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Thursday, August 4, 2011

Dodged A Big One, But What's Next?

Congress and the President has dodged the total collapse of the ours and the world's economies by passing the increase in credit and debt reduction bill. But we are not out of the woods or on the road to recovery. Actually we are declining into another recession with the potential of slipping deeper than the previous, if Washington does not get some backbone and clear thinking. The bill that was passed most economists say will make things worse and push us into a second dip recession.

Unfortunately one thing we do not have in Washington is backbone and clear thinking. What we do have are Democrats who are afraid of their own shadow and Republicans that have been commandeered by the Religious Tea Party (RTP). This new RTP has the objective to reduce, if not eliminate, federal government, to a level that one stated, "small enough to put in a bathtub and drown." They have also learned that by holding the entire American economy and people hostage, they can get their way, even though they are a very small minority.

From now on, there will be no diplomacy and negotiations, just stall and hold everyone hostage until the deadline or it's too late. The Democrat then must cave in to their demands or disaster will strike. We have lost any semblance of fair play and acting in the best interest of the country. We have total dysfunctional government and no governance.

The debt reduction deal is bad policy when the recovery has stalled. Why? When you have high unemployment, you have fewer people buying much in the way of goods and services. If there are fewer people buying, then there is lower demand, lower demand requires fewer workers to make the produce or provide the service, so in turn workers are terminated, which then starts the downward cycle all over again.

To rectify this downward spiral you have to have demand. This demand can come from foreign markets like Europe, Asia and maybe a few emerging 3rd world nations. But today all of these potentials are also having their own economic down turn.

China is now into a recession that is requiring laying off of workers, thus reducing demand in that market.

Japan is in bad shape from its almost 20 year recession, then compound this with the earthquake and tsunami and the Fukushima Daiichi nuclear accident, all of which is draining their treasury. They are in need of outside money to borrow to recover. This adds to the demand for money from the world bank, which is primarily funded by America and Europe and trades in the US Dollar, which is loosing value.

Europe has been harmed by the housing bust and huge holding of the bad mortgage backed derivatives that American investment companies sold to them. Italy, Spain, and Portugal are teetering on economic collapse that will destroy the fragile Euro.

John Maynard Keynes was a British economist that believed that government could moderate the business cycle through economic policy in order to stabilize the economy and working class wages. He also supported social liberalism; that government was best suited to provide some of the basic needs of the people, for the collective good. This being health care, retirement, and business regulation to protect the people from inherent harm of bad products and greed by capitalists.

His ideas were widely adapted by western capitalist countries in the early 20th century. They were a critical part of FDR's New Deal that established Social Security and his public works projects that even today we enjoy the benefits of that effort. Under Keynes economic model, only the government has the ability to infuse huge capital into the private sector to stimulate job growth. The private sector does not have the structure or incentive to stimulate jobs when business is slow. It is not in their best interest. His ideas were also part of Lyndon Johnson's Great Society that established Medicare and Medicaid.

But in the 1970's when we entered a recession due to Europe and Asia recovering from their destruction from WWII and was now producing goods at the same level as the US at a lower cost than the US, American companies saw a huge reduction in demand for their goods and services. We started to import a larger portion of goods. During the war recovery period, we exported at a much higher level than we imported. Most of our imports were raw material not found in the US.

The 1970's was also the time the Baby Boomers where entering the work force and our immigration policy allowed huge numbers of people to immigrate into the US. The number of people seeking work was huge compared to the declining job need.

Technology also added to this problem, computers were being introduce into business to perform tasks otherwise done by humans. First accounting, then engineering, then manufacturing. This use of technology increased productivity while using fewer humans in the process.

The combination of these events pushed companies to layoff workers, which slowed demand further and downward we started.

Milton Friedman an economist in Chicago came up with a new economic idea that the free market can correct itself without any interference or support by government. Ronald Reagan adopted this economic policy and started the attempt to eliminate government regulations.

At this same time, conservatives like Berry Goldwater and others created a underground movement to change the progressive movement we were in to a very conservative and more correctly anaco-capitalists form of society. As Reagan stated, "I'm a conservative and that means a libertarian." A libertarian movement is to eliminate all government and allow capitalist to do whatever they want. They feel that capitalist have a natural need to treat the people well, because they are the work force. But we know from history that this is not true and actually just the opposite. They abuse their power and enslave the working class for their own profit.

The first visible sign of this new conservative movement was when Reagan deregulated the Savings and Loan industry. The greed and corruption didn't take long and they quickly imploded. Savings and Loan banks were the major underwriters of home mortgages. They would use the deposits made by ordinary people in their savings accounts, mainly in Certificates of Deposit, and use it to finance new mortgages. Then they would sell these mortgages to Fannie Mae, the private, but publicly guaranteed mortgage finance company set up by the Government in 1938 to help people buy a private home and not live in rented apartments, which was common at that time.

What we now call banks, the retail bankers like Wells Fargo and Bank of America, did not hold home loans. It was not part of their business model to hold 30 year loans. They operated on short term, higher interest loans.

Fannie Mae was a private corporation that first used private capital to buy mortgages from the Saving and Loan banks, so these banks could use their capital for more mortgages. However, the government guaranteed the mortgages bought by Fannie Mae from the S&Ls. This put you and me at risk for these loans, which we paid dearly for when the S&Ls started to fail and all closed up shop. We the tax payers forked over billions to save these mortgages held by Fannie Mae.

Fannie Mae was split in the 1970s in response to the recession and potential foreclosures resulting from it. This split created a private/government company called Freddie Mac. In 1989 after the S&L breakdown, something had to be done to secure mortgages to get the housing market moving again. Reagan expanded the two programs by authorizing them to purchase more mortgages and become the primary holder of nearly every mortgage in America. Now the government, you and me, are on the hook for everyone's mortgages.

