Chart of U.S. Consumer Inflation (CPI)

Chart of U.S. Unemployment

Chart of U.S.Dollar Indices

Lately I’ve been reading more about economics, in self-defence against all the corporatist-government thievery and lies going on out there.

I’m aware that most people find what is happening in our economy and financial systems unfathomable, so I thought I’d try to simplify the complex. I confess up front this is a substantial over-simplification, and I’m not a professional economist. Recent events really boil down to governments doing what they’re told to do because their self-serving advisors have made them so terrified of the consequences of not doing so, that they feel they have no alternative. It’s not so much “too big to fail” as “failure is not an option”.

Our modern economic system is founded on a false premise — that unregulated ‘free’ markets are the most efficient (free of waste) and effective they will produce better ‘collective’ outcomes than markets that government manages or intervenes in). This has been repeatedly shown to be false, but it still governs mainstream economic, and conservative, thought. In most countries (other than the US and struggling nations) experience with the failures of the ‘free’ enterprise market system — laissez faire capitalism — has led governments to play a significant, if not dominant, role in economic regulation and decision-making. These are what are called “balanced economies”, where governments intervene to limit the excesses of self-serving private interests and to provide goods and services (like health care and education) that the majority believe should be available to all, regardless of wealth or income.

Where there is no balance, as in struggling nations where the government is weak or hopelessly corrupt, the result is a hegemony (total dominance) by a wealthy elite that effectively owns and dictates policy to politicians, regulators and judges. This near-monopoly of consolidated power is variously called corpocracy, corporatism, or fascism. Many right-wing ideologues like Mussolini believed such a hegemony was the much-sought “benign dictatorship” that would act in the collective interest more knowledgeably and efficiently than any democracy. There is a second school of right-wing libertarian ideologues, especially in the US, who believe that the ‘market’ is able to act in this fashion, and that any government intervention will necessarily worsen every situation.

The problem is that the US has never had a ‘free’ market economy. It subsidizes large corporations to the tune of hundreds of billions of dollars, and ignores international legal and ‘free’ trade rulings that go against American corporations. It uses its economic wealth and power to bully other nations into giving it easy and uncompetitive access to their resources, labour and markets at bargain prices. So the current state in the US is an “unbalanced economy” — one where a few rich corporations essentially dictate policy to governments. Any government that refuses to play ball is threatened with the withdrawal of reelection funds by these large corporations in favour of other parties and candidates. In the US it takes a huge amount of money to get elected, and dueling with the corporatists is political suicide. It is not surprising, then, that the wealthiest 1% of Americans now control more than half of the nation’s total wealth, resources and private property, and that while the top 5% of Americans have achieved staggering real increases in wealth and income over the past 40 years, real net wealth and real income for everyone else have declined.

The US economy was substantially built on war. Most of the accumulated wealth of the country was made through war and “defense” activities, a large proportion of American innovations stemmed from huge military investments, and military and defense spending still directly or indirectly provides 20-30% of US economic activity (economic production and jobs).

On top of this, our global economy is addicted to growth. Without steady, continuous, unending growth, corporations could not raise capital or borrow money, so they would collapse. The stock market requires sustained double-digit growth in profits to keep it from collapsing — current share prices have an implicit “price/earnings multiple” that assumes continuous rapid growth in profits, forever, and if you took away that profit growth, shares would be worth substantially nothing. Every stock market ‘investment’ is a gamble on perpetual growth.

This exhaustive need for growth has led to (a) globalization — opening up markets in struggling nations to fuel affluent nation revenue growth, (b) a huge supply of credit to encourage citizens to borrow more and more, and spend more and more (notably larger and more expensive houses), and throw out and replace more and more, (c) the replacement of one-income families with two-income families, so that more cars, gasoline, child care, restaurant meals and other expenditures are needed to permit these two-income families to focus most of their lives on their jobs, and (d) ridiculously and artificially low ‘official’ interest rates, to encourage reckless borrowing to be used for even more consumption.

Over the last 50 years, this system has been ratcheted up tighter and tighter, because if any of these four growth factors dries up, growth ends, the stock market collapses, housing prices collapse, corporations collapse, and the global economy plunges into depression. Bad for corporations, bad for incumbent governments — we can’t have that. To keep this whole thing going, governments began, in the Reagan years, to lie to their citizens. They ‘recalibrated’ how unemployment and inflation are calculated, so that both ‘official’ numbers were much lower than the more honest numbers that had been reported up until then. If they reported honest inflation numbers, people would panic and demand higher wages and indexing of pensions and social security benefits. If they reported honest unemployment numbers, people would riot. So, while the ‘reported’ average rate of inflation in this decade has been about 2%, the true average rate of inflation (as anyone who manages the family finances intuitively knows) has been, until recently, about 10% — a doubling of the cost of living every 7 years (see first chart above). And the true US unemployment rate is not 10%, but 21% (see 2nd chart above), and has averaged 12%, not 5%, this decade. If you’re not feeling ‘better off’ as a result of all the reported GDP growth over the last few decades, that’s why.

