Thomas Palley: A second great depression still possible.

This is no doubt a minority view but Palley argues that there could very well be a second dip. Palley argues that deleveraging will involve saving and paying off debt which militates against spending that would stimulate the economy. Also, the government will gradually ease stimulus spending which also could increase debt. Of course as the article notes programs such as cash for clunkers just temporarily increase sales and this is followed by a huge slump during the next period.Thoms

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A second Great Depression is still possible
October 11, 2009 4:37pm
by FT
By Thomas Palley
Over the past year the global economy has experienced a massive contraction, the deepest since the Great Depression of the 1930s. But this spring, economists started talking of “green shoots” of recovery and that optimistic assessment quickly spread to Wall Street. More recently, on the anniversary of the Lehman Brothers crash, Ben Bernanke, Federal Reserve chairman, officially blessed this consensus by declaring the recession is “very likely over”.
The future is fundamentally uncertain, which always makes prediction a rash enterprise. That said there is a good chance the new consensus is wrong. Instead, there are solid grounds for believing the US economy will experience a second dip followed by extended stagnation that will qualify as the second Great Depression. Some indications to this effect are already rolling in with unexpectedly large US job losses in September and the crash in US automobile sales following the end of the “cash-for-clunkers” programme.
That rosy scenario thinking has returned to Wall Street should be no surprise. Wall Street profits from rising asset prices on which it charges a management fee, from deal-making on which it earns advisory fees, and from encouraging retail investors to buy stock, which boosts transaction fees. Such earnings are far larger when stock markets are rising, which explains Wall Street’s genetic propensity to pump the economy.
As for mainstream economists, their theoretical models were blind-sided by the crisis and only predict recovery because of the assumptions in the models. According to mainstream theory, it is assumed that full employment is a gravity point to which the economy is pulled back.
Empirical econometric models are equally questionable. They too predict gradual recovery but that is driven by patterns of reversion to trends found in past data. The problem, as investment professionals say, is that “past performance is no guide to future performance”. The economic crisis represents the implosion of the economic paradigm that has ruled US and global growth for the past thirty years. That paradigm was based on consumption fuelled by indebtedness and asset price inflation, and it is done.
There is a simple logic to why the economy will experience a second dip. That logic rests on the economics of deleveraging which inevitably produces a two-step correction. The first step has been worked through, and it triggered a financial crisis that caused the worst recession since the Great Depression. The second step has only just begun.
Deleveraging can be understood through a metaphor in which a car symbolises the economy. Borrowing is like stepping on the gas and accelerates economic activity. When borrowing stops, the foot comes off the pedal and the car slows down. However, the car’s trunk is now weighed down by accumulated debt so economic activity slows below its initial level.
With deleveraging, households increase saving and re-pay debt. This is the second step and it is like stepping on the brake, which causes the economy to slow further, in a motion akin to a double dip. Rapid deleveraging, as is happening now, is the equivalent of hitting the brakes hard. The only positive is it reduces debt, which is like removing weight from the trunk. That helps stabilise activity at a new lower level, but it does not speed up the car, as economists claim.
Unfortunately, the car metaphor only partially captures current conditions as it assumes the braking process is smooth. Yet, there has already been a financial crisis and the real economy is now infected by a multiplier process causing lower spending, massive job loss, and business failures. That plus deleveraging creates the possibility of a downward spiral, which would constitute a depression.
Such a spiral is captured by the metaphor of the Titanic, which was thought to be unsinkable owing to its sequentially structured bulkheads. However, those bulkheads had no ceilings, and when the Titanic hit an iceberg that gashed its side, the front bulkheads filled with water and pulled down the bow. Water then rippled into the aft bulkheads, causing the ship to sink.
The US economy has hit a debt iceberg. The resulting gash threatens to flood the economy’s stabilising mechanisms, which the economist Hyman Minsky termed “thwarting institutions”.
Unemployment insurance is not up to the scale of the problem and is expiring for many workers. That promises to further reduce spending and aggravate the foreclosure problem.
States are bound by balanced budget requirements and they are cutting spending and jobs. Consequently, the public sector is joining the private sector in contraction.
The destruction of household wealth means many households have near-zero or even negative net worth. That increases pressure to save and blocks access to borrowing that might jump-start a recovery. Moreover, both the household and business sector face extensive bankruptcies that amplify the downward multiplier shock and also limit future economic activity by destroying credit histories and access to credit.
Lastly, the US continues to bleed through the triple haemorrhage of the trade deficit that drains spending via imports, off-shoring of jobs, and off-shoring of new investment. This haemorrhage was evident in the cash-for-clunkers program in which eight of the top ten vehicles sold had foreign brands. Consequently, even enormous fiscal stimulus will be of diminished effect.
The financial crisis created an adverse feedback loop in financial markets. Unparalleled deleveraging and the multiplier process have created an adverse feedback loop in the real economy. That is a loop which is far harder to reverse, which is why a second Great Depression remains a real possibility.
Thomas Palley is former chief economist of the US-China Economic and Security Review Commission and is currently Schwartz Economic Growth Fellow at the New America Foundation

Economic woes hit U.S. state budgets

There is no sign of the economic woes hitting the war on terror or the war in Iraq and Afghanistan. Where the defence budget is concerned there are never cutbacks or cries about entitlements.

Economic woes hit state budgets

Peter Grier | Staff writer
The Christian Science Monitor
April 2, 2008

Soaring inflation and shrinking tax revenues will make it tougher for
at
least 25 states to fund public services.

Washington - In Nevada, Gov. Jim Gibbons told legislators on March 31
that
the state's budget shortfall could reach $900 million by the middle of
next
year - and that he wants spending cuts beyond the 4.5 percent cutbacks
he
ordered in January.

In Florida, state leaders say they are facing a series of budget
shortfalls
unprecedented in modern history. They're considering using up as much
as
$1.7 billion in revenue reserves to plug spending gaps in coming
months.

In Maryland, the General Assembly last fall raised taxes by $1.4
billion a
year at Governor Martin O'Malley's urging. His job approval rating has
now
fallen below 40 percent.

Across the United States, soaring inflation and shrinking tax revenues
have
combined to place state budgets under severe stress.

This fiscal year is tight, and the next one promises to be even
tighter. At
least 25 states will be in the red for fiscal 2009, which begins this
coming
July for many. The combined shortfall is expected to total at least $39
billion, according to figures compiled by the Center on Budget and
Policy
Priorities.

"The result may be a squeeze on states' ability to fund services," said
Robert Ward, deputy director of the State University of New York's
Rockefeller Institute of Government in a report on state budgets
released
March 31.

The causes of state budget problems are easy to spot with even a
cursory
glance at the business section of a newspaper.

Falling home prices are causing consumers to curb spending, which in
turn
reduces state sales tax revenues. Unemployment is rising, and income is
flat
or declining - resulting in state income tax revenues that are not as
high
as once projected.

With the effects of inflation and enacted tax changes added to this
mix,
combined state tax revenues decreased by 4.3 percent in the fourth
quarter
of fiscal 2007, according to figures compiled by the Rockefeller
Institute.

Meanwhile, the cost of the items states spend their money on is rising
at a
rate greater than that of overall national inflation. State and local
government inflation rose 6.2 percent for fiscal 2007, with jumps in
fuel
and healthcare and pension costs big contributors.

"States are experiencing a classic nutcracker effect: costs are rising
sharply just as revenues falter," said Mr. Ward.

Among the states where revenues dropped significantly were Oregon,
Florida,
West Virginia, Mississippi, Arizona, and Nevada, according to the
Rockefeller survey.

Kentucky, Oklahoma, Tennessee, North Carolina, Wyoming, Delaware, and
Wisconsin showed smaller declines.

Meanwhile, some mineral and petroleum-rich states showed revenue
increases.
These included Alaska, Colorado, and Texas.

Given the unpredictable nature of the course of the national economy
and the
course of action Washington may pursue in attempting to jump-start it,
predicting the status of future state budgets is fraught with
uncertainty,
notes the Rockefeller Institute report.

"One apparently safe prediction: [It will be] a very difficult year for
state budget makers," it concludes.

Of course, those budget makers may be used to trouble by now. Though a
booming economy eased some of their problems in recent years, overall,
many
states have never recovered from the fiscal crisis of the early part of
the
decade.

The recession of 2001 was a difficult one in many state capitals. State
expenditures fell sharply - and for all states combined, today they
remain
below the level of 2001, when inflation is taken into account,
according to
a report by the Center on Budget and Policy Priorities (CBPP).

And budget problems can be more severe for states than the federal
government. By law many cannot run a deficit as Washington can.

Among the budget cuts that have been made or proposed, according to a
roundup compiled by CBPP, are reductions in public health programs. In
California, for instance, Gov. Arnold Schwarzenegger has proposed
making
some families pay more for the State Children's Health Insurance
Program.

At least eight states are proposing to cut K-12 education, according to
the
CBPP roundup. Arizona may eliminate childcare subsidies for some
low-income
working families.

Meanwhile, eight states - including Florida, Kentucky, and Virginia -
either
have already reduced or may soon reduce funds for public higher
education.

Tax hikes are another means of dealing with red ink. But as the
experience
of Governor O'Malley shows, they can be very unpopular.

