How the US Economy Was Lost
By Paul Craig Roberts
February 24, 2009 "Information Clearing House" --
The American economy has gone away. It is not coming back until free trade myths are buried six feet under.
America’s 20th century economic success was based on two things. Free
trade was not one of them. America’s economic success was based on
protectionism, which was ensured by the union victory in the Civil War,
and on British indebtedness, which destroyed the British pound as world
reserve currency. Following World War II, the US dollar took the role
as reserve currency, a privilege that allows the US to pay its
international bills in its own currency.
World War II and socialism together ensured that the US economy
dominated the world at the mid 20th century. The economies of the rest
of the world had been destroyed by war or were stifled by socialism.
The ascendant position of the US economy caused the US government to be
relaxed about giving away American industries, such as textiles, as
bribes to other countries for
cooperating with America’s cold war and foreign policies. For example,
Turkey’s US textile quotas were increased in exchange for over-flight
rights in the Gulf War, making lost US textile jobs an off-budget war
expense.
In contrast, countries such as Japan and Germany used industrial policy
to plot their comebacks. By the late 1970s, Japanese auto makers had
the once dominant American auto industry on the ropes. The first
economic act of the “free market” Reagan administration in 1981 was to
put quotas on the import of Japanese cars in order to protect Detroit
and the United Auto Workers.
Eamonn Fingleton, Pat Choate, and others have described how negligence
in Washington DC aided and abetted the erosion of America’s economic
position. What we didn’t give away, we let be taken from us while
preaching a “free trade” doctrine at which the rest of the world
scoffed.
Fortunately, our adversaries at the time, the Soviet Union and China,
had unworkable economic systems that posed no threat to America’s
diminishing economic prowess.
The proverbial hit the fan when Soviet, Chinese, and Indian socialism
collapsed around 1990, to be followed shortly thereafter by the rise of
the high speed Internet. Suddenly, American and other first world
corporations discovered that a massive supply of foreign labor was
available at practically free wages.
To get Wall Street analysts and shareholder advocacy groups off their
backs, and to boost shareholder returns and management bonuses,
American corporations began moving their production for American
markets offshore. Products that were made in Peoria are now made in
China.
As offshoring spread, American cities and states lost tax base, and
families and communities lost jobs. The replacement jobs, such as
selling the offshored products at Wal-Mart, brought home less pay.
“Free market economists” covered up the damage done to the US economy
by preaching a New Economy based on services and innovation. But it
wasn’t long before corporations discovered that the high speed Internet
let them offshore a wide range of professional service jobs. In
America, the hardest hit have been software engineers and information
technology (IT) workers.
The American corporations quickly learned that by declaring “shortages”
of skilled Americans, they could get from Congress H-1b work visas for
lower paid foreigners with whom to replace their American work force.
Many US corporations are known for forcing their US employees to train
their foreign replacements in exchange for severance pay.
Chasing after shareholder return and “performance bonuses,” US
corporations deserted their American workforce. The consequences can be
seen everywhere. The loss of tax base has threatened the municipal
bonds of cities and states and reduced the wealth of individuals who
purchased the bonds. The lost jobs with good pay resulted in the
expansion of consumer debt in order to maintain consumption. As the
offshored goods and services are brought back to America to sell, the
US trade deficit has exploded to unimaginable heights, calling into
question the US dollar as reserve currency and America’s ability to
finance its trade deficit.
As the American economy eroded away bit by bit, “free market”
ideologues produced endless reassurances that America had pulled a fast
one on China, sending China dirty and grimy manufacturing jobs. Free of
these “old economy” jobs, Americans were lulled with promises of
riches. In place of dirty fingernails, American efforts would flow into
innovation and entrepreneurship. In the meantime, the “service economy”
of software and communications would provide a leg up for the work
force.
Education was the answer to all challenges. This appeased the
academics, and they produced no studies that would contradict the
propaganda and, thus, curtail the flow of federal government and
corporate grants.
The “free market” economists, who provided the propaganda and
disinformation to hide the act of destroying the US economy, were well
paid. And as Business Week noted, “outsourcing’s inner circle has deep
roots in GE (General Electric) and McKinsey,” a consulting firm.
