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THE POPULIST|The Third Depression Episode
A. Scott PirainoThe US economy as we know it will soon
collapse. This has happened before, twice, and history is about to
repeat itself again. This will be the Third Depression the United
States has suffered, and it will probably be the worst.In the
Gilded Age of the 1890's, and the Roaring 1920's, improvements in
technology and industry fueled rapid economic expansions. Capitalism
was revered as the new engine of progress, onerous government
regulations were an impediment to growth. These were days of "laissez
faire" economics and unscrupulous robber barons.Sound familiar?Inevitably
there was a growing disparity in incomes, but the majority of Americans
were more concerned with getting rich than helping the poor. Most
investors believed these economic booms would last forever, but this
optimism proved to be their undoing as exuberance bid up share prices.
Inevitably the day came when prices fell, and markets collapsed.The
Gilded Age ended with a monetary crisis in the first decade of the
twentieth century. Incoming President Teddy Roosevelt was forced to
borrow money from wealthy elites to finance the government. The Roaring
Twenties ended in a more spectacular fashion, a stock market crash in
1929 ushered in the Great Depression.Depressions are created
when money disappears. People suddenly become poorer, and they spend
less money. With less demand for goods and services, production
declines and prices fall, causing a downward spiral of unemployment and
falling incomes. Our country has endured deflationary periods after
numerous boom and bust cycles, most notably during the Great
Depression. But the coming collapse will be different. Debt,
and our dependence on imported oil and manufactured goods are the
reasons the Third Depression will be different, and much worse. The
U.S. ran a $318 budget deficit last year, but that was dwarfed by our
trade deficit of $726 billion, a new record high, and an 18% increase over 2004. To
finance our current account deficits, we have to import three billion
dollars in cash, every working day. Our deficits now consume 80 percent
of the entire world's net savings, and our demand for debt is
increasing. This is unsustainable.Interest rates on
our national debt are low only because bondholders are confident in our
ability to make payments. The US dollar maintains its value on world
markets because foreign nations believe we can afford our appetite for
imported goods. As our economy falters and our deficits rise, the world
is losing faith in our ability to finance our deficits.This is
why world markets are beginning to reject the US dollar. The dollar has
lost about one third of its value against other major currencies since
2002, and has been falling at a much faster rate in recent months. The
danger of course is that as the dollar declines in value, it becomes
less profitable to hold, and the incentive to sell dollars increases. If
enough central banks and foreign investors began unloading US assets,
other investors and financial institutions would see the dollar rapidly
losing value. They would have to sell their US securities quickly, to
protect themselves from further losses on their dollar denominated
holdings. There would be a financial panic, and the US dollar would collapse. This
danger is very real, and our declining dollar is creating a vicious
cycle which will inevitably cause our currency to depreciate more. As
our dollar loses value, foreign goods purchased with dollars become
more expensive. Since we are now dependent on imported goods, our
shrinking dollar means higher prices for those goods. In
addition to the inflation caused by rising prices for imported wares,
we have to worry about oil. The price of oil is skyrocketing even
faster than the value of our dollar is falling. Oil now costs us 75
dollars a barrel, and gasoline prices nationally are over $3.00 a
gallon at the pump.These market forces are putting immense
pressure on our economy. Higher costs for energy and transportation
have been driving up prices at a 4% annual rate. While inflation is
gaining momentum, recent economic reports and corporate earning
statements show an economy rapidly losing steam. Ford Motor Company just announced plans to cut production by 20%. General Motors reported a net loss of over three billion dollars
in their most recent quarter. U.S. purchases of durable goods orders
decreased by 2.4 billion dollars last month, (although this is not such
bad news, since most of our durable goods are now made abroad). New
housing starts have plunged 20 percent since January, and sales of
existing homes plummeted by 11 percent. Every housing indictor is in
free fall, including home prices. According to a Bank of America Real
Estate survey released Tuesday, "consumer sentiment toward buying a home soured in August" . "Prices fell sequentially for the 11th consecutive month. Prices tumbled in 82% of the markets surveyed". Even
more telling is a report prepared by the Economic Policy Institute in
April of 2005. The report shows that wages and salaries as a share of
national income fell to their lowest levels on record, even lower than
the Great Depression of 1929. Although corporate profits are at all
time highs, wages, (which represent total income for 80% of Americans),
have not kept pace with inflation. The US economy may be