Further, Reagan nearly deregulated the mortgage writing industry, so it could sell mortgages by predatory lending practices by issuing mortgages at 100% of home value and on stated income only. No down payment, no real financial check of the borrower, just sign here and buy a home, and not just a home, but a BIG, BIG home, more than you can afford, because the payment is low at first then after 10 years it will jump up. And of course the idea was that your income would jump up accordingly also, therefore, you should have no problem paying the higher payments each month.

Brokerage houses then started to bundle these high risk mortgages with moderate risk and low risk mortgages to sell as investment instruments. AIG issued a default insurance policy that was to cover any loss by the investor, should they buy the policy, should the instrument go bad. But AIG didn't have any funds to backup these default swap policies. Of course Fannie Mae and Freddie Mac purchased these derivatives, as they are called, as well as investors and banks all over the world. They were rated as AA or better, but actually they were mostly junk. This was the cause of the biggest house bubble America has ever seen.

In the 1990s, computers, robotic and the Internet created great demand for computer engineers, but it also started to reduce the demand for labor as these technologies started to perform work that humans did before. Employment was high during the 1990s as the Internet stimulated a lot of job opportunities.

By 2000 the impact of these technologies being applied in the business process started to be felt. The auto industry reduced the number of humans needed to build a car. Even making computers required fewer people as demand for them escalated. The communications revolution was starting, workers didn't need to be located in an office or even in the same country to perform their task. Out migration of workers, out sourcing, to foreign countries accelerated to the speed of light.

By 2000 the dot com bubble of the new expanding internet started to burst because their value was based on the amount of visitors to a site than actual revenue generated by the site. This was not sustainable and people were still reluctant to purchase items online and advertising revenue was small, as companies had not yet embraced the internet as a viable marketing medium. this started a shallow recession.

George W then came along and lowered taxes, mainly on the wealthy and corporations, thus reducing revenue to the country, increased spending on Medicare Part D, the prescription drug benefit without a way to pay for it, and entered us into two wars without a way to pay for them. The government had to borrow huge amounts of capital from the open market to finance these new expenses, thus draining the capital for business to use.

The loss of local capital pushed companies to move more quickly and the shift their plants and operations to foreign countries, like India, China, Indonesia, and Malaysia. This started the huge reduction in employment to the tune of nearly 8 million jobs. With all these people now unemployed, they could not meet their mortgage payments that were programed to increase as scheduled. Defaults and foreclosures tipped the house of card and it all started to come down. Welcome to 2008.

There were provisions in the Bush tax reduction that encouraged corporation to move their business to other countries by giving government guarantees to loans to build factories in designated developing countries. This was part of Bush's foreign policy of winning over these countries loyalty. This zapped jobs in America because some commercial lender would only loan money, if the plant was in one of these countries that the government would guarantee the loan. This has to change, which was in the financial reform bill that the Republicans killed in the Senate.

The housing collapse was a dominoes effect, it caused further unemployment, mainly in the construction industry and real estate industry. When they are down, lumber, appliances, carpeting, furniture, cabinets, lighting, and so on all have lower demand and thus go out of business. The cycle continued until the mediocre stimulus bill passed by the Democrats and Obama in 2009. But it was far to small and was very lean on infrastructure building that would have stimulated a lot more jobs than what he was able to get with the small stimulus package he got passed. Now remember that TARP was under George W and it was a giveaway to Wall Street with no strings attached.

Obama also bailed out GM and Chrysler that saved several million jobs and so far has increased jobs as these companies recover. Much of the money has been paid back with interest. But with the second dip recession, they may fall back and get into trouble again.

Wages of the working class has been flat for nearly 30 years. Their buying power has dwindled, which also causes less demand on goods. American's used credit to keep their standard of living the same. But that added to the credit crunch when the housing market collapsed. Many home owners used the equity in their homes to secure their second mortgage to pay off some of their credit card debt. This placed them in great danger of loosing their home when the recession hit.

We need to go back to Keynes economic model of government infusing huge sums of capital into the private sector through infrastructure building and new technologies to create employment demand and thus an increase in demand for goods.

Under the current Friedman model, business will just wait until there is demand for goods before they start to employ again. They can sit on their money and manipulate it in the money markets to earn revenue. There is no incentive for them to hire and why should they, there is no one to buy their goods if they did hire new employees.

For Friedman's model to work, these companies that are sitting on nearly 3 trillion dollars of cash need to spend it on rebuilding our infrastructure and not wait on government to do it. Besides, they are the ones who benefit the most from a vibrant modern infrastructure such as highways, freeways, high speed rail, broadband fiber optics communications networks, fresh water, waste management and a host of other services they get from these otherwise government provided services. But they won't because that is not their business model or ethic. They hate government when it regulates them, but they love it when it assumes the cost of these services.

Yes, we need to reduce our long term debt. That goes without question, but we must get people back to work to generate income, that then generates taxes, that then can be used to pay down the debt. We also must increase the amount of taxes paid by the wealthy and highly profitable companies. By improving employment and taxing the wealthy, with some reduction in spending, mainly on military, we can eliminate the national debt in 15 to 20 years. If George W had not fucked up things, the Clinton policies would have created enough surplus to have paid of the national debt by now. You can read more about the reason why he did this in some of my other posts about "Starve the Beast."

I fear that we are in a long, very long recession, if not a depression, and with the current narrative being controlled by the Tea Party of reducing government, rather than raising capital to create jobs, there is little hope things will get better. In fact, they are about to get much, much worse.

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