Part Two - 3 - Financial Crisis Watch

PART TWO: HOW AMERICA BECAME ENSNARED IN THE DEBT TRAP (Cont'd)

ENSNARED THROUGH THE ACCELERATION OF SPENDING

You might already be suspicious that since ‘fiat’ currency can be printed without gold to back it up, that there would be a temptation to print and spend. You would be right. And by the time we went to fiat currency, a very influential economist named John Maynard Keynes had already convinced us that spending is a good thing.

1) Keynesian Economic Theory -- Because world nations were tied to the dollar, they also adopted Keynesian economic policies that had been embraced by the U.S. government. This set all nations of the world on a path of escalating debt. The economic ideas of Keynes were adopted in the 1930’s and spread widely until the 1970’s, with renewed application in recent decades. Keynes believed that the government should intervene in the economy in slow times through deficit spending (that is, borrowing to spend more than we have). He argued that with government spending, recessions and inflation could be avoided and constant growth could be maintained. His idea was to acquire debt by short-term deficit spending during recessions and then pay it down by surpluses achieved as growth was stimulated. Unfortunately the theory didn’t account for politicians’ tendency to use the surplus funds of boom times for politically flashier choices than paying down debt. Instead of reducing our debt we kept accumulating it as we implemented programs that required more spending.

2) The Encroachment of Socialist Ideology -- Marxist and socialist thinking has been a strong undercurrent in the U.S. since Marxism began to flourish in the late 19th century. Periodically discredited, it has often remained underground, but has never gone away.

Its siren song of utopian promises regularly rises to claim fresh recruits in the youthful idealism of new generations. Socialism’s main flaw is the shifting of responsibility from the individual to the government. It claims imaginary ‘rights’ and builds an expectation that ‘someone out there’ should provide them. Not understanding that there is no such thing as ‘government’ money, socialist policies dampen and discourage the productivity of individual initiative in the private sector. It seeks to redistribute the amount of pie everyone gets, but only succeeds in cutting off the flow of pie ingredients while increasing the expectation and appetite for more pie. As Margaret Thatcher was famous for saying, “The problem with Socialism is that you eventually run out of other people’s money.”

ENSNARED THROUGH CULTURAL FACTORS

It should be clear that both the banking and currency systems set us up for the growth of debt. But other factors weigh in, too. A mind-set shift has taken place in our culture that has diminished our economic potency by reducing our production prowess.

1. Deteriorating U.S. Culture -- The post-WW2 culture in the U.S. weakened dramatically in its work-oriented ethic, becoming used to a lifestyle of increasing prosperity and leisure while drifting increasingly into a consumption-oriented mindset. The post-WW2 industrial boom created a generation of incredible growth and production. We learned not only to enjoy the fruits of our productivity, but to expect them as a way of life. We became increasingly consumption-oriented rather than production-oriented. Of course, those who could sell goods to us more cheaply got our business. Manufacturing learned that it could make these goods much cheaper overseas. As technology made international trade ever-more feasible we gradually but steadily allowed our own manufacturing base to be gutted. But even the cheaper price of foreign-produced goods wasn’t enough to satisfy our growing appetite for consumption. Americans increasingly took on personal debt to acquire their ‘stuff’. As a whole, Americans owe about $11 trillion dollars in debt, with the average family owing $15,000 in credit card debt, $149,000 in mortgage debt and $33,000 in student loans. So instead of producing things to increase our wealth, we are dissipating our wealth through buying things that other nations are now producing. And we’re not only spending our wealth, we’re going deep into debt to spend wealth we do not even have.

2. Entitlement Mentality -- Beginning in the 1930’s and growing throughout the 20th century, the U.S. economy became encumbered by the financial demands and promises of entitlement programs. These programs are rooted in the collectivistic mentality of socialist thinking. Socialism thrives on utopian promises that cannot be delivered by real-world economics. Programs promising to provide these ‘rights’, initially sound great, seem reasonable and begin small, but grow unsustainable in size over time. Socialist thinking spreads a steadily increasing culture of government dependency rather than individual initiative, gradually undermining national productivity. Union-secured quality of living demands brought many needed improvements to workers in the early 20th century. But unions have driven jobs to countries with less-expensive work forces, as their demands for increases in pay and benefits outpaced the economy’s ability to provide them.