The $1.37 billion in tax increases approved by Maryland's General
Assembly
last year is already facing a significant alteration: Fierce industry
reaction to a surcharge on computer services has led to the
consideration of
a proposed tax on millionaires to replace the computer levy.

Michigan also passed a broad tax increase in late 2007. Other states
considering revenue enhancements include Kentucky, where the governor
has
proposed raising the tobacco tax.

.Material from the Associated Press was used in this report.

http://www.csmonitor.com/2008/0402/p03s05-usec.html

Report from an Unfolding Crisis, or What I Learned in Washington

This is from a Canadian economics blog. This is an analysis of the developing crisis from the point of view of a progressive Canadian economist. So far European authorities have not attempted to stimulate their own economies as has the U.S. As the article notes one of the key factors in creating the crisis has been lax regulation of the financial sector. While the U.S. has acted quickly to stimulate the economy and bail out Bear/Sterns it seems in no hurry to develop regulations to prevent the same fiasco from occuring again.

Report From an Unfolding Crisis, or What I Learned in Washington.


I was in Washington last week for meetings of economists from central trade union bodies, mainly from the OECD countries. While the main purpose of the meetings was to draft the annual union statement to the upcoming G-8 summit in Japan, we had a full day of meetings with researchers and senior officials from the International Monetary Fund, and also a half day mini conference on the unfolding economic crisis with progressive US economists, including Bob Kuttner, Robert Pollin, Bill Spriggs and Tom Palley.
With Bear Sterns collapsing just before we met and the US visibly headed into a potentially deep recession, the key theme of discussion and debate was, of course, the growing global financial and economic crisis, and what to do about it.
On the union and progressive economist side, the current crisis is seen as rooted in the current neo liberal global model, marked by a powerful, largely unregulated financial sector, by a global shift of power from labour to capital which has been depressing wages, and by unsustainable trade imbalances between major economic regions.
The IMF officials we met with hardly share this perspective but they were, to say the very least, deeply worried about where we are headed. Indeed, the extent of their concern was worrying in and of itself given that, until very recently, the IMF and central banks had tended to downplay if not dismiss concerns that financial de-regulation would lead to a major crisis.
The global economic outlook is currently being revised downwards, with, as the saying goes, pronounced risks on the downside, meaning that things could spin out of control. Key concerns expressed by and to the IMF from our group are that the US is in or near recession, which threatens to become deep and prolonged if the financial crisis turns into a credit crisis in which households and businesses are unable to borrow, and if housing prices continue to fall and destroy household wealth. Effective borrowing rates have not fallen despite recent deep cuts to policy interest rates by the US Federal Reserve, and risk spreads are now rising for even what would seem to be sound assets such as high grade corporate bonds. There is no indication when US housing markets will hit bottom, and more and more US households have seen their housing equity evaporate to nothing.
Growth in Europe could be slowing due to the knock-on effects of the financial crisis on their financial institutions and, as in Japan, the impacts of high oil prices. Some of the most worrying aspects of the financial crisis persist and are deepening. No one knows for sure who is holding the bad debts, what distressed assets will be worth if an when markets finds a bottom, and which institutions will survive and can be trusted not to renege on their own debts and deposits. Some of the distressed assets such as low grade sub prime mortgage securities may turn out to be worthless, and there is talk of eventual losses of 20% or more on even the highest grade, early vintage sub prime mortgage backed securities. Some of the highest risk securities such as the last tranches of sub prime mortgage debt may turn out to be almost worthless.
The current liquidity crisis - the difficulties banks and hedge funds face in finding cash - threatens to turn into a broader solvency crisis in which banks lack the capital to match any shortfall between their assets and liabilities. Clearly it was not just hedge funds which borrowed heavily to invest in what turned out to be very risky assets, but also major US and European banks which were supposed to be more closely regulated. To say the least, the collapse of Bear Stearns almost overnight shocked everyone, and will likely come to be seen as one of the defining events of this crisis.
On a more reassuring note, the anticipated slowdown is only just turning up in the hard data on production and jobs, meaning that something can be done about it in the US and elsewhere. Meanwhile, there are few signs to date of the crisis spreading in a major way to developing countries, which can still borrow, and where internal demand is still leading growth. That said, risk spreads on developing country debt are rising, and their stock markets have mainly been falling. If the US does go into recession, developing country exports and commodity prices will likely fall from current high speculation- fueled levels, further worsening the downturn.
What is interesting, to say the least, is that the IMF is concerned enough that they (now led by ex French Socialist Finance Minister Dominique Strauss- Kahn) have begun to tell governments with strong fiscal positions that they should provide some fiscal stimulus to global growth - a message that is being studiously ignored by the OECD and by most European governments.
Moreover, the IMF seem to generally approve the somewhat unorthodox actions of central banks, notably the US Federal Reserve, to provide credit to the banking system based on some rather risky and non traditional assets, and even to decisively intervene in the financial markets as in the brokered take-over of Bear Stearns by JP Morgan (partially financed by the Fed.) The scale of US Federal Reserve action in terms of lowering policy interest rates has been generally approved of, even though the US faces rising inflation. Officials even talk of the possible need for much more radical interventions by governments moving forward, such as buying up distressed mortgages and other assets to create a bottom to the housing market and to stop the slide in prices. There was also talk of forcing the banks to wipe bad loans off their balance sheets as quickly as possible. The big concern seems to be to learn from the lesson of Japan’s decade long depression and to act decisively so as to stop the credit squeeze from worsening and becoming prolonged.
In terms of the underlying causes of the crisis, discussion on the trade union side and at the progressive economist meetings focused on three key, inter-related themes - financial deregulation, global economic imbalances, and the stagnation of working class living standards. It is clear that very lax regulation of banks and hedge funds played a major role in allowing a massive growth of very risky, complex debt in the US, which was in turn widely dispersed throughout the global financial system. Governments could and should have been limiting leverage, promoting greater transparency, and countering outright fraud and insider profiting which have jeopardised overall financial stability. But another key underlying factor has been the huge current account surpluses which fulled global liquidity, and generated massive amounts of low cost money, which the global banks deployed into risky loans of all kinds. The fact that wages have been stagnant in the US and much of Europe as a result of labour market de-regulation and financial pressures on firms to maximize returns to capital has meant that demand growth became unhealthily dependent on a continuing expansion of household debt, above all in the US.
In terms of policy response in the US, major concern was expressed about the fate of US working families, who have sustained consumption over a long period of stagnant wages growth by borrowing against their fast-eroding home equity. It is not just the sub prime borrowers who are in difficulty, but the many households who refinanced their mortgages over the past few years. Indeed it is very slow real wage growth which made US growth hostage to financial manipulations, stretching out an unsustainable growth of consumption based on ever-rising household debt.
Financialization of the real economy has also repressed wage growth by forcing companies to adopt short term profit maximization at the expense of long term investment. Hedge funds and private equity have further promoted a ruthless drive to cut wage costs, while doing nothing to raise the rate of real investment.
Those who lose their jobs in the US in the coming months will have little or no financial cushion or social safety net to fall back upon. Yet the modest tax rebate package just approved by Congress fails to even extend unemployment insurance benefits beyond the current maximum of 26 weeks. The majority of Democrats, including Hillary and Obama, are prepared to support modest public infrastructure investment/green jobs/alternative energy programs to create jobs, but are still not talking about re-regulation of Wall Street (source of half of all campaign funds) or about major government action to put a floor under house prices. Indeed the Democrats have been adamant, with the Republicans, that any fiscal stimulus must be very targeted and temporary, and not risk balanced budgets moving forward. A few progressive Democrats are now thinking about more radical actions, including a major shift to public investment financed in part by much higher taxes on corporations and the rich, and effective aid to highly indebted home-owners. The plan most likely to gain traction is for the US government to help refinance reduced mortgages, while taking some equity position in housing, combined with aid to banks in return for a share of equity.
In terms of global solutions the trade union and progressive economists are generally thinking along the same lines. China and other countries with large trade and current account surpluses must shift from export-led to internal demand driven growth. Europe and Japan should help the US administer a fiscal and monetary stimulus to global growth, with a tilt to investment in infrastructure and green jobs. The financial sector must be re-regulated, both nationally and globally, to reduce leverage and high risk lending, to end the perverse alignment of high insider compensation with highly risky and de-stabilizing financial practices. Wages and working class living standards must rise - at the expense of a growing profit share in all countries - to reduce reliance on financial sector driven growth, and to link wages with rising productivity.
We are at a moment when progressives will have to move from critique to prescription. As Naomi Klein argued in the Shock Doctrine, neo liberalism took advantage of past crises by having a set of coherent prescriptions ready to hand to advance to policy-makers. We are just beginning to define a new global agenda to replace the neo liberal prescription which has led into the current crisis.

No Depression just recession.

This is the conventional wisdom but the conventional wisdom not long ago was that the securities that are now virtually worthless had great ratings. That is why all those banks now taking billion dollar writedowns bought them. How reliable are the ratings of the chances of depression by conventional economists? It is true that the conventional theology about not interfering in markets that helped fuel the Great Depression has been thrown overboard this time.The same conventional economists who in normal times trumpet the virtues of the market unsullied by government intervention are now trumpeting the virtues of government intervention to cut interest rates and to stimulate the economy. But this could very well cause problems itself such as inflation especially when combined with humungous expenditures on war and the military.


