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| | The Third Depression
© A. Scott Piraino
The 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, while
onerous government regulations were seen as an impediment to growth.
These were days of “laissez faire” economics and unscrupulous robber
barons.
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 our 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. budget deficit climbed to a
record high $412 billion last year, which was surpassed by our trade
deficit of $496 billion, also a new record. This year’s deficits will
be even larger. The Bush administration has projected a budget deficit
of $390 billion for the year, not including $80 billion for
the war in Iraq. Meanwhile our trade deficit is growing even faster, at
an annual rate of $592 billion.
To finance our current account
deficit, 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, (see the
trade deficit figures above), 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,
rising 30% in the last three months alone. As of this writing the price
of oil has reached 50 dollars a barrel, and gasoline prices nationally
are at a record high $2.11 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 3% annual rate. Last
month the Consumer Price Index jumped 0.6 %, the largest increase in
four years, even when rising prices for food and energy are excluded.
While
inflation is gaining momentum, recent economic reports and corporate
earning statements show an economy rapidly losing steam. General Motors
reported a net loss of over one billion dollars in their most recent
quarter. U.S. durable goods orders plummeted by 2.8 percent in March,
while new housing starts plunged 17.6 percent, marking their steepest
drop in more than 14 years.
Even more telling is a report
prepared by the Economic Policy Institute on April 21st. 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,
and pessimistic economic data sent all three US stock indexes to their
lows for the year in April. The Dow Jones declined by 3 percent, the
tech-heavy Nasdaq dropped by 4 percent, while the S&P 500 lost 2
percent. The market is waiting for the other shoe to drop, and in April
the warnings became more shrill.
In testimony before Congress two weeks ago, Fed Chairman Alan Greenspan warned that “these deficits would cause the economy to stagnate or worse“.
He’s
right, and he knows our economic problems are even worse than our
deficits, a declining dollar, and inflation. 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 eight 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, has recently admitted
to $8.4 billion dollars in losses stemming from derivatives. JP Morgan
Chase has $43 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.
Alan Greenspan is trapped, and he knows it. The Federal Reserve must
raise interest rates to improve the rate of return on dollar
investments, and keep foreign investors from abandoning the US
currency. But higher interest rates will slow down the already moribund
US economy, 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 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 catastrophe we are about to experience, but we have no right
to be surprised. This is the Third Depression after all.
…
| | | Posted 5/2/2005 1:50 PM - 183 Views - 22 eProps - 14 comments
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