3. Aging population -- The U.S. population demographic began to rise in age, with retirees increasing the demand on Social Security, Medicare and other government-funded entitlement programs, and reducing the ability of government to generate revenue from income tax.

All of these factors have had a weakening effect on both the character and mindset of our nation. Perhaps this is why we have seen an increasing tendency in our leadership to cut corners where we shouldn’t.

ENSNARED THROUGH CUTTING CORNERS

Outward circumstances in culture and technology continually develop, often leading to the general assumption that ‘things have changed’. Some things DO change, but some things DO NOT change. The essence of wisdom is being able to discern which is which.

Technology and historical circumstances change. Patterns or laws embedded in the nature of the universe do not change. Among the patterns that do not change are economic laws. By deceiving ourselves into thinking that ‘things are different now’, we inevitably invite the return of unsound financial practices that are repackaged to look like modern progressive developments. Buying into faulty assumptions has repeatedly led us to financial disaster. In the 1920’s some had become convinced that stocks were going up and would never come down. Preceding the housing market crash of 2006-7 there was an almost universal assumption that housing prices would never come down. Technological developments in economic management led congress to assume that the banking mismanagement of the 1920’s wouldn’t be repeated. Current stimulus spending assumes that the economy will be spurred to a growth level that will pay off the debt incurred by stimulus spending.

We have seen that banking, currency and cultural factors were weighing in against U.S. financial strength as the 20th century progressed. Adding to this load, misplaced assumptions led to a growing number of bad financial decisions.

1. Abusing the Artificial Strength of the Dollar – In spite of our use of fiat currency and growing debt, the U.S. dollar has been able to continue in an artificially strong position. This is due to two factors. The dollar has continued to hold both World Reserve status and Petrodollar status. This situation made deficit spending tempting because it enabled us to carry more debt while still maintaining a high credit rating.

2. Bank Deregulation – Commercial banks have historically held a reputation for being strict and conservative, leading to high confidence in their soundness and reliability (think Mr. Banks in ‘Mary Poppins’) Financial investment companies, on the other hand, are more inclined to take risks in pursuit of potentially huge profits that can be made from speculative ventures. It was the blending of the traditional practices of commercial banks with investment services that set the stage for the market crash of 1929. Banks began loaning to very speculative ventures and highly leveraging them. In the aftermath of the Great Depression, these two functions were separated by banking regulations put into force through the Glass-Steagall Act of 1933. This crucial separation of commercial and investment functions was reversed by the Gramm-Leach-Bliley Act in 1999, with the assumption that modern banking could be ‘self-regulating’. In spite of the lessons learned from the stock market craze and crash of the 1920’s, commercial and investment banking were once again allowed to co-mingle. This may be the most predominant factor causing the 2008 crisis and our ensuing problems.

3. Sub-Prime debacle set-up -- The financial crisis of 2008 was the convergence of several intense economic weather patterns.

FIRST OF ALL, faulty assumptions usually set the stage for disaster and nearly everyone bought into a big one here. There was a widespread belief that real estate prices would always continue to increase, because they always had. But housing prices had never grown out of proportion to earned income levels, which they slowly did beginning in the 1970’s accelerating rapidly in the first decade of the 21st century. As the gap between housing prices and earned income levels grew, this trend developed a massive bubble in real estate prices.

SECONDLY, the Community Investment Act of 1977, which was updated and relaxed in 1995, was a government initiative requiring banks to provide mortgages to less-qualified applicants. Again, with the assumption that housing prices always go up, it was intended to increase the number of American home-owners, helping to raise their standard of living.
Banks began to issue ‘sub-prime’ mortgages, often called NINA (No Income, No Assets, No Problem loans) and NINJA (No Income, No Job, No Assets, No Problem loans).