NY Times, March 23, 2008
The Nation
Depression, You Say? Check Those Safety Nets
By CHARLES DUHIGG

The stock markets are spiraling like whirling dervishes, one of the
nation's largest financial institutions has flirted with bankruptcy
and the former Federal Reserve chairman Alan Greenspan invoked the
ghost of past calamities when he wrote that the current economic
turmoil is likely to become the "most wrenching" since World War II.
Meanwhile, home foreclosures are at their fastest pace in at least 30
years and in a survey conducted by USA Today and Gallup, more than
half of respondents indicated that they had fears the downturn could
become a depression.

Some innocent bystanders might be forgiven for wondering why that
last word — "depression" — has started popping up. Is it possible
our
economy could speed past a recession into a full-blown depression
like that of the 1930s, when American unemployment reached 25 percent?

Well, the economists are here to say that you can dig up the family
silver and stop training the kids how to jump onto a moving train.
While many who study the nation's economic health agree that a
recession has probably already begun, and that it may be long and
severe, they also say the odds of a full-blown depression are almost
nonexistent.

Why? Because so many of them have spent so much time studying the
Great Depression and trying to figure out how to react more
effectively if things turn really bad again. Take last week, for
example.

"I used to give a lecture explaining that the Great Depression could
never happen now because of the regulations that emerged from that
crisis," said Barry Eichengreen, an economist at the University of
California at Berkeley. "But we're learning that there is a shadow
banking system, of hedge funds and investment banks, that are outside
of those safety nets. What happened to Bear Stearns last week looked
a lot like a 19th-century run on the bank. And that's why the Fed
reacted so quickly."

Indeed, when the government moved last weekend to help save Bear
Stearns, the fifth-largest securities firm on Wall Street, from
bankruptcy, policy makers were motivated by concerns that the
investment bank's failure could start a chain reaction of collapses
at other investment houses. Stopping those dominoes was such a
priority that the Federal Reserve helped broker the sale of Bear
Stearns to its rival JPMorgan Chase.

A century ago, such government hustle would have been unthinkable.
Even the distinction between a recession (a significant decline in
economic activity that lasts more than a few months) and a depression
(a decline that is much longer and deeper) didn't really matter,
because turmoil in the economy was often taken for granted.

Between 1857 and 1929, while regulators largely stood idle, the
American economy swung through 19 national boom-and-bust gyrations
that sometimes threatened to wipe out whole industries within months.

But in the wake of the Great Depression, American policy makers began
actively managing the economy with a handful of tools, including
adjusting interest rates and using massive government spending to
spur growth. Since 1945, there have only been 10 boom-and-bust
cycles, most of them much shallower than earlier ones, and the
unemployment rate has never topped 9.7 percent.

Much of that stability, economic historians say, stems from reforms
designed to calm consumers during downturns, like the Federal Deposit
Insurance Corporation, which guarantees most checking and savings
accounts up to $100,000 if a bank fails.

But as the Internet boom and recent housing bubble demonstrate, even
relatively stable periods can be part of a cycle of extreme ups and
downs. The prolonged expansion that just ended had an unusually long
run of more than six years. As a result, some are speculating that
the crash will be equally drawn out.

"The biggest difference with this recession is that it's starting in
the housing market," said Victor Zarnowitz, an economist at the
Conference Board who is also a member of the National Bureau of
Economic Research's business-cycle committee. For the first time in
more than 50 years, the nation faces a broad risk "that people's most
important asset, their home, will lose value," he said.

As homeowners see the value of their homes decline, they become more
likely to delay purchases of the big items — like automobiles,
electronics and home appliances — that are ballasts of the American
economy. When those purchases decline, large manufacturing firms,
suddenly short on funds, could begin laying off employees. Those
workers, uncertain about the future, might in turn stop buying
Starbucks lattes and movie tickets, and in a worst-case scenario,
that could spur coffee shops and theaters to begin layoffs of their
own.

Such a chain reaction was one reason unemployment during the Great
Depression was so persistent and widespread.

But today, say economists, fundamental changes make such contagion
unlikely. For one thing, incomes are more stable. Many more Americans
hold jobs in service sectors, like medicine or education. And more
Americans work for the government, which is less inclined to fire
people just because the economy turns gloomy.

Moreover, there are safety nets that can be traced to the Great
Depression, like Social Security, unemployment benefits, food stamp
programs. These "give people a sense of security even when they're
out of work," said the Harvard economist Benjamin Friedman. "That
establishes a floor for how panicked consumers become."

Even if consumer confidence hit rock bottom, that most likely would
not be enough, by itself, to cause a depression. For things to become
really dire, the nation's financial institutions would have to fail
at the same time that unemployment began significantly rising. Only
if banks suddenly closed, or it became impossible for companies to
access short-term lines of credit, would things begin spiraling out of
control.

A credit shortage, in fact, has played a significant role in today's
economic turmoil, and was the reason some economists began invoking
the Great Depression. But those comparisons were more to stress how
differently policy makers are behaving today than their counterparts
did in 1930, when a wave of panics started that eventually caused
one-fifth of the nation's banks to fail.

Today, the Federal Reserve is so cautious about the stability of
major financial institutions that regulators sometimes jump into
action almost immediately, as they did in the Bear Stearns case. One
goal of such an intervention, say economic historians, is to slow
down the turmoil as much as possible. In the 1920s and early 1930s,
policy makers became overwhelmed by a cascade of crises they were
unable to temper.

"In the 1920s, everyone was still reeling from the First World War,
which had realigned capital structures and boundaries and had put the
defeated countries in positions where they had much less economic
flexibility," said Peter Temin, an economic historian at the
Massachusetts Institute of Technology. In particular, one cause of
the Great Depression was that policy makers in the United States and
elsewhere were either reluctant or unable to increase their
countries' supplies of money, which at the time were often backed by
gold.

"Today, we have a lot more flexibility and we can prop up banks and
the economy to give us enough time to let things stabilize,"
Professor Temin added. Already, some lawmakers are proposing to help
refinance or purchase failing mortgages in order to slow down how
quickly other problems might spread; that approach, however, might
carry risks of its own, like encouraging irresponsible behavior and
increasing government deficits.

Of course, all of these techniques do not guarantee an easy path to
rosier times. Some economists and financiers say it's likely that the
current recession will extend for at least a year. Others think the
American economy will suffer from an extended malaise as Japan did in
the 1990s.

But whatever name economists give the current downturn, we are
unlikely to see the bread lines, shantytowns and dust bowl of the
Great Depression. More likely, these economists say, would be a
sudden increase in the number of people selling belongings on eBay.

Hollywood, which until now has largely catered to American tastes,
might begin more explicitly choosing scripts based on how they would
play in rising economies like India and China. And while exports of
manufactured goods might accelerate, the outsourcing trends that sent
some American jobs abroad might reverse. Already, Germany-based BMW
is expanding a South Carolina plant, betting that the weak dollar
will make American workers cheaper than those in Germany or Japan.

Which isn't to say that anyone is starting to hum "Happy Days Are
Here Again." Even the Federal Reserve chief, Ben Bernanke, has warned
against becoming too sanguine.

"To understand the Great Depression is the Holy Grail of
macroeconomics," Mr. Bernanke wrote in a 1994 paper, when he was a
professor at Princeton focused on analyzing the financial cataclysm
that began in 1929. While economists have made great progress, he
continued, "we do not yet have our hands on the Grail by any means."

_______________________

A new Great Depression? It's different this time.

Notice that it is an unregulated area that the problem cropped up and that one of the reason's for the Great Crash was the market theology that markets corrected themselves! There was no regulation of the greed that led to the mortgage meltdown:
"The agencies bestowed lofty AAA ratings on some extremely complex mortgage bundles even though their inherent risks were not understood. The banks and firms that packaged the securities and hawked them to clients simply accepted the rating agencies' conclusions, which were often favorable to the packagers. The dubious valuations of many of these securities are at the core of the credit crisis roiling the financial markets today"
Just what has been done to correct this problem? What has been done is to rescue those who sought to benefit from this greed using taxpayer funds.

A new Great Depression? It's different this time


The shadow of the '30s looms over every economic downturn or crisis. But unemployment reached 25% during the Depression; last month it was reported at 4.8%.
Fear is spreading with the financial system in disarray. But the global boom is ongoing, unemployment is low and the government has new tools to address the downturn.
By Michael A. Hiltzik, Los Angeles Times Staff Writer
March 20, 2008
Dysfunctional capital markets, frantic central banks, stressed-out consumers, fear and uncertainty -- all are alarming echoes of the global economic cataclysm of the 1930s.

Which raises the inevitable question: Could another Great Depression be lurking over the horizon?



TV news programs show grainy footage of Depression-era bankers as reporters tick off grim economic statistics. The Federal Reserve invokes powers it hasn't used since the 1930s. Critics of President Bush's economic policies are emboldened to use the H-word: "Hoover."