Indeed, one of McKinsey’s main apologists for offshoring of US jobs,
Diana Farrell, is now a member of Obama’s White House National Economic
Council.
http://www.businessweek.com/globalbiz/content/feb2006/gb20060223_186829.htm?campaign_id=nws_insdr_feb24&link_position=link10
The pressure of jobs offshoring, together with massive imports, has
destroyed the economic prospects for all Americans, except the CEOs who
receive “performance” bonuses for moving American jobs offshore or
giving them to H-1b work visa holders. Lowly paid offshored employees,
together with H-1b visas, have curtailed employment for older and more
experienced American workers. Older workers traditionally receive
higher pay. However, when the determining factor is minimizing labor
costs for the sake of shareholder returns and management bonuses, older
workers are unaffordable. Doing a good job, providing a good service,
is no longer the corporation’s function. Instead, the goal is to
minimize labor costs at all cost.
Thus, “free trade” has also destroyed the employment prospects of older
workers. Forced out of their careers, they seek employment as shelf
stockers for Wal-Mart.
I have read endless tributes to Wal-Mart from “libertarian economists,”
who sing Wal-Mart’s praises for bringing low price goods, 70% of which
are made in China, to the American consumer. What these “economists” do
not factor into their analysis is the diminution of American family
incomes and government tax base from the loss of the goods producing
jobs to China. Ladders of upward mobility are being dismantled by
offshoring, while California issues IOUs to pay its bills. By shifting
production offshore, offshoring reduces US GDP. When the goods and
services are brought back to America to be sold, they increase the
trade deficit. As the trade deficit is financed by foreigners acquiring
ownership of US assets, the change in ownership means that profits,
dividends, capital gains, interest, rents, and tolls leave American
pockets for foreign ones.
The demise of America’s productive economy left the US economy
dependent on finance, in which the US remained dominant because the
dollar is the reserve currency. With the departure of factories,
finance went in new directions. Mortgages, which were once held in the
portfolios of the issuer, were securitized. Individual mortgage debts
were combined into a “security.” The next step was to strip out the
interest payments to the mortgages and sell them as derivatives, thus
creating a third debt instrument based on the original mortgages.
In pursuit of ever more profits, financial institutions began betting
on the success and failure of various debt instruments and by
implication on firms. They bought and sold collateral debt swaps. A
buyer pays a premium to a seller for a swap to guarantee an asset’s
value. If an asset “insured” by a swap falls in value, the seller of
the swap is supposed to make the owner of the swap whole. The purchaser
of a swap is not required to own the asset in order to contract for a
guarantee of its value. Therefore, as many people could purchase as
many swaps as they wished on the same asset. Thus, the total value of
the swaps greatly exceeds the value of the assets. (An excellent explanation of swaps can be found here )
The next step is for holders of the swaps to short the asset in order
to drive down its value and collect the guarantee. As the issuers of
swaps were not required to reserve against them, and as there is no
limit to the number of swaps, the payouts can easily exceed the net
worth of the issuer.
This was the most shameful and most mindless form of speculation.
Gamblers were betting hands that they could not cover. The US
regulators had abandoned their posts. The American financial
institutions abandoned all integrity. As a consequence, American
financial institutions and rating agencies are trusted nowhere on
earth.
The US government should never have used billions of taxpayers’ dollars
to pay off swap bets as it did when it bailed out the insurance company
AIG. This was a stunning waste of a vast sum of money. The federal
government should declare all swap agreements fraudulent contracts,
except for a single swap held by the owner of the asset. Simply wiping
out these fraudulent contracts would remove the bulk of the vast
overhang of “troubled” assets that threaten financial markets.
The billions of taxpayers’ dollars spent buying up subprime derivatives
were also wasted. The government did not need to spend one dime. All
government needed to do was to suspend the mark-to-market rule. This
simple act would have removed the solvency threat to financial
institutions by allowing them to keep the derivatives at book value
until financial institutions could ascertain their true values and
write them down over time.
