In a dress rehearsal for this November’s mid-term election, Democrats and Republicans vied last week for who could denounce the banks and blame the other party the most for the giveaways to Wall Street that have swollen the public debt since September 2008, pushing the federal budget into deficit and the economy into a slump.
by Prof Michael Hudson
Global Research, January 26, 2010
How Much More “Debt Recovery” can the Economy Take?
It’s make or break time for Democrats since the January 19 defeat in Massachusetts. At stake is Mr. Obama’s credibility as an agent for change. Exit polls show that voters see his main change to be favoritism to Wall Street, to a degree that the “old Democrats” would not have let a Republican administration get away with. Rivalry over just what party is more Wall Street friendly prompted Jay Leno to joke that Mr. Obama has done the impossible: resurrected the seemingly dying Republican Party and given it the coveted label of the “Party of Change” running against Wall Street.
Ben Bernanke has been a bigger disaster than Hurricane Katrina. But the senate is about to re-up him for another four-year term. What are they thinking? Bernanke helped Greenspan inflate the biggest speculative bubble of all time, and still maintains that he never saw it growing. Right. How can retail housing leap from $12 trillion to $21 trillion in 7 years (1999 to 2006) without popping up on the Fed’s radar? It’s not possible. Bernanke is just fudging the facts to save his skin.
Bernanke was also staunch supporter of the low interest rate policy which led to the crash. Greenspan never believed that it was the Fed’s job to deal with credit bubbles. “The free market is self-correcting”, he thought. He was the nation’s chief regulator, but he was opposed to the idea of government regulation. Go figure? Here’ a quote from Greenspan in 2002:
“Economic recovery” is a term that has no fixed meaning. But it’s worth mulling over to determine whether aggregate demand is strong enough to keep the economy from tipping back into recession. In normal times, the Fed slashes interest rates to increase the flow of capital to the markets and to consumers via lending at the banks. That’s the traditional method of “jump starting” the economy.
The Fed has never initiated policies which provide unlimited guarantees for underwater financial institutions. Nor has it ever poured more than a trillion dollars directly into the financial system by creating excess reserves at the banks and direct purchases of long-term assets. (Quantitative Easing) All of this is new. Naturally, this ocean of liquidity has produced price distortions which have been confused with real recovery. The S&P has soared more than 60 percent in the last 9 months, even though the yield on short-term Treasuries are at historic lows.
There’s no fixed number of greenbacks in a vault at the Treasury which limit how much the federal government can spend. Since the US pays its debts in its own currency–it can print as many dollars as it pleases. Of course, if boosting the money supply triggers inflation, the Fed has to withdraw liquidity and raise interest rates. But that’s not the problem at present. The problem is how to zap the economy back to life. The problem is how to get 16 million people out of unemployment lines and back to work. That’s the real challenge. The problem is political not economic. Obama is surrounded by industry reps who are trying to scare him about the size of the deficits. But deficits aren’t the problem; unemployment is. Once people get back to work and build their savings, their creditworthiness will improve, and the next economic expansion will begin. When more people are paying into the system, the deficits will come down. But the deficits won’t come down if tens of millions of people are still on the sidelines and forced to cut their spending. Judging by last Thursday’s speech at the “Jobs Summit”, Obama still doesn’t grasp this:
Eliot Spitzer: Geithner, Bernanke “Complicit” in Financial Crisis and Should Go
In an extended interview, we speak with former New York governor Eliot Spitzer about the financial crisis and how it was handled by Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner. Bernanke and Geithner “actually built and participated in creating the structure that now has collapsed,” Spitzer says and calls on them to be replaced. Spitzer also talks about the scandal that erupted last year that forced him to resign as governor. “I have no doubt there were many people who were opposed to me, very powerful forces, who were happy to see me go,” Spitzer says. “Whether they participated, I’ll let others figure that out. I resigned because of what I did.” [includes rush transcript]
WASHINGTON, December 2 – Sen. Bernie Sanders (I-Vt.) today placed a hold on the nomination of Ben Bernanke for a second term as chairman of the Federal Reserve.
“The American people overwhelmingly voted last year for a change in our national priorities to put the interests of ordinary people ahead of the greed of Wall Street and the wealthy few,” Sanders said. “What the American people did not bargain for was another four years for one of the key architects of the Bush economy.”
Barack Obama’s chief economic advisor, Lawrence Summers, is determined to sabotage a second round of stimulus. And, he’s getting plenty of help, too. Congressional Democrats are dragging their feet because they’re worried about the political backlash and midterm elections, the GOP deficit hawks are looking for a way they can derail the Obama agenda and reestablish their bone fides as fiscal conservatives, and the bailout-traumatized American people are simply opposed to anything that generates more red ink. Even Obama has joined the fray and started badmouthing stimulus stressing the importance of living within our means and trimming the deficits. So it looks like a done-deal; no more stimulus. There’s only one problem, without another blast of stimulus the economy is headed for the skids.