On the surface, there are disquieting parallels between economic conditions in the early 1930s and those of today. There is the popping of enormous asset bubbles -- stocks then, housing now.

And, as in the Great Depression, the financial system is in disarray. It was symbolized back then by the failure of thousands of banks, mostly small, local outfits -- 2,300 in 1931 alone.The parallel today is the crippling ofonetime giantssuch as Bear Stearns Cos., Countrywide Financial Corp. and Ameriquest Mortgage Co.

Many economists believe that the U.S. will find it almost impossible to avert a recession, if one has not started already. Housing remains mired in a deep slump,with some analysts projecting that Southern California home values could plunge 40% from their peaks last year.The Commerce Department reported this week that new residential building permits nationwide plummeted 36.5% in February from a year earlier.

Then, like now, stock prices were highly volatile. The S&P 500 index, which fell more than 56% from 1928 through 1940, nevertheless recorded four up years in that span, including a 46.5% gain in 1933.

The shadow of the '30s looms over every economic downturn or crisis, no matter how modest. Pundits were quick to invoke the Depression as a cautionary model during the stock market crash of 1987, the bailout of the giant hedge fund Long-Term Capital Management in 1998 and the dot-com meltdown of 2000 and 2001.

But there are vast differences between the 1930s and today. U.S. unemployment reached 25% during the Depression; last month it was reported at 4.8%. The international industrial economy was a shambles in the '30s. Today it is coming off a global boom.

"I've been asked many times whether we will have another Great Depression," said David M. Kennedy, a Stanford University history professor and the author of "Freedom From Fear," a Pulitzer Prize-winning history of the Depression and World War II. "My standard answer is that we won't have that one again -- I'd be surprised to have one of that seriousness and duration. But that doesn't mean we wouldn't have a catastrophe we haven't seen before."

Economists and historians say the most important difference between today's economic environment and the old days is the government's role.

"There's a perception now that you don't stand around at the central bank and whack people with a ruler for making bad decisions," said Robert Brusca, chief economist at New York-based Fact and Opinion Economics. "Instead, you do something."

Nothing demonstrates that as vividly as the Fed's orchestration of the takeover of Bear Stearns by JPMorgan Chase & Co. over the weekend. The deal staved off a possible Bear bankruptcy, which the central bank feared might traumatize financial systems worldwide.

The resolution drew a stark contrast with the Fed's role in the 1930 collapse of the Bank of the United States, a New York institution largely serving Jewish immigrants. The failure was then the largest in U.S. history, and the Fed's inability to arrange a rescue by Wall Street banks -- including J.P. Morgan & Co., the predecessor to the "white knight" in the Bear Stearns case -- caused a cataclysmic loss of confidence in the entire national banking system. That fueled a panic that historians regard as a key cause of the Depression.

The Fed's relative powerlessness in 1930 led directly to New Deal reforms that vastly expanded its authority. Some of the agency's new powers, such as its ability to lend directly to brokers and investment banks, were seldom or never used until the current crisis.

Fed Chairman Ben S. Bernanke, an expert in the central bank's Depression-era history, is also knowledgeable about the instruments at its disposal in a crisis.

In a 2002 speech -- he was then a member of the central bank's Board of Governors under Alan Greenspan -- he outlined a number of drastic steps the Fed could take in extreme conditions and still remain within its legal authority.

Among them were buying up foreign government debt to influence dollar exchange rates, and even lending, if indirectly, against private assets. The subject of Bernanke's speech was how to combat deflation, a broad decline in consumer prices that is not currently a problem on the Fed's agenda. Still, the powers he described could apply in a wide range of dire scenarios.

But as Fed Vice Chairman Donald L. Kohn conceded in testimony before a Senate committee this month, the most serious challenges generally arise not from scenarios that can be forecast but from the unforeseen.

Alluding, in effect, to the tendency of regulated industries to burst at their weakest seams, Kohn blamed "the most sophisticated banks" for allowing credit rating agencies such as Moody's and Standard & Poor's to paper over the unsoundness of mortgage securities on their books.

The agencies bestowed lofty AAA ratings on some extremely complex mortgage bundles even though their inherent risks were not understood. The banks and firms that packaged the securities and hawked them to clients simply accepted the rating agencies' conclusions, which were often favorable to the packagers. The dubious valuations of many of these securities are at the core of the credit crisis roiling the financial markets today.

Brusca, the economist, says the most dangerous behavior often occurs just beyond regulators' reach -- in the exotic strategies of the hedge fund industry, to use a contemporary example. "We have a far more extensive regulatory network now," he said, "but it's always the unregulated sector that pushes change."

Does it make sense to require banks to maintain adequate capital relative to their obligations, Brusca added, "but let them have an unregulated hedge fund?"

There are also limits to what monetary policy -- the Fed's responsibility -- can achieve on its own to forestall a drastic economic downturn. The Franklin D. Roosevelt administration not only reformed the Fed but also experimented with stimulative fiscal policy, such as unemployment relief.

New Deal programs aimed at staving off a wave of home foreclosures may be especially relevant today. Among the most important was the Home Owners Loan Corp., or HOLC, which is one of several models for homeowner relief being considered by Congress.

HOLC took over 1 million mortgages in default starting in 1933, worked to keep the owners in their homes and made new loans to strapped mortgage holders. When the agency was finally liquidated in 1951, it even returned a small profit to the U.S. Treasury.

The Fed's recent actions were "a temporary palliative" to the fundamental problem in the economy, which is the rapid fall in home prices and its ripple effect on mortgage bonds and other securities, said Barry Eichengreen, a professor of economics and political science at UC Berkeley. "You have to reorganize the system, but the discussion about that has only begun."

michael.hiltzik@latimes.com

AP Poll: Leaving Iraq will help economy..

This is from wiredispatch.
Actually the Iraq war is itself a stimulus a type of what is called Military Keynesianism. I suppose what people are thinking is that the money used in Iraq could be better used as a stimulus back at home in other areas than military spending. Or it may be that people are worried about the debt caused by the Iraq war spending. Politicians do not seem to raise this issue.

AP Poll: Leaving Iraq will help economy
AP Poll: Stimulus Checks Welcome, but to Really Help the Economy US Should Leave Iraq
JEANNINE AVERSAAP News
Feb 08, 2008 18:00 EST
The heck with Congress' big stimulus bill. The way to get the country out of recession — and most people think we're in one — is to get the country out of Iraq, according to an Associated Press-Ipsos poll.
Pulling out of the war ranked first among proposed remedies in the survey, followed by spending more on domestic programs, cutting taxes and, at the bottom end, giving rebates to poor people in hopes they'll spend the economy into recovery.
The $168 billion economic rescue package Congress rushed to approval this week includes rebates of $600 to $1,200 for most taxpayers, the hope being that they will spend the money and help revive ailing businesses. President Bush is expected to sign the measure next week. Poor wage-earners, as well as seniors and veterans who live almost entirely off Social Security and disability benefits, would get $300 checks.
However, just 19 percent of the people surveyed said they planned to go out and spend the money; 45 percent said they'd use it to pay bills. And nearly half said what the government really should do is get out of Iraq.
Forty-eight percent said a pullout would help fix the country's economic problems "a great deal," and an additional 20 percent said it would help at least somewhat. Some 43 percent said increasing government spending on health care, education and housing programs would help a great deal; 36 percent said cutting taxes.
"Let's stop paying for this war," said Hilda Sanchez, 44, of Waterford, Calif. "There are a lot of people who are struggling. We can use the money to pay for medical care and help people who were put out of their homes."
The subject of leaving Iraq shows a sharp partisan divide — 65 percent of Democrats think it would help the economy a lot, but only 18 percent of Republicans think so.
Just 29 percent of people think putting more money in the hands of the poor would help a great deal in fixing the country's economic problems.
According to many economists, the lower people are on the income ladder, the more probable it is that they will spend a rebate and do it quickly — a shot in the arm for the ailing economy.
In the poll, 61 percent said they think the economy is already in a recession.
"Things are bad, but it will get a lot worse," said Jim Sims, 60, of Greer, S.C.
And Nanette Dahlin, 52, of St. Louis Park, Minn., said the economic stimulus package "would only make a recession less damaging."
The economy nearly stalled in the final three months of last year. Some economists, like the majority of poll respondents, say it may actually be shrinking now, given the strains from a persistent housing slump and a painful credit crunch. The worry is that people and businesses will hunker down further and pull back their spending, sending the economy into a tailspin.
Federal Reserve Chairman Ben Bernanke has gotten more forceful in cutting interest rates to spur people to buy more and to energize businesses. And now Republicans, Democrats and the White House have shown rare cooperation in approving relief.
Rebate checks could start showing up in mailboxes in May. However, Sanchez is typical is saying the money will "go automatically to bills." Thirty-two percent said they would save or invest the rebate. Said Sims: "I'm hoping to hold onto it."
Just 19 percent — like Dahlin — said they would spend it, while 4 percent said they would donate it to charity.
Paying off bills or saving the money won't give the economy a quick boost, though it may well be a wise financial decision for many people who are up to their eyeballs in bills.
"What is good for the economy as a whole — spending a rebate — is not the best idea at an individual household level if you are buried in debt," said Greg McBride, senior financial analyst at Bankrate.com. "Issuing rebate checks to give a boost to consumer spending amounts to a Band-Aid over the much bigger problem of consumer debt burdens," he said.
With Wall Street in turmoil, the top economic worry for poll respondents was seeing their nest eggs shrink. Fifty-nine percent said they were worried "a lot" or "some" about seeing the value of stocks and retirement investments drop. Those approaching retirement fretted the most.
Nearly half — 46 percent — said they were worried about being able to pay their bills. This is especially a concern for people whose household incomes are under $50,000, and for minorities. Twenty-eight percent most feared losing their jobs; minorities and those with a high school education or less were especially concerned.
Also, 48 percent of homeowners polled worried that the value of their homes would drop. The housing bust has led to record-high foreclosures, and weaker home values have made people feel less wealthy.
Who deserves most of the blame for the economy's troubles?
More than half — 56 percent — pointed the finger at mortgage lenders. Forty-four percent said Bush deserves a lot of the blame. After that come Congress, Wall Street, consumers themselves and in last place the Federal Reserve.
The Fed has the public's confidence that it will be able to right the economy.
More than half — 55 percent — said they have a great deal or some confidence in Fed to turn things around. Forty-one percent said that about Congress, only 28 percent about Bush.
In fact, economic problems have contributed to pulling the president's approval ratings to all-time lows. Only 29 percent approve of his handling of the economy, the lowest mark yet in this polling. Bush's overall job-approval rating slid to 30 percent, also a record low.
The AP-Ipsos poll was conducted Monday through Wednesday this week and involved telephone interviews with 1,006 adults. It had a margin of sampling error of plus or minus 3.1 percentage points.
___

