks. But what does the United States have to offer? To ask foreign governments to make an economic sacrifice of this magnitude cannot be negotiated without the U.S. Government negotiating a grand global bargain. Having little quid pro quo to offer, the most promising way to get foreign countries to voluntarily give up their financial claims on the U.S. economy must include the one thing America can offer – the military dimension.
There is only one way that I can see this being done. The United States would agree to dismantle all its overseas military bases (or at least, those outside of the Western Hemisphere). This would mean relinquishing its dream of imposing world hegemony by force of arms. This also would free it – and other countries – from the post-Cold-War arms race. It would help revive the “real” economy’s production and consumption by freeing revenue for spending on consumption and new direct investment. In the process it would free the United States from “Pentagon capitalism,” that is, cost-plus production contracts that seemingly has led American industrial engineering to be incapable of cost-minimizing production methods, thereby losing what used to be its competitive technological advantage.
Foreign countries are coming to view the United States from the same perspective that the Bush Administration viewed other countries: Any economic potential is by definition military in character. It follows that what COULD be, should be stifled at the outset. The United States has become the world’s major aggressive destabilizing force. Without dealing openly with this military “elephant in the room,” any alleviation of foreign claims on the U.S. economy by foreign governments would simply permit America to maintain and even to increase its global military presence, building yet more foreign bases and imposing a yet larger balance-of-payments drain on the dollar. “Supporting the dollar” is synonymous with subsidizing the Executive Branch’s addiction to hegemonic military diplomacy.
Unfortunately, this is not a truth that the American public wants to hear.