Summers knows this because he is an extremely bright and competent economist. With Summers, the issue is loyalty, not intelligence. To prove this point, consider Summers comments in a Washington Post editorial (September of 2008) where he explains what needs to be done to put the economy back on track:
Barack Obama has decided to push the economy back into recession, and no one can figure out why. Perhaps the impressionable Obama has come under the spell of the deficit hawks and crystal gazers who see Armageddon around every corner. Or maybe he’s thrown-in with the snappish Marc Faber whose dire predictions of hyperinflation are about as cheery as Hieronymus Bosch’s vision of Hell. Whatever the reason, the President has done a hasty volte-face and decided that trimming the deficits in the middle of a severe economic downturn is the way to go. Here’s what Obama said just days ago on his Asia tour:
“I think it is important to recognize if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the U.S. economy in a way that could actually lead to a double-dip recession.”
The Fed’s monetary stimulus is driving the market higher. What started as a trickle has turned into a torrent buoying stocks and commodities on a river of liquidity. Oil has more than doubled in the last 8 months while stock indexes have gained 50 percent or more in the same period. Even the shunned homebuilders and battered financials have staged a comeback. Meanwhile, consumer credit continues to shrivel and the “real” rate of unemployment climbs inexorably towards 20 percent. Overpriced equities with bloated P/E ratios of (average) 19 continue to produce record profits for breathless speculators, while the productive economy languishes in a Depression. The Fed’s zero-rate policy and easing programs have created another bubble, further widening the chasm between the investor class and the working rabble.
Former Fed governor Frederic Mishkin delivered a defense of Bernanke’s stock/commodities bubble in an article in this week’s Financial Times titled “Not all bubbles present a risk to the economy”. Oddly enough, Mishkin makes no attempt to dispute the Fed’s bubblemaking strategy, but only to clarify the difference between good and bad bubbles. This may go-down as the most poorly-considered public relations campaign in history.
Interest rates. The Fed does not need slinky women in plunging necklines to peddle money. All it needs is low interest rates. When rates are pushed lower than the rate of inflation, the Fed provides a subsidy for borrowing. This is not as hard to grasp as it sounds. If I offered to give you $1.00 for very 90 cents you gave me in return, you would buy as many dollars from me as you could. The Fed operates the same way. It generates market activity by creating incentives for borrowing. Borrowing leads to speculation, and speculation leads to steadily rising asset prices. This is how the game is played. The Fed is not an unbiased observer of free market activity. The Fed drives the market. It fuels speculation and controls behavior by fixing interest rates.
When Lehman Bros flopped last year, markets went into freefall. A sharp correction turned into a full-blown panic. The bubble burst and trillions of dollars in credit vanished in a flash. Trading in exotic debt-instruments stopped overnight. A global sell-off ensued. Markets crashed. For a while, it looked like the whole system might collapse.
Size matters. And it particularly matters when the size of the financial system grossly exceeds the productive capacity of the underlying economy. Then problems arise. Surplus capital flows into paper assets triggering a boom. Then speculators pile in driving asset prices higher. Margins grow, debts balloon, and bubbles emerge. The frenzy finally ends when the debts can no longer be serviced and the bubble begins to unwind, sometimes violently. As gas escapes; credit tightens, businesses are forced to cut back, asset prices plunge and unemployment soars. Deflation spreads to every sector. Eventually, the government steps in to rescue the financial system while the broader economy slumps into a coma.
The crisis that started two years ago, followed this same pattern. A meltdown in subprime mortgages sent the dominoes tumbling; the secondary market collapsed, and stock markets went into freefall. When Lehman Bros flopped, a sharp correction turned into a full-blown panic. Lehman tipped-off investors that that the entire multi-trillion dollar market for securitized loans was built on sand. Without price discovery, via conventional market transactions, no one knew what mortgage-backed securities (MBS) and other exotic debt-instruments were really worth. That sparked a global sell-off. Markets crashed. For a while, it looked like the whole system might collapse.
The Fed’s emergency intervention pulled the system back from the brink, but at great cost. Even now, the true value of the so-called toxic assets remains unknown. The Fed and Treasury have derailed attempts to create a public auction facility–like the Resolution Trust Corporation (RTC)–where prices can be determined and assets can be sold. Billions in toxic waste now clog the Fed’s balance sheet. Ultimately, the losses will be passed on to the taxpayer.
The dollar is not going to crash. There may be grumblings in foreign capitals and “secret meetings” between finance ministers but, for now, the dollar appears to be safe.
Foreign countries don’t trade in dollars because they like America. They do it because they have no choice. If they want oil, they need dollars; it’s as simple as that.
It’s great to talk about a “basket of currencies” replacing the dollar, but that’s still a work-in-progress. It might happen, or it might not; no one really knows. What’s clear, is that we still live in dollar-centric world where paper claims on wealth are arbitrarily increased at will by a handful of unelected officials at the Federal Reserve. It’s a process which relies more on Gutenberg than moral authority.