The reckless greed of the few harms the future of the many

This is an interesting analysis of the financial crisis by Will Hutton from the Observer. It seems that the reckless greed was not just of a few. Throughout the world major financial institutions are now writing off investments they took as money makers. So far I have not seen much move to strengthen lending regulations by the government. The deregulation of the financial sector was supposed to remove the dead hand of government and let markets reign. The government Hand is dead only when it restricts profits, but when runaway capitalism causes crises the government Hand is called upon for Handouts.

This reckless greed of the few harms the future of the manyThe government must act firmly to control an industry that destabilises all our lives with its naked pursuit of huge profits Will HuttonSunday January 27, 2008The Observer
Never in human affairs have so few been allowed to make so much money by so many for so little wider benefit. Across the globe, societies and governments have been hoodwinked by a collection of self-confident chancers in the guise of investment bankers, hedge and private equity fund partners and bankers who, in the cause of their monumental self-enrichment, have taken the world to the brink of a major recession. It has been economic history's most one-sided bargain.




Last week's financial panic was further evidence of the extreme foolhardiness with which global finance has been organised and managed. There was the biggest one-day fall in Wall Street since 11 September, which spilled over into every world stock market and the largest single cut in American interest rates for 25 years as an emergency attempt to stop the rout. A new crisis emerged in an obscure American insurance business (monoline, it is called). To cap it all, there was the £3.7bn bank fraud at Société Générale.
The growing realisation of how exposed the financial system is - and from transactions that should never have taken place - is reinforcing the mounting credit crunch, which, in turn, is spooking stock markets. The US economy is weakening while in Britain new mortgage lending is at a 10-year low. The staples of a settled life - jobs, pensions and house prices - are all under threat.
The availability of credit is one of the fundamental pillars of any economic system. Like the delivery of gas, electricity and water, finance should be regarded as a utility and after the credit-crunch disasters of the 1930s, following the free-market 1920s, it was regulated as one. But Anglo-American financiers have used the theories of the free-market fundamentalists to argue that it should be liberated from such regulatory 'shackles' and again run as a business like any other.
Yet finance is not like any other business. When a bank makes a mistake, the ramifications for the rest of the financial and economic system are so severe that it has to be bailed out - witness Northern Rock. Because of this truth, financiers have organised themselves so that actual or potential losses are picked up by somebody else - if not their clients, then the state - while profits are kept to themselves. An industry that socialises losses while privatising profit, and that has the capacity to create booms and busts alike, has to be as closely regulated as any utility.
I was reminded of the system's proclivities by a consultant friend who was hired to arbitrate over a performance bonus between a hedge fund and one of its asset managers. The individual in question was paid a base salary of some $100,000, but the investment funds he managed had done well over 2007, rising in value by more than $500m. His bonus was $206m and he felt that to conform to industry norms, his bonus should be nearer $250m - the cause of the dispute.
What, I asked, would happen in 2008 if the assets he managed fell in value? He would get paid his base salary and no bonus came the reply. And would he be required to repay any of the $250m he had pocketed this year? Of course not.
This is the one-way, short-term bet that is endemic in the way the financial services industry rewards itself and which incentivises recklessness. Raghuram Rajan, former chief economist of the IMF, differentiated between two sources of wealth generation in the financial markets in an insightful article in the Financial Times earlier this month. There is run-of-the-mill 'beta' value created because stock markets and the economy are set fair and going up; then there is special 'alpha' value generated by investors such as American billionaire Warren Buffett who see opportunities others do not.
The problem is that while we know a priori that there are only one or two Buffetts around who deserve alpha-style pay, this has become the way the entire financial system's executive class rewards itself - being paid as if just one year's performance revealed them to be alpha superstars when, in truth, most are ordinary beta performers. It takes longer than a year to reveal who is alpha and who is beta, whatever executives like the hedge-fund manager in dispute over his bonus may claim.
The remuneration structure is a disaster. One of the reasons why rogue trader Jérôme Kerviel faked a stunning £3.7bn of transactions at SocGen may have been because he regarded himself as being paid as a beta when he should have been paid as an alpha like everybody else. Moreover, he was able to fool the bank by trading in the daffy instruments that the financial system created to persuade national governments that it is not running excessive risks, an insurance that laid off risks to others. Hence the casino character of many new financial markets, which essentially operate as bookmakers accepting differing bets on future prices. Underneath their technical names - monoline insurance, derivatives, debt securitisation - lies little more than bookie principles and practice.
But selling off bad risks doesn't mean the catastrophe won't occur. And when the balloon goes up, the financial system screams for government intervention - to cut interest rates aggressively and to bail out stricken banks and insurance companies. Indeed, better still for the financiers, a gullible government can be persuaded to assume the risk, the exact principles of the Goldman Sachs-devised bail-out of Northern Rock - lubricated by excessive fees to the partners.
Thirteen years ago, I tried to blow the whistle on financial market liberalisation in my book The State We're In. It was obvious then what is even more obvious now: financial market freedom embeds short-termism, guarantees lower investment, works against business building and innovation, generates booms and busts, inflates house prices, creates system-wide risk and excessively rewards those who work in them. I thought the Germans and Japanese were better than the British and Americans in the way they organised and regulated finance and that while Britain and America might look good in the short term, their economies would eventually come back to earth with a bump.
New Labour threw a protective mantle around the financial markets in a way it never would for industry and sceptics were patronised as backward-looking, Old Labour know-nothings. Let's hopes these new crises will prompt a root-and-branch rethink. Of course, like the Americans, the British need to respond by aggressively cutting interest rates, cutting taxes and lifting public spending.
But more, we need to regulate closely how the financial system deploys its capital, develops its loans and how its people are paid, an initiative that requires global support. We need the financiers to serve business and the economy rather than be its master.
This is not a question of helping the financial system better to understand the risks it runs through more 'transparency', the friendly diagnosis deployed by both the Governor of the Bank of England and the Prime Minister in speeches last week. This is about reworking the one-sided bargain between finance and our economies. Only then can we lay the foundations for recovery and bring some semblance of fairness and rationality to the way these plutocrats behave.

Panitch: U.S. Econonic Crisis in Perspective.