Taxpayers, equity owners, and the credit standing of the US government
are being ruined by financial shysters who are manipulating to their
own advantage the government’s commitment to mark-to-market and to the
“sanctity of contracts.” Multi-trillion dollar “bailouts” and bank
nationalization are the result of the government’s inability to respond
intelligently.
Two more simple acts would have completed the rescue without costing
the taxpayers one dollar: an announcement from the Federal Reserve that
it will be lender of last resort to all depository institutions
including money market funds, and an announcement reinstating the
uptick rule.
The uptick rule was suspended or repealed a couple of years ago in
order to permit hedge funds and shyster speculators to rip-off American
equity owners. The rule prevented short-selling any stock that did not
move up in price during the previous day. In other words, speculators
could not make money at others’ expense by ganging up on a stock and
short-selling it day after day.
As a former
Treasury official, I am amazed that the US government, in the midst of
the worst financial crises ever, is content for short-selling to drive
down the asset prices that the government is trying to support. No
bailout or stimulus plan has any hope until the uptick rule is
reinstated.
The bald fact is that the combination of ignorance, negligence, and
ideology that permitted the crisis to happen is still present and is
blocking any remedy. Either the people in power in Washington and the
financial community are total dimwits or they are manipulating an
opportunity to redistribute wealth from taxpayers, equity owners and
pension funds to the financial sector.
The Bush and Obama plans total 1.6 trillion dollars, every one of which
will have to be borrowed, and no one knows from where. This huge sum
will compromise the value of the US dollar, its role as reserve
currency, the ability of the US government to service its debt, and the
price level. These massive costs are pointless and are to no avail as
not one step has been taken that would alleviate the crisis.
If we add to my simple menu of remedies a ban, punishable by instant
death, for short selling any national currency, the world can be
rescued from the current crisis without years of suffering, violent
upheavals and, perhaps, wars.
According to its hopeful but economically ignorant proponents,
globalism was supposed to balance risks across national economies and
to offset downturns in one part of the world with upturns in other
parts. A global portfolio was a protection against loss, claimed
globalism’s purveyors. In fact, globalism has concentrated the risks,
resulting in Wall Street’s greed endangering all the economies of the
world. The greed of Wall Street and the negligence of the US government
have wrecked the prospects of many nations. Street riots are already
occurring in parts of the world. On Sunday February 22, the right-wing
TV station, Fox “News,” presented a program that predicted riots and
disarray in the United States by 2014.
How long will Americans permit “their” government to rip them off for
the sake of the financial interests that caused the problem? Obama’s
cabinet and National Economic Council are filled with representatives
of the interest groups that caused the problem. The Obama
administration is not a government capable of preventing a catastrophe.
If truth be known, the “banking problem” is the least of our worries.
Our economy faces two much more serious problems. One is that
offshoring and H-1b visas have stopped the growth of family incomes,
except, of course, for the super rich. To keep the economy going,
consumers have gone deeper into debt, maxing out their credit cards and
refinancing their homes and spending the equity. Consumers are now so
indebted that they cannot increase their spending by taking on more
debt. Thus, whether or not the banks resume lending is beside the point.
The other serious problem is the status of the US dollar as reserve
currency. This status has allowed the US, now a country heavily
dependent on imports just like a third world or lesser-developed
country, to pay its international bills in its own currency. We are
able to import $800 billion annually more than we produce, because the
foreign countries from whom we import are willing to accept paper for
their goods and services.
If the dollar loses its reserve currency role, foreigners will not
accept dollars in exchange for real things. This event would be
immensely disruptive to an economy dependent on imports for its energy,
its clothes, its shoes, its manufactured products, and its advanced
technology products.
If incompetence in Washington, the type of incompetence that produced
the current economic crisis, destroys the dollar as reserve currency,
the “unipower” will overnight become a third world country, unable to
pay for its imports or to sustain its standard of living.
How long can the US government protect the dollar’s value by leasing
its gold to bullion dealers who sell it, thereby holding down the gold
price? Given the incompetence in Washington and on Wall Street, our
best hope is that the rest of the world is even less competent and even
in deeper trouble. In this event, the US dollar might survive as the
least valueless of the world’s fiat currencies.