But, of course, mortgage requirements were established for a reason. There is no benefit to getting a mortgage when you can’t make mortgage payments.

Thirdly, lax regulation of banking practices and credit rating agencies enabled bankers to bundle these high-risk mortgages along with good ones and sell them off as good investments. All three of these forces, plus others, created a massive financial implosion when mortgages began to fail and real estate prices began dropping in 2006-7.

4. Complex Leveraged Securities – Computer-powered technical ability enabled the development of new, highly creative and complicated securities. These instruments have reached a level of complexity difficult to understand even by highly trained financial specialists. This makes detection of the actual status of institutional finances quite difficult to expose. For example, the Goldman Sachs bank helped Greece use derivatives to hide their debt so they could qualify for admittance to the European Union. Toxic assets spread throughout the globe escalated in their impact through a leveraging process called ‘hypothecation’ and ‘re-hypothecation’, meaning that collateral for existing loans could be re-applied as collateral for other loans many times over. Because the collateral is not considered cash, it does not show up on corporate balance sheets, making the dangerous debt levels easy to hide from public view. This practice led to the collapse of Lehman Brothers in 2008 and continues to be a huge factor in the shadowy world of the international derivatives market. It is estimated that the shadow derivatives market conceals debt at a level between $600 trillion and $1.4 quadrillion. Keep in mind that the GDP of the entire world is approximately $65 trillion.

5. Questionable reserves of precious metals --- The U.S. silver reserve was 3.5 billion ounces in the 1950’s, but has since been entirely depleted in efforts to keep the price low as well as to supply the increasing industrial demand for silver. The government’s gold-reserve status now stands in question. Observers note the lack of openness to inspection and accounting, along with fractional-banking practices which sell paper shares of gold and silver. This raises suspicions that whatever remaining stocks may exist have been vastly over-sold and will not be available if called for redemption.

6. Acceleration of money creation -- Monetary policy of the U.S. Federal Reserve Bank has turned to ‘Quantitative Easing’, or acceleration of the printing of fiat-currency. This policy is spoken of as ‘stimulus’, intended to spark growth in the economy that will boost GDP (Gross Domestic Product) and thereby raise government revenue. But stimulus money that doesn’t increase long-term production has a short-term growth effect while adding to the debt and devaluing (inflating) the currency. As debt grows the government is trapped into spending in order to keep the interest rate down because a rising interest rate makes our interest payment on the debt go up. This becomes a losing battle. It sets up the danger for – many say the inevitability of -- hyper-inflation, or complete collapse of currency value, the way in which fiat currency typically dies. While government ‘stimulus’ is used as a ‘boost’ to economic growth, its effect is artificial. As it wears off, more is needed. But unless real growth factors are at work, every ‘boost’ has to be larger. You can think of it like a clutch that starts slipping. The worse it gets, the more acceleration has to be increased to achieve the same pull, until eventually there is no pull left at all. Another way to think of it is like a drug fix. The addict continually needs more of the drug to get the same high, leading to an eventual overdose.

7. Monetizing the debt – It has historically been advantageous for prosperous countries to ‘park’ their wealth by buying U.S. treasuries, essentially loaning us their money. U.S. treasuries are regarded as one of the surest safeguards of money because of our historically stable government and strong economy. Making purchases of U.S. debt has the effect of protecting other nations’ wealth and strengthening their ties with the U.S. The increasingly precarious state of the U.S. economy causes concern that nations which were previously large purchasers of U.S treasuries will begin reducing the amounts of U.S. debt they are willing to buy. For the first time, China recently began reducing its amount of U.S. debt purchase. As a result, the Federal Reserve has begun buying our own debt (called ‘monetizing the debt’). This practice is seen by many economic observers as the beginning of the end of a fiat-currency, because it reflects a decreasing confidence in the state of the U.S. economy by other nations.

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