America’s Economic Meltdown
There’s growing concern among economists and market-savvy pundits that the
global financial system is hanging by a few well-worn threads that could snap
at any time. The $10.4 trillion real estate “bubble” has attracted
the most attention, but the shaky derivatives market, hedge funds, and falling
dollar are equally worrisome. 20 years of deregulation has created an economic
monster which is increasingly unmanageable and threatens to bring down the whole
system in a heap.
As Gabriel Kolko said in a recent counterpunch article (“Why
a Global Economic Deluge Looms”), “The entire global financial
structure is becoming uncontrollable in crucial ways its nominal leaders never
expected. Instability is increasingly its hallmark….Contradictions now
wrack the world’s financial system, and if we are to believe the institutions
and personalities who have been in the forefront of the defense of capitalism,
it may very well be on the verge of serious crisis.”
Deregulation has reduced market transparency and created a plethora of financial
instruments which are relatively untested and extraordinarily volatile. By eliminating
the “rules of the game” the market big shots have raked in hefty
profits but reshaped the economic landscape in a way that no one can predict
what the ultimate outcome will be. The new investment-regime includes such opaque
standards as credit derivatives, credit derivative futures, and collateralized
debt obligations. Hedge funds are now loaded with these over-leveraged debt-instruments
that promise a generous return in an “up-tempo” market, but certain
doom in an economic downturn. Now, that the indicators are all pointing toward
a slowdown or recession, the potentially devastating effects of this new “liberalized”
system will soon be felt throughout the global economy.
Kolko’s article is a “must-read” for anyone who wants to
get a better idea of the fragility of the present system. Americans have dumped
trillions of their hard-earned savings into risky hedge funds which have only
been in existence for a short period of time. No one knows what the future holds
for these “flash-in-the-pan” investments. As Kolko says, “The
credit derivative market was almost nonexistent in 2001, grew fairly slowly
until 2004 and went into the stratosphere, reaching $17.3 trillion by the end
That’s right; a whopping $17.3 trillion, enough to sink the entire economy
if the market takes a nosedive.
This whole idea of re-selling debt is a relatively new phenomenon and fraught
with peril. Hedge funds can bundle together a slew of Adjustable Rate Mortgages
(ARMs) and make a handsome profit, but when the housing market starts listing,
the investor is trapped on a sinking ship with little hope of recouping his
Deregulation is characterized in the business-friendly media as a way of lifting
the burdensome restrictions on the free flow of capital. This is nonsense. Deregulation
is, in fact, the removal of the laws which traditionally protect the public
from the hucksters and scam-artists who create lofty-sounding investments which
are nothing more than Ponzi-schemes. (The purchase of “credit derivative
futures” definitely falls within this category of dicey investments) Deregulation
has gravely undermined the long-term prospects for western capitalism to succeed.
By removing the safeguards to investment, the business and banking communities
have created what many call “casino capitalism,” an anarchic structure
with few protections that is hurling the markets toward a system-wide meltdown.
Similar problems plague the sagging real estate market. In recent years a buyer
could pick up a house with no down payment, an “interest-only” loan,
a low ARM, and be reasonably certain that the next year it would increase 20
to 30% in value. This allows the buyer to refinance his home, use his “presto-equity”
as discretionary income, and begin the cycle all over again next year. With
wages stagnating since the 1970s, the increase in home equity has been the preferred
method for most Americans to “get ahead”. Housing prices have steadily
increased since the 1980s and skyrocketed in the last 5 years. This has created
a feeding-frenzy for low interest loans and attracted millions of speculators
and (traditionally) unqualified applicants to the real estate gold rush.
It’s been a great deal for the banks, too. Mortgages make up the bulk
of the banks loans in America, more than $400 billion last year alone. If it
wasn’t for the steady steam of mortgages many banks would have seen negative
growth in the last decade. Now that housing prices are flattening out and expected
to fall (precipitously) the easy money has dried up and many over-leveraged
homeowners are facing the dismal prospect of having to pay off an asset that
is quickly losing its value. Economist Michael Hudson calls this phenomenon
“negative equity”, that is, when the current value of the house
falls beneath the amount that one has to pay on his mortgage. It is a predicament
which now faces an estimated 30 million Americans who are drowning in red ink
and skittering towards a life of indentured servitude.
The magnitude of the housing bubble is shocking and unprecedented. According
to the Federal Reserves own figures, “The total amount of residential
housing wealth in the US just about doubled between 1999 and 2006 up from $10.4
trillion to $20.4 trillion.”(Times Online) This tells us that the Fed
had a clear idea of the size of the equity balloon their low interest policies
were creating, but decided not to take corrective action. It also tells us that
there will be no “soft landing”. When the market begins to fall,
no one knows when it will hit bottom. $10 trillion is more than a “little
froth”, as Greenspan opined; it is an earth-shaking, economy-busting catastrophe
that will put millions at risk of foreclosure, bankruptcy and ruin.
