[THS] Paul Craig Roberts: The Crisis Is Not Over

[Peter Webster]

http://www.informationclearinghouse.info/article24576.htm

The Crisis Is Not Over

By Paul Craig Roberts

February 03, 2010 "Information Clearing House" -- Readers ask if the financial crisis is
over, if the recovery is for real and, if not, what are Americans’ prospects. The short
answer is that the financial crisis is not over, the recovery is not real, and the U.S.
faces a far worse crisis than the financial one. Here is the situation as I understand it:

The global crisis is understood as a banking crisis brought on by the mindless
deregulation of the U.S. financial arena. Investment banks leveraged assets to highly
irresponsible levels, issued questionable financial instruments with fraudulent
investment grade ratings, and issued the instruments through direct sales to
customers rather than through markets.

The crisis was initiated when the U.S. allowed Lehman Brothers to fail, thus
threatening money market funds everywhere.The crisis was used by the investment
banks, which controlled U.S. economic policy, to secure massive subsidies to their
profits from a taxpayer bailout and from the Federal Reserve. How much of the crisis
was real and how much was hype is not known at this time.

As most of the derivative instruments had never been priced in the market, and as
their exact composition between good and bad loans was unknown (the instruments
are based on packages of securitized loans), the mark-to-market rule drove the
values very low, thus threatening the solvency of many financial institutions. Also, the
rule prohibiting continuous shorting had been removed, making it possible for hedge
funds and speculators to destroy the market capitalization of targeted firms by driving
down their share prices.

The obvious solution was to suspend the mark-to-market rule until some better idea
of the values of the derivative instruments could be established and to prevent the
abuse of shorting that was destroying market capitalization. Instead, the Goldman
Sachs people in charge of the U.S. Treasury and, perhaps, the Federal Reserve as
well, used the crisis to secure subsidies for the banks from U.S. taxpayers and from
the Federal Reserve. It looks like a manipulated crisis as well as a real one due to
greed unleashed by financial deregulation.

The crisis will not be over until financial regulation is restored, but Wall Street has
been able to block re-regulation. Moreover, the response to the crisis has planted
seeds for new crises. Government budget deficits have exploded. In the U.S. the
fiscal year 2009 federal budget deficit was $1.4 trillion, three times higher than the
2008 deficit. President Obama’s budget deficits for 2010 and 2011, according to the
latest report, will total $2.9 trillion, and this estimate is based on the assumption that
the Great Recession is over. Where is the U.S. Treasury to borrow $4.3 trillion in
three years? This sum greatly exceeds the combined trade surpluses of America’s
trading partners, the recycling of which has financed past U.S. budget deficits, and
perhaps exceeds total world savings.

It is unclear how the 2009 budget deficit was financed. A likely source was the bank
reserves created for financial institutions by the Federal Reserve when it purchased
their toxic financial instruments. These reserves were then used to purchase the new
Treasury debt. In other words, the budget deficit was financed by deterioration in
the balance sheet of the Federal Reserve. How long can such an exchange of assets
continue before the Federal Reserve has to finance the government’s deficit by
creating new money?

Similar deficits and financing problems have affected the EU, particularly its
financially weaker members. To conclude: the initial crisis has planted seeds for two
new crises: rising government debt and inflation.

A third crisis is also in place. This crisis will occur when confidence is lost in the U.S.
dollar as world reserve currency. This crisis will disrupt the international payments
mechanism. It will be especially difficult for the U.S. as the country will lose the ability
to pay for its imports with its own currency. U.S. living standards will decline as the
ability to import declines.

The financial crisis is essentially a U.S. crisis, spread abroad by the sale of toxic
financial instruments. The rest of the world got into trouble by trusting Wall Street.
The real American crisis is much worse than the financial crisis. The real American
crisis is the offshoring of U.S. manufacturing, industrial, and professional service jobs
such as software engineering and information technology.

Jobs offshoring was initiated by Wall Street pressures on corporations for higher
earnings and by performance-related bonuses becoming the main form of
managerial compensation. Corporate executives increased profits and obtained
bonuses by substituting cheaper foreign labor for U.S. labor in the production of
goods and services marketed in the U.S.

Jobs offshoring is destroying the ladders of upward mobility that made the U.S. an
opportunity society and eroding the value of a university education. For the first
decade of the 21st century, the U.S. economy has been able to create net new jobs
only in domestic nontradable services, such as waitresses, bartenders, sales, health
and social assistance and, prior to the real estate collapse, construction. These jobs
are lower paid than the jobs were that have been offshored, and these jobs do not
produce goods and services for export.

Jobs offshoring has increased the U.S. trade deficit, putting more pressure on the
dollar’s role as reserve currency. When offshored goods and services return to the
U.S., they add to imports, thus worsening the trade imbalance.

The policy of jobs offshoring is insane. It is shifting U.S. GDP growth to the offshored
locations, such as China, thus halting growth in U.S. consumer incomes. For the past
decade, U.S. households substituted an increase in indebtedness for the lack of
growth in income in order to continue increasing their consumption. With their home
equity refinanced and spent, real estate values down, and credit card debt at
unsustainable levels, it is no longer possible for the U.S. economy to base its growth
on a rise in consumer debt. This fact is a brake on U.S. economic recovery.

Stimulus packages cannot substitute for the growth in real income. As so many high
value-added, high productivity U.S. jobs have been offshored, there is no way to
achieve real growth in U.S. personal incomes. Stimulus spending simply adds to
government debt and pressure on the dollar, and sows seeds for high inflation.

The U.S. dollar survives as reserve currency because there is no apparent substitute.
The euro has its own problems. Moreover, the euro is the currency of a non-existent
political entity. National sovereignty continues despite the existence of a common
currency on the continent (but not in Great Britain). If the dollar is abandoned, then
the result is likely to be bilateral settlements in countries’ own currencies, as Brazil
and China now are doing. Alternatively, John Maynard Keynes’ bancor scheme could
be implemented, as it does not require a reserve currency country. Keynes’ plan is
designed to maintain a country’s trade balance. Only a reserve currency country can
get its trade and budget deficits so out of balance as the U.S. has done. The
prospect of U.S. default and/or inflation and decline in the dollar’s exchange value is
a threat to the reserve system.

The threats to the U.S. economy are extreme. Yet, neither the Obama administration,
the Republican opposition, economists, Wall Street, nor the media show any
awareness. Instead, the public is provided with spin about recovery and with higher
spending on pointless wars that are hastening America’s economic and financial ruin.

Dr. Roberts was Assistant Secretary of the U.S. Treasury in the Reagan
administration. His latest book, How The Economy Was Lost, has just been published
by CounterPunch/AK Press.