Leo Panitch is a well known--at least in Canada--academic leftist. I didn't realize that Schwarzenegger had cut back on a lot of public expenditures in California. One would think that such expenditures would be a good stimulus. I guess if it were military expenditure it would be OK.

~~~~~~~~~~~~~~(((( T h e B u l l e t ))))~~~~~~~~~~~~~~A Socialist Project e-bulletin .... No. 80 .... January 31, 2008_________________________________________________
Putting the U.S. Economic Crisis in Perspective
Leo Panitch
It is time to take stock. The centrality of the American economy to the capitalist world – which now literally does encompass the whole world – has spread the financial crisis that began in the U.S. housing market around the globe. And the economic recession which that financial crisis has triggered in the U.S. now threatens to spread globally as well.
Capitalism has had an incredible run – politically and culturally as well as economically – since the stagflation crisis of the 1970s. The resolution of that crisis required, as economists put it at the time, 'reducing expectations' of the kind nurtured by the trade union militancy and welfare state gains of the 1960s. This was accomplished via the defeats suffered by trade unionism and the welfare state since the 1980s at the hands of what might properly be called capitalist militancy. This was accompanied by dramatic technological change, massive industrial restructuring, labour market flexibility and the over – all discipline provided by 'competitiveness.'
It was also accompanied, of course, by massive economic inequality. But this did not mean capitalism was no longer able to integrate the bulk of the population. On the contrary, this was now achieved through the private pension funds that mobilized workers savings, on the one hand, and through the mortgage and credit markets that loaned them the money to sustain high levels of consumer spending on the other. At the centre of this were the private banking institutions which, after their collapse in the Great Depression, had been nurtured back to health in the postwar decades and then unleashed the explosion of global financial innovation that has defined our era.
The question begged by the current crisis is whether capitalism's capacity to integrate the mass of people through their incorporation in financial markets has run out of steam. That the fault line should have appeared in 'sub-prime' mortgage loans to African-Americans is hardly surprising – this has always been the Achilles heel of working class incorporation into the American capitalist dream. But an economic earthquake will actually only result if there is a devaluation of working class assets in general through a collapse of housing prices and the stock and bonds in which their retirement savings are invested.
We are by no means there yet. The role being played to prevent just this by the Federal Reserve, very much acting as the world central bank in light of the global implications of a U.S. recession, should once and for all dispel the illusion that capitalist markets thrive without state intervention. It was through the types of policies that promoted free capital movements, international property rights and labour market flexibility that the era of free trade and globalization was unleashed. And this era has been kept going as long as it has by the repeated coordinated interventions undertaken by central banks and finance ministries to contain the periodic crises to which such a volatile system of global finance inevitably gives rise. The Fed has repeatedly poured liquidity into its financial system at the first sign of trouble. Yet the capacity of the system to go on integrating ordinary Americans though the expansion of investor and credit markets in this way may have reached its limit. This is indeed suggested by the Bush administration's sudden (non-military) Keynesian turn with its recently announced $150 billion fiscal stimulus. The announcement at the same time of massive public expenditure cutbacks by the Schwarzenegger administration in California is a reminder, however, that fiscal stimulus at the federal level may be undone at the state level.
This is especially likely to be the case with municipal government cutbacks, given their massive dependence on property taxes. The recent evidence that the financial institutions that specialize in selling risk insurance on municipal bonds are enveloped in the credit crisis further compounds the problem. This indeed brings to mind the extent to which it was municipal governments that were on the front lines of the Great Depression. The kind of fiscal stimulus that is needed to boost the economy now probably entails public infrastructure spending, but the type of state intervention that brought us financial globalization is not well suited to this, as the collapsed levies of New Orleans and the collapsed bridges of Minneapolis prove.
To see this go unmentioned in the Democratic primary debate this week may be hardly surprising given the absence of even a trade union campaign around this, but it bespeaks an impoverishment of American politics that in fact goes all the way back to the New Deal. The issue of economic democracy that had been placed on the political agenda alongside the New Deal's public infrastructure projects was set aside for the remainder of the century after the FDR's administration's self-described 'grand truce with capital' in the late 1930s.
There should be no illusion that a recession, or even a depression, will necessarily bring the issue of economic democracy back onto the U.S. political agenda. It would require a transformation of American politics to do so – and that too would have global implications.
Leo Panitch is Canada Research Chair in Comparative Political Economy at York University.

How to Sink America

This is from Tom Dispatch. The article shows how support US hegemony globally is in effect sinking America economically. This is military Keynesianism gone wild but not happy with this huge military pump priming the US is now reducing interest rates and also cutting taxes to stimulate spending and consumption.


Within the next month, the Pentagon will submit its 2009 budget to Congress and it's a fair bet that it will be even larger than the staggering 2008 one. Like the Army and the Marines, the Pentagon itself is overstretched and under strain -- and like the two services, which are expected to add 92,000 new troops over the next five years (at an estimated cost of $1.2 billion per 10,000), the Pentagon's response is never to cut back, but always to expand, always to demand more.

After all, there are those disastrous Afghan and Iraqi wars still eating taxpayer dollars as if there were no tomorrow. Then there's what enthusiasts like to call "the next war" to think about, which means all those big-ticket weapons, all those jets, ships, and armored vehicles for the future. And don't forget the still-popular, Rumsfeld-style "netcentric warfare" systems (robots, drones, communications satellites, and the like), not to speak of the killer space toys being developed; and then there's all that ruined equipment out of Iraq and Afghanistan to be massively replaced -- and all those ruined human beings to take care of.

You'll get the gist of this from a recent editorial in the trade magazine Aviation Week & Space Technology:


"The fact Washington must face is that nearly five years of war have left U.S. forces worse off than they have been in a generation, yes, since Vietnam, and restoring them will take budget-building unlike any in the past."

Even on the rare occasion when -- as in the case of Boeing's C-17 cargo plane -- the Pentagon decides to cancel a project, there's Congress to remember. Contracts and subcontracts for weapons systems, carefully doled out to as many states as possible, mean jobs, and so Congress often balks at such cuts. (Fifty-five House members recently warned the Pentagon of a "strong negative response" if funding for the C-17 is excised from the 2009 budget.) All in all, it adds up to a defense menu for a glutton.

Already, Secretary of Defense Robert Gates has said that 2009 funding is "largely locked into place." The giant military-industrial combines -- Lockheed Martin, Northrop Grumman, Boeing, Raytheon -- have been watching their stocks rise in otherwise treacherous times. They are hopeful. As Ronald Sugar, Northrop CEO, put it: "A great global power like the United States needs a great navy and a great navy needs an adequate number of ships, and they have to be modern and capable" -- and guess which company is the Navy's largest shipbuilder?

There should be nothing surprising in all this, especially for those of us who have read Chalmers Johnson's Nemesis, The Last Days of the American Republic, the final volume of his Blowback Trilogy. Published in 2007, it is already a classic on what imperial overstretch means for the rest of us. The paperback of Nemesis is officially out today, just as global stock markets tumble. It is simply a must-read (and if you've already read it, then get a copy for a friend). In the meantime, hunker in for Johnson's latest magisterial account of how the mightiest guns the Pentagon can muster threaten to sink our own country. (For those interested, click here to view a clip from a new film, "Chalmers Johnson on American Hegemony," in Cinema Libre Studios' Speaking Freely series in which he discusses military Keynesianism and imperial bankruptcy.) Tom


Going Bankrupt
Why the Debt Crisis Is Now the Greatest Threat to the American Republic
By Chalmers Johnson

The military adventurers of the Bush administration have much in common with the corporate leaders of the defunct energy company Enron. Both groups of men thought that they were the "smartest guys in the room," the title of Alex Gibney's prize-winning film on what went wrong at Enron. The neoconservatives in the White House and the Pentagon outsmarted themselves. They failed even to address the problem of how to finance their schemes of imperialist wars and global domination.

As a result, going into 2008, the United States finds itself in the anomalous position of being unable to pay for its own elevated living standards or its wasteful, overly large military establishment. Its government no longer even attempts to reduce the ruinous expenses of maintaining huge standing armies, replacing the equipment that seven years of wars have destroyed or worn out, or preparing for a war in outer space against unknown adversaries. Instead, the Bush administration puts off these costs for future generations to pay -- or repudiate. This utter fiscal irresponsibility has been disguised through many manipulative financial schemes (such as causing poorer countries to lend us unprecedented sums of money), but the time of reckoning is fast approaching.

There are three broad aspects to our debt crisis. First, in the current fiscal year (2008) we are spending insane amounts of money on "defense" projects that bear no relationship to the national security of the United States. Simultaneously, we are keeping the income tax burdens on the richest segments of the American population at strikingly low levels.

Second, we continue to believe that we can compensate for the accelerating erosion of our manufacturing base and our loss of jobs to foreign countries through massive military expenditures -- so-called "military Keynesianism," which I discuss in detail in my book Nemesis: The Last Days of the American Republic. By military Keynesianism, I mean the mistaken belief that public policies focused on frequent wars, huge expenditures on weapons and munitions, and large standing armies can indefinitely sustain a wealthy capitalist economy. The opposite is actually true.

Third, in our devotion to militarism (despite our limited resources), we are failing to invest in our social infrastructure and other requirements for the long-term health of our country. These are what economists call "opportunity costs," things not done because we spent our money on something else. Our public education system has deteriorated alarmingly. We have failed to provide health care to all our citizens and neglected our responsibilities as the world's number one polluter. Most important, we have lost our competitiveness as a manufacturer for civilian needs -- an infinitely more efficient use of scarce resources than arms manufacturing. Let me discuss each of these.