Greenspan and the privately-owned fed played a major role in putting us in
this mess by rubber-stamping the new system of precarious loans (no down payments,
interest-only loans, ARMs) and perpetuating their “cheap money”
policies. Greenspan admitted this a few months ago when he said that current
housing increases were “unsustainable” and would have corrected
long ago if not for the “the dramatic increase in the prevalence of interest-only
loans…and more exotic forms of adjustable rate mortgages that enable marginally-qualified,
highly leveraged borrowers to purchase homes at inflated prices.”
Greenspan’s circuitous comments are tantamount to an admission of guilt.
The fallout from the fed’s policies are bound to be widespread and devastating.
The country has been buoyed along on $10 trillion of borrowed money which has
created the unfortunate sense of prosperity which is not reflected in the general
economy. The increase in housing prices has not come from wages (which have
actually decreased under Bush) or from demand (inventory is now at a 10 year
high) It has merely been the availability of low interest loans and the promise
of getting rich quick. As the market cools, millions of Americans will either
face foreclosure or be shackled to a mortgage that is higher than the dwindling
value of their home. It is a grim picture of 21st century debt-slavery.
Industry trade groups now believe that the falling housing market will trigger
“a softening of capital spending which will cause a slowdown in US manufacturing
“The housing market has turned; it’s going to be down this year
and even more sharply next year,” said Dan Meckstroth, chief economist
an Arlington, Virginia-based trade group. (Reuters) As the housing bubble deflates,
economic growth will slump, and the anticipated recession will steadily deepen.
Alas, the deregulated “matchstick” markets and the housing bubble
are just two of the three worms which now infect the American economy. The last
of the fiscal demons is the falling dollar. Since, Bush took office the dollar
has dropped a whopping 30% against the euro. At the same time Bush has added
another $3 trillion to the national debt and increased the trade deficit to
an astonishing $800 billion a year; 6.5% of GDP. The US now needs $2.5 billion
per day just to cover its trade deficit. No one believes that this will go on
forever, in fact, Greenspan sagely noted that it was “unsustainable”.
The Bush administration seems to think that if they corner the global oil-trade
by integrating Iran and Iraq (60% of world oil will come from the Middle East
by 2020) into the US economic system, they can forestall the demise of the greenback
as the world’s “reserve currency”. As long as oil continues
to be denominated (mainly) in dollars, the dollar will remain the de-facto international
currency and western elites will maintain their role as the stewards of the
global system. However, as America’s debts continue to mushroom, the US
produces fewer manufactured goods, and the oil-producing countries become more
hostile to Bush’s belligerent foreign policy, there’s a real chance
the dollar will be abandoned as the main unit of foreign exchange. If this happens,
then the $3 trillion that is currently held in central banks overseas will flood
the US triggering hyper-inflation and economic disaster.
Most people understand now that our involvement in Iraq had a lot to do with
oil supplies, but that is only part of the story. The administration is trying
to maintain US dollar-hegemony so they can preserve the system whereby fiat
money is traded for precious resources. That system is under growing strain
and bound together by the tattered webbing of military force. If the mission
in Iraq fails, the dollar-system, which has dominated the world since the Second
World War, will quickly unravel sending tremors through America’s economic
Doug Casey, president of Casey Research, comments on the fate of the dollar
in uniquely apocalyptic terms in a recent article in “Review and Focus”.
“Foreign owners of the big green mountain of US dollars have become uneasy
and are generally looking to sell. There’s no dumping, at least not yet.
When it comes, the flight from the dollar will come slowly, and then gain momentum
before moving into a blow off. Like a glacier sliding toward a cliff, movement
that seems inevitable may take a puzzlingly long time to get underway. But once
it does, things speed up at a surprising rate….Given the choice between
(A) a dead housing market and a scorched earth depression in the US or (B) a
collapsing currency, which at least has the virtue of reducing the real cost
of paying off all those Treasury bonds, I’m forced to believe the US government
will choose to sacrifice the dollar.”
Casey does not mince words, but his sentiments are becoming more mainstream
as the Bush administration continues to increase its “dollar-savaging”
deficits and reckless economic policies.
Many of America’s fiscal troubles could have been mitigated by prudent
management or judicious leadership, but that won’t change things now.
The system is not in the control of the elected representatives and the deeply
rooted problems are likely to persist until a calamitous event precipitates
a fundamental change. The imbalances are now so humongous that everyone agrees
that something has to give. The system is on its last legs as manifested by
its increasing tendency to express itself in terms of repression at home and
militarism abroad; the ominous signs of an injured beast in its death throes.
From the cratering hedge funds, to the faltering dollar, to the fizzling housing
bubble, western-style capitalism is in the advanced stages of collapse. Deregulation
and liberalization have only hastened its decline.
The mighty locomotive of global growth is slowly grinding to a standstill,
bogged down by the accumulated weight of it own inconsistencies and inequities.
Change is coming, for good or bad.
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