expanding as government statistics claim, but the majority of Americans
are actually getting poorer. US household debt now stands at $10
trillion, ( a record high, of course), and has been increasing by over
one trillion dollars per year since 2002. Americans cannot spend enough
money to lift the economy out of the doldrums, nor can they afford
higher prices, or higher interest rates.The trembling dollar,
inflation jitters, stagnating wages, a collapsing real estate market,
wars in the Middle East, these are all very bad signs, but our economic
problems are even worse. Derivatives are financial holdings that derive their
value from other securities. These new financial instruments have
created a speculative bubble unlike anything ever seen, and pose a
mortal danger to our economy. In a letter to shareholders, billionaire
investor Warren Buffet warned that derivatives were "time bombs, both for the parties that deal in them and the economic system". He went on to explain how derivatives work, and why they are so dangerous:"Essentially,
these instruments call for money to change hands at some future date,
with the amount to be determined by one or more reference items, such
as interest rates, stock prices or currency values. If, for example,
you are either long or short an S&P 500 futures contract, you are a
party to a very simple derivatives transaction -with your gain or loss
derived from movements in the index.""Unless
derivatives contracts are collateralized or guaranteed, their ultimate
value also depends on the creditworthiness of the counterparties (sic)
to them. In the meantime, though, before a contract is settled, the
counterparties record profits and losses -often huge in amount- in
their current earnings statements without so much as a penny changing
hands." In 1986, the global market for derivatives stood
at just over one trillion dollars. By 2004, The U.S. Comptroller of the
Currency estimated the value of derivatives held by U.S. commercial
banks at around $84 trillion. That's seven times the size of the US economy. Derivatives
are now one of the pillars of our financial system. Fannie Mae, a
federally subsidized home-mortgage corporation, admitted to $8.4
billion dollars in losses stemming from derivatives last year. JP
Morgan Chase has over $40 trillion in derivatives contracts, by far the
largest portfolio of any commercial bank. The implosion of one
of our banks or lending agencies due to losses on derivatives would
cause a panic, and wipe out the US economy. And the fact is, many of
our financial institutions are only solvent as long as their derivative
holdings are profitable. This situation is now very dangerous because
87% of derivative positions consist of interest rate contracts.The
Federal Reserve is trapped. The Fed must raise interest rates to
improve the rate of return on dollar investments, and keep foreign
investors from abandoning the US currency. That's why the Fed has
increased rates seventeen times since June of 2004.But higher
interest rates will slow down the already moribund US economy,
force borrowers and to pay more in interest, and create immense losses
on derivative contracts.Monetary policy cannot save us from an
impending financial reckoning caused by our soaring levels of debt and
speculation. The only people who can get us out of our economic
difficulties are the very people who have put us in this mess. Yet the
Bush administration appears to be blithely marching the United States
over the brink of an economic abyss.After the economic crises
following the Gilded Age and Roaring Twenties, there was a backlash
against the excesses of capitalism. Teddy Roosevelt reined in
monopolies, and passed the first income tax into law. During the Great
Depression, Franklin D. Roosevelt raised taxes on the wealthy to
finance his New Deal legislation. Unfortunately, we don't have
a Roosevelt in office to champion the majority against business
interests. President Bush has repeatedly cut taxes for our wealthiest
citizens, and signed more free trade agreements, while our deficits
have soared. He and his cronies have offered nothing but the same
warmed over Reaganomics that created our trade and budget deficits in
the first place. If the US Government does not take
drastic action immediately to reduce our deficits and increase
investment in the US economy, one or more of the following scenarios
will take place: 1) The dollar's value will depreciate until
enough investors and foreign central banks decide to unload our
currency, causing a financial panic. 2) Higher interest rates
will cause multi-billion dollar losses in derivatives trading, and when
a financial institution admits to the scale of those losses, there will
be a financial panic. 3) Too many Americans will foreclose on
variable-rate mortgages and credit card debts, causing a default in a
bank or lending agency, and a financial panic. 4) Fearing any
of the above eventualities, US and global stock markets melt down as
investors liquidate their holdings, causing a financial panic. Either
way, the house of cards that Reaganomics built will soon collapse. We
have a right to be angry about the economic calamity we are about to
experience, but we have no right to be surprised. This is the
Third Depression after all. ...
[ Fri, 1 Sep 2006 17:01:00 GMT ]
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