A couple of years ago, this whole system of ‘perpetual growth’ and deception started to come unsprung. Essentially, American citizens ran out of money, and spending capacity. They’d maxed out their credit cards, borrowed against their inflated home values to the hilt, and, thanks to real inflation, their 30-year slide in real disposable income had pushed them to the point they just couldn’t spend any more. On top of this, they were so deep in debt that they were terrifyingly vulnerable to a loss of either bread-winner’s job, or to illness, or to an increase in interest rates. Many of them were already paying usurous interest charges on ill-advised debts and sub-prime mortgages — rates as high as 30% annually, and, as the book The Two Income Trap describes, an average rate of 16%. When you can get 16% or 30% annual return on your mortgage loans, you’re prone to take a lot of risks.

The last straw was the spike in gasoline prices. So US citizens, responsible for driving 72% of all domestic GDP, suddenly stopped buying. Housing sales, especially in cities, collapsed as buyers vanished from the market. Housing prices followed suit. The whole set of dominos started to fall. Without inflated house values to borrow against, credit started to dry up. Suddenly banks realized that house prices couldn’t be depended on to rise forever, and their mortgages were suddenly higher than the value of the properties they ‘secured’. People unable to pay the outrageous interest on their debts realized this too, and rather than banking on a recovery, just defaulted, and walked away from their homes. This was especially true among speculators, who weren’t living in those houses anyway — they were just buying them no-money-down (like the infomercials said) and waiting for them to go up for a quick flip.

Now you have all these financial institutions, which over the last 50 years have grown from 10% of the US GDP to over 30%, panicking. They’d bought all these junk mortgages and repackaged them to hide their risk and now people were saying they weren’t going to buy any of these ‘financial instruments’ until they were sure they weren’t contaminated with these now-worthless ‘sub-prime’ loans. That included other banks, which suddenly refused to lend to each other. With no liquidity, the entire over-extended, risk-crazy banking system went into free-fall. No one could get money. Everything started to collapse.

The banks went to the government (then run by the idiot Bush) and said “You have to bail us out, we’re too big to fail. You have to give us trillions of dollars in loans and loan guarantees. You have to basically underwrite, with US taxpayer dollars, the entire US financial system — 1/3 of the whole US economy — and indemnify us all from losses on these bad loans. There is no alternative. It’s not just us on the line, it’s the whole economy, and perhaps the stability of the government.”

So the governments, Bush’s and Obama’s and all the governments of all the affluent nations of the world (because some of them had more invested proportionally in this worthless US debt than the US itself had), all ponied up trillions of dollars to guarantee or refinance all the (unknown amount of) worthless debt that the financial institutions had created. They wrote a blank cheque to the banks, with virtually no strings attached. A catastrophe was averted due to a whole series of fortunate occurrences. Because the crisis was global, the printing of trillions of US dollars with no underlying value didn’t collapse the US dollar. Ironically, because the crisis pinpointed the fragility of all the world’s banking systems and currencies, it actually drove people to buy more US dollars, since it is (for a while longer anyway) the world’s official ‘reserve’ currency — the one all others are officially gauged against. It’s the currency that the World Bank and IMF have essentially deemed ‘too big to fail’. So (as the third chart above shows), the 25-year-long steady collapse of the US dollar — due to its impossible debt levels and trade deficits even before the crisis — actually paused during the crisis. It is now resuming, as worry sets in about US debt levels that have spiked by several more trillions of dollars.

Now, the interesting thing is that, when the governments paid trillions of dollars in extortion to the banks to bail them out for their reckless lending decisions, what they did with these trillions was not use them to restore liquidity to the banking system and start lending again to banks and mortgage companies and people whose houses had lost most of their underlying value. No, that would be risky behaviour, because these houses just weren’t good collateral in the first place. The banks found it was far more profitable to evict homeowners and sell off their homes for what they could get for them, than to lend money against houses that were worth — who knows what? So instead, they plowed those trillions into something they thought less risky — the stock market that had collapsed on the heels of the housing market collapse.

When they started doing so, the S&P 500 had fallen from nearly 1600 to 680 (i.e. it had lost 60% of its value, as had the Dow Jones Index). Once they’d thrown those billions in taxpayer dollars into the stock market, they’d pushed the index back up to nearly 1100 (an increase of over 50%). And because much bank investing is leveraged, they’d made a fortune in the process. The banks were happy — and ready to hand back most of the free taxpayer bailout money they’d received. The corporations were happy — their share value was back up so they were no longer in serious financial difficulty. The government, looking at these huge paper profits, and increases in share values, could joyfully declare the recession “over” and pat themselves on the back for averting a Great Depression.