The Current Fiscal Disaster

It is virtually impossible to overstate the profligacy of what our government spends on the military. The Department of Defense's planned expenditures for fiscal year 2008 are larger than all other nations' military budgets combined. The supplementary budget to pay for the current wars in Iraq and Afghanistan, not part of the official defense budget, is itself larger than the combined military budgets of Russia and China. Defense-related spending for fiscal 2008 will exceed $1 trillion for the first time in history. The United States has become the largest single salesman of arms and munitions to other nations on Earth. Leaving out of account President Bush's two on-going wars, defense spending has doubled since the mid-1990s. The defense budget for fiscal 2008 is the largest since World War II.

Before we try to break down and analyze this gargantuan sum, there is one important caveat. Figures on defense spending are notoriously unreliable. The numbers released by the Congressional Reference Service and the Congressional Budget Office do not agree with each other. Robert Higgs, senior fellow for political economy at the Independent Institute, says: "A well-founded rule of thumb is to take the Pentagon's (always well publicized) basic budget total and double it." Even a cursory reading of newspaper articles about the Department of Defense will turn up major differences in statistics about its expenses. Some 30-40% of the defense budget is "black," meaning that these sections contain hidden expenditures for classified projects. There is no possible way to know what they include or whether their total amounts are accurate.

There are many reasons for this budgetary sleight-of-hand -- including a desire for secrecy on the part of the president, the secretary of defense, and the military-industrial complex -- but the chief one is that members of Congress, who profit enormously from defense jobs and pork-barrel projects in their districts, have a political interest in supporting the Department of Defense. In 1996, in an attempt to bring accounting standards within the executive branch somewhat closer to those of the civilian economy, Congress passed the Federal Financial Management Improvement Act. It required all federal agencies to hire outside auditors to review their books and release the results to the public. Neither the Department of Defense, nor the Department of Homeland Security has ever complied. Congress has complained, but not penalized either department for ignoring the law. The result is that all numbers released by the Pentagon should be regarded as suspect.

In discussing the fiscal 2008 defense budget, as released to the press on February 7, 2007, I have been guided by two experienced and reliable analysts: William D. Hartung of the New America Foundation's Arms and Security Initiative and Fred Kaplan, defense correspondent for Slate.org. They agree that the Department of Defense requested $481.4 billion for salaries, operations (except in Iraq and Afghanistan), and equipment. They also agree on a figure of $141.7 billion for the "supplemental" budget to fight the "global war on terrorism" -- that is, the two on-going wars that the general public may think are actually covered by the basic Pentagon budget. The Department of Defense also asked for an extra $93.4 billion to pay for hitherto unmentioned war costs in the remainder of 2007 and, most creatively, an additional "allowance" (a new term in defense budget documents) of $50 billion to be charged to fiscal year 2009. This comes to a total spending request by the Department of Defense of $766.5 billion.

But there is much more. In an attempt to disguise the true size of the American military empire, the government has long hidden major military-related expenditures in departments other than Defense. For example, $23.4 billion for the Department of Energy goes toward developing and maintaining nuclear warheads; and $25.3 billion in the Department of State budget is spent on foreign military assistance (primarily for Israel, Saudi Arabia, Bahrain, Kuwait, Oman, Qatar, the United Arab Republic, Egypt, and Pakistan). Another $1.03 billion outside the official Department of Defense budget is now needed for recruitment and reenlistment incentives for the overstretched U.S. military itself, up from a mere $174 million in 2003, the year the war in Iraq began. The Department of Veterans Affairs currently gets at least $75.7 billion, 50% of which goes for the long-term care of the grievously injured among the at least 28,870 soldiers so far wounded in Iraq and another 1,708 in Afghanistan. The amount is universally derided as inadequate. Another $46.4 billion goes to the Department of Homeland Security.

Missing as well from this compilation is $1.9 billion to the Department of Justice for the paramilitary activities of the FBI; $38.5 billion to the Department of the Treasury for the Military Retirement Fund; $7.6 billion for the military-related activities of the National Aeronautics and Space Administration; and well over $200 billion in interest for past debt-financed defense outlays. This brings U.S. spending for its military establishment during the current fiscal year (2008), conservatively calculated, to at least $1.1 trillion.

Military Keynesianism

Such expenditures are not only morally obscene, they are fiscally unsustainable. Many neoconservatives and poorly informed patriotic Americans believe that, even though our defense budget is huge, we can afford it because we are the richest country on Earth. Unfortunately, that statement is no longer true. The world's richest political entity, according to the CIA's "World Factbook," is the European Union. The EU's 2006 GDP (gross domestic product -- all goods and services produced domestically) was estimated to be slightly larger than that of the U.S. However, China's 2006 GDP was only slightly smaller than that of the U.S., and Japan was the world's fourth richest nation.

A more telling comparison that reveals just how much worse we're doing can be found among the "current accounts" of various nations. The current account measures the net trade surplus or deficit of a country plus cross-border payments of interest, royalties, dividends, capital gains, foreign aid, and other income. For example, in order for Japan to manufacture anything, it must import all required raw materials. Even after this incredible expense is met, it still has an $88 billion per year trade surplus with the United States and enjoys the world's second highest current account balance. (China is number one.) The United States, by contrast, is number 163 -- dead last on the list, worse than countries like Australia and the United Kingdom that also have large trade deficits. Its 2006 current account deficit was $811.5 billion; second worst was Spain at $106.4 billion. This is what is unsustainable.

It's not just that our tastes for foreign goods, including imported oil, vastly exceed our ability to pay for them. We are financing them through massive borrowing. On November 7, 2007, the U.S. Treasury announced that the national debt had breached $9 trillion for the first time ever. This was just five weeks after Congress raised the so-called debt ceiling to $9.815 trillion. If you begin in 1789, at the moment the Constitution became the supreme law of the land, the debt accumulated by the federal government did not top $1 trillion until 1981. When George Bush became president in January 2001, it stood at approximately $5.7 trillion. Since then, it has increased by 45%. This huge debt can be largely explained by our defense expenditures in comparison with the rest of the world.

The world's top 10 military spenders and the approximate amounts each country currently budgets for its military establishment are:

1. United States (FY08 budget), $623 billion
2. China (2004), $65 billion
3. Russia, $50 billion
4. France (2005), $45 billion
5. Japan (2007), $41.75 billion
6. Germany (2003), $35.1 billion
7. Italy (2003), $28.2 billion
8. South Korea (2003), $21.1 billion
9. India (2005 est.), $19 billion
10. Saudi Arabia (2005 est.), $18 billion


World total military expenditures (2004 est.), $1,100 billion
World total (minus the United States), $500 billion

Our excessive military expenditures did not occur over just a few short years or simply because of the Bush administration's policies. They have been going on for a very long time in accordance with a superficially plausible ideology and have now become entrenched in our democratic political system where they are starting to wreak havoc. This ideology I call "military Keynesianism" -- the determination to maintain a permanent war economy and to treat military output as an ordinary economic product, even though it makes no contribution to either production or consumption.

This ideology goes back to the first years of the Cold War. During the late 1940s, the U.S. was haunted by economic anxieties. The Great Depression of the 1930s had been overcome only by the war production boom of World War II. With peace and demobilization, there was a pervasive fear that the Depression would return. During 1949, alarmed by the Soviet Union's detonation of an atomic bomb, the looming communist victory in the Chinese civil war, a domestic recession, and the lowering of the Iron Curtain around the USSR's European satellites, the U.S. sought to draft basic strategy for the emerging cold war. The result was the militaristic National Security Council Report 68 (NSC-68) drafted under the supervision of Paul Nitze, then head of the Policy Planning Staff in the State Department. Dated April 14, 1950, and signed by President Harry S. Truman on September 30, 1950, it laid out the basic public economic policies that the United States pursues to the present day.

In its conclusions, NSC-68 asserted: "One of the most significant lessons of our World War II experience was that the American economy, when it operates at a level approaching full efficiency, can provide enormous resources for purposes other than civilian consumption while simultaneously providing a high standard of living."

With this understanding, American strategists began to build up a massive munitions industry, both to counter the military might of the Soviet Union (which they consistently overstated) and also to maintain full employment as well as ward off a possible return of the Depression. The result was that, under Pentagon leadership, entire new industries were created to manufacture large aircraft, nuclear-powered submarines, nuclear warheads, intercontinental ballistic missiles, and surveillance and communications satellites. This led to what President Eisenhower warned against in his farewell address of February 6, 1961: "The conjunction of an immense military establishment and a large arms industry is new in the American experience" -- that is, the military-industrial complex.

By 1990, the value of the weapons, equipment, and factories devoted to the Department of Defense was 83% of the value of all plants and equipment in American manufacturing. From 1947 to 1990, the combined U.S. military budgets amounted to $8.7 trillion. Even though the Soviet Union no longer exists, U.S. reliance on military Keynesianism has, if anything, ratcheted up, thanks to the massive vested interests that have become entrenched around the military establishment. Over time, a commitment to both guns and butter has proven an unstable configuration. Military industries crowd out the civilian economy and lead to severe economic weaknesses. Devotion to military Keynesianism is, in fact, a form of slow economic suicide.

On May 1, 2007, the Center for Economic and Policy Research of Washington, D.C., released a study prepared by the global forecasting company Global Insight on the long-term economic impact of increased military spending. Guided by economist Dean Baker, this research showed that, after an initial demand stimulus, by about the sixth year the effect of increased military spending turns negative. Needless to say, the U.S. economy has had to cope with growing defense spending for more than 60 years. He found that, after 10 years of higher defense spending, there would be 464,000 fewer jobs than in a baseline scenario that involved lower defense spending.

Baker concluded:


"It is often believed that wars and military spending increases are good for the economy. In fact, most economic models show that military spending diverts resources from productive uses, such as consumption and investment, and ultimately slows economic growth and reduces employment."

These are only some of the many deleterious effects of military Keynesianism.

Hollowing Out the American Economy

It was believed that the U.S. could afford both a massive military establishment and a high standard of living, and that it needed both to maintain full employment. But it did not work out that way. By the 1960s, it was becoming apparent that turning over the nation's largest manufacturing enterprises to the Department of Defense and producing goods without any investment or consumption value was starting to crowd out civilian economic activities. The historian Thomas E. Woods, Jr., observes that, during the 1950s and 1960s, between one-third and two-thirds of all American research talent was siphoned off into the military sector. It is, of course, impossible to know what innovations never appeared as a result of this diversion of resources and brainpower into the service of the military, but it was during the 1960s that we first began to notice Japan was outpacing us in the design and quality of a range of consumer goods, including household electronics and automobiles.

Nuclear weapons furnish a striking illustration of these anomalies. Between the 1940s and 1996, the United States spent at least $5.8 trillion on the development, testing, and construction of nuclear bombs. By 1967, the peak year of its nuclear stockpile, the United States possessed some 32,500 deliverable atomic and hydrogen bombs, none of which, thankfully, was ever used. They perfectly illustrate the Keynesian principle that the government can provide make-work jobs to keep people employed. Nuclear weapons were not just America's secret weapon, but also its secret economic weapon. As of 2006, we still had 9,960 of them. There is today no sane use for them, while the trillions spent on them could have been used to solve the problems of social security and health care, quality education and access to higher education for all, not to speak of the retention of highly skilled jobs within the American economy.

The pioneer in analyzing what has been lost as a result of military Keynesianism was the late Seymour Melman (1917-2004), a professor of industrial engineering and operations research at Columbia University. His 1970 book, Pentagon Capitalism: The Political Economy of War, was a prescient analysis of the unintended consequences of the American preoccupation with its armed forces and their weaponry since the onset of the Cold War. Melman wrote (pp. 2-3):


"From 1946 to 1969, the United States government spent over $1,000 billion on the military, more than half of this under the Kennedy and Johnson administrations -- the period during which the [Pentagon-dominated] state management was established as a formal institution. This sum of staggering size (try to visualize a billion of something) does not express the cost of the military establishment to the nation as a whole. The true cost is measured by what has been foregone, by the accumulated deterioration in many facets of life by the inability to alleviate human wretchedness of long duration."

In an important exegesis on Melman's relevance to the current American economic situation, Thomas Woods writes:


"According to the U.S. Department of Defense, during the four decades from 1947 through 1987 it used (in 1982 dollars) $7.62 trillion in capital resources. In 1985, the Department of Commerce estimated the value of the nation's plant and equipment, and infrastructure, at just over $7.29 trillion. In other words, the amount spent over that period could have doubled the American capital stock or modernized and replaced its existing stock."

The fact that we did not modernize or replace our capital assets is one of the main reasons why, by the turn of the twenty-first century, our manufacturing base had all but evaporated. Machine tools -- an industry on which Melman was an authority -- are a particularly important symptom. In November 1968, a five-year inventory disclosed (p. 186) "that 64 percent of the metalworking machine tools used in U.S. industry were ten years old or older. The age of this industrial equipment (drills, lathes, etc.) marks the United States' machine tool stock as the oldest among all major industrial nations, and it marks the continuation of a deterioration process that began with the end of the Second World War. This deterioration at the base of the industrial system certifies to the continuous debilitating and depleting effect that the military use of capital and research and development talent has had on American industry."

Nothing has been done in the period since 1968 to reverse these trends and it shows today in our massive imports of equipment -- from medical machines like proton accelerators for radiological therapy (made primarily in Belgium, Germany, and Japan) to cars and trucks.

Our short tenure as the world's "lone superpower" has come to an end. As Harvard economics professor Benjamin Friedman has written:


"Again and again it has always been the world's leading lending country that has been the premier country in terms of political influence, diplomatic influence, and cultural influence. It's no accident that we took over the role from the British at the same time that we took over… the job of being the world's leading lending country. Today we are no longer the world's leading lending country. In fact we are now the world's biggest debtor country, and we are continuing to wield influence on the basis of military prowess alone."

Some of the damage done can never be rectified. There are, however, some steps that this country urgently needs to take. These include reversing Bush's 2001 and 2003 tax cuts for the wealthy, beginning to liquidate our global empire of over 800 military bases, cutting from the defense budget all projects that bear no relationship to the national security of the United States, and ceasing to use the defense budget as a Keynesian jobs program. If we do these things we have a chance of squeaking by. If we don't, we face probable national insolvency and a long depression.

Chalmers Johnson is the author of Nemesis: The Last Days of the American Republic, just published in paperback. It is the final volume of his Blowback Trilogy, which also includes Blowback (2000) and The Sorrows of Empire (2004).

[Note: For those interested, click here to view a clip from a new film, "Chalmers Johnson on American Hegemony," in Cinema Libre Studios' Speaking Freely series in which he discusses "military Keynesianism" and imperial bankruptcy. For sources on global military spending, please see: (1) Global Security Organization, "World Wide Military Expenditures" as well as Glenn Greenwald, "The bipartisan consensus on U.S. military spending"; (2) Stockholm International Peace Research Institute, "Report: China biggest Asian military spender."]


Copyright 2008 Chalmers Johnson

Old Remedies Wont Work this Time.

It remains to be seen if Myerson is correct. It seems that cutting taxes will mean that unless the government is willing to undertake even more debt social programs will be cut when they are most needed. Reducing interest rates will just encourage people to take on more debt that just postpones further crises. So far a recession is not even officially admitted although the stock markets certainly suggest that these are not good times. President Bush is to speak to the nation this afternoon so at least hot air is still in good supply.

Washington Post, Wednesday, January 16, 2008; A15
A Different Recession
The Old Remedies Won't Work This Time

By Harold Meyerson

In a normal recession, the to-do list is clear. Copies of Keynes are
dusted off, the Fed lowers interest rates, the president and Congress
cut taxes and hike spending. In time, purchasing, production and loans
perk up, and Keynes is placed back on the shelf. No larger alterations
to the economy are made, because our economy, but for the occasional
bump in the road, is fundamentally sound.

This has been the drill in every recession since World War II.

Republicans and Democrats argue over whose taxes should be cut the most
and which projects should be funded, but, under public pressure to do
something, they usually find some mutually acceptable midpoint and
enact
a stimulus package. Even in today's hyperpartisan Washington, the odds
still favor such a deal.

This time, though, don't expect that to be the end of the story --
because the coming recession will not be normal, and our economy is not
fundamentally sound. This time around, the nation will have to craft
new
versions of some of the reforms that Franklin Roosevelt created to
steer
the nation out of the Great Depression -- not because anything like a
major depression looms but because we face an economy that's been
warped
by two developments we've not seen since FDR's time.

The first of these is the stagnation of ordinary Americans' incomes, a
phenomenon that began back in the 1970s and that American families have
offset by having both spouses work and by drawing on the rising value
of
their homes. With housing values toppling, no more spouses to send into
the workplace, and prices of gas, college and health care continuing to
rise, consumers are played out. December was the cruelest month that
American retailers have seen in many years, and, as Michael Barbaro and
Louis Uchitelle reported in Monday's New York Times, delinquency rates
on credit cards, auto loans and mortgages have all been rising steeply
for the past year.

What's alarming is that this slump in purchasing power doesn't appear
to
be merely cyclical. Wages have been flat-lining for a long time now,
the
housing bubble isn't going to be reinflated anytime soon, and the
upward
pressure on oil prices is only going to mount. As in Roosevelt's time,
we need a policy that boosts incomes and finds new solutions for our
energy needs.

FDR's long-term income remedies included Social Security, the Wagner
Act
(which made it possible for many workers to join unions) and public
works projects -- including a massive electrification of rural America.
A comparable set of solutions today would include the passage of the
Employee Free Choice Act, which would enable workers in nonexportable
service-sector jobs to unionize without fear of being fired. It would
include a massive, federally financed program to retrofit America,
creating several million "green jobs" in the process.

On these issues, there's a clear difference between the two parties.

Barack Obama, Hillary Clinton, John Edwards and the congressional
Democrats favor these measures; the Republicans oppose them (though
John
McCain at least has begun speaking about creating green jobs).

What Republicans favor is simply more tax cuts, which will do nothing
to
address our deeper problems of income distribution and energy
dependence.

The second way in which the current downturn echoes the Depression is
the role played by our deregulated financial sector. Now, as then, the
financial foundations of our leading banks and other lending
institutions have turned out to be made of mush. Now, as then, this
news
has come as an appalling surprise not just to consumers but to many of
the banks themselves. Now, as then, the banks created such complex and
deliberately opaque financial vehicles -- all devised to make them a
buck every time they swapped some paper -- that they long ago lost
track
of the paper's true value.

In his time, Roosevelt, through the Securities and Exchange Act and
other legislation, compelled banks to be both more prudent and
transparent. Over the past 30 years, however, Wall Street has created a
host of new, unregulated institutions (such as private equity
companies)
and devices (such as the bundled, and bungled, resale of mortgages into
ever-larger investment pools). Now it's time to enforce some
transparency and prudence regarding financial institutions that have
been gambling with other people's money and lives.

When it comes to reining in Wall Street, however, the Democrats have
been AWOL almost as much as the Republicans have been -- not least
because their presidential candidates get so much money from Wall
Street. By refusing to take on the Street, however, they forfeit what
could be a potent issue this fall and lay the groundwork for yet
another
recession.