Unfortunately, it’s been one more quick fix, one more ratcheting of the fragile, creaking machinery of the industrial growth economy one click tighter. The underlying weaknesses remain unaddressed, and the wreckage is massive. Real unemployment is 21%, and it will take decades to recover from this. US housing prices remain, well, unknown.

There are so many houses that have been put on and taken off the market in despair that no one really knows what any property is now worth. When there’s so much supply and no demand it’s anyone’s guess. The ability of citizens to spend their way out of this recession remains horrifically low, even if they’re stupid enough to bid prices back up again until they’re hopelessly in debt. The value of the stock market today bears no reality whatsoever to the earnings of the companies in it — it’s driven solely by excess liquidity created by the government using taxpayer dollars, which has no ‘safe’ place to park, so it’s in the stock market by default (bonds, the other ‘safe haven’, are earning paltry rates like 1%).

What effectively happened is that our governments printed trillions of dollars in currency that will have to be paid back by future generations (i.e. they ‘borrowed’ trillions from future taxpayers) to give to banks to prop up the stock market. That’s what the bailout was all about.

Alas, it’s even worse than that. Obama and the bankers have to find some way to push up the value of real estate, because as long as most people’s wealth is tied up in it, they’re going to be unwilling or unable to spend on anything else. They came up with a clever idea. They’re using government money, via the housing authorities and Ginnie Mae (soon to be as bankrupt as Freddy Mac and Fannie Mae), to tempt people with small amounts of cash that they can use towards down payments on new homes. Because this allows people with no money and no credit to buy houses that they can just walk away from (thanks, taxpayer!), and because of the leverage this ‘free’ money offers, its effect, according to the researchers at Automatic Earth, could be to keep the value of houses at more than twice what their ‘real’ value would be in an unsubsidized market. So what happens to house prices, borrowing capacity and the taxpayer’s guarantee money when these artificial ‘incentives’ are removed? The same thing that will happen to the stock market when all that bailout money has to be paid back to the government. Crash.

mortgage guarantors

As the chart above shows, the US federal government (i.e. the taxpayer) is now virtually the sole lender in the US housing market. In today’s analysis in Automatic Earth, there’s a prediction of how much damage is to come from this ‘mini-bailout’:

It has cost the American people trillions of dollars to prop up the market to the present day, where general price levels have fallen “only” 30%. All attempts to keep the market alive have failed miserably, at least, that is, from the point of view of ordinary Americans.

With the government support about to vanish, the future prospects for home prices and the building and mortgage industries are Halloween material, while Bank of America (which bought Countrywide) and Wells Fargo (the country’s largest mortgage lender) face increasingly shaky days. Home prices are ready to go into a freefall. When the smoke clears prices will be down 80-90% from their peak. Needless to say that will cause such a chaos it’s hard to predict what America will look like.

Now, here’s a quote from today’s CNN economic summary:

The dollar rose to a two-week high against the euro Tuesday after a report showing U.S. consumer confidence deteriorated sharply in October boosted the greenback’s safe-haven appeal. The disappointing confidence data bodes ill for U.S. growth because it indicates lower consumer spending, which accounts for 70% of the economy. Without U.S. consumers, the world economy is also unlikely to recover as swiftly as hoped.

“When the U.S. consumer is not likely to continue spending, it means it’s going to be a long, drawn-out type of recovery. Nothing is going to happen overnight,” said Dan Cook, senior market analyst at IG Markets in Chicago. “So we see that drive to risk aversion.” The Conference Board’s U.S. consumer confidence index fell to its weakest since July and well below forecasts.

The insanity continues. Investors are rushing to the ‘safe haven’ of the US dollar because of bad economic news, despite the fact that that US dollar now has almost no fundamental value. The possibility of the US ever being able to repay $16 trillion in government debts, even in the mythical perpetual growth industrial ‘free’ market economy, is zero. The US dollar has value for the same reason the stock market has value — money has to go somewhere, and the other places to put it look even worse.

This is how Ponzi schemes are built — on the psychology that some idiot will always pay more than something’s worth if they can be convinced that another idiot will come along who will pay even more.

Until we run out of idiots.

So now you know, in oversimplified terms, where our precarious economy sits, and how it got there. Prices are going to go down, a lot, as sure as gravity, and in an economy that is addicted to growth, and whose existence depends on perpetually increasing prices, and debts, and spending, and profits, that will be catastrophic. How soon that will happen, no one can say. It probably depends on when we run out of idiots. Because it’s going to be ugly, I hope it happens gradually. For the sake of our children and grandchildren, the victims of this theft, who will suffer its consequences for decades, I hope it starts soon.

(If you want to keep up to date on where all this is going, and learn more, The Automatic Earth is worth reading regularly).