PAUL CRAIG ROBERTS – Save the dollar, not the banks!
As an assistant secretary of the Treasury in the Reagan Administration, Paul Craig Roberts had a front-row seat to observe Wall Street greed and Federal Reserve mistakes imperil the economy. Long before George W. Bush left office, Roberts decried the Iraq War, the neocon hijacking of legitimate conservatism and the looting of America’s wealth.
HUSTLER: What happened to our economy?
PAUL CRAIG ROBERTS: Most people don’t realize that the current economic crisis has several dimensions. It’s not just the result of bad mortgages. It’s also the result of a bad interest-rate policy, deregulation of the banks and a ballooning trade deficit that could end up destroying the value of the dollar.
The government’s explanation is that the big banks and insurance giants like AIG were threatened when the housing bubble burst. Interest payments from risky mortgages stopped flowing in, sucking the value out of the whole system of derivatives and credit swaps that the banks use to make money off of mortgages. Bank assets took a huge hit. AIG, which had backed risky investments without making sure it had enough reserves to cover them, couldn’t make good on its obligations.
There are two key aspects of the banking crisis that the government doesn’t like to talk about. One is former Federal Reserve Chairman Alan Greenspan’s low-interest-rate policy. Greenspan made borrowing money cheap to boost construction and real estate jobs in an attempt to mask job losses in other sectors, such as manufacturing and high-tech. As American corporations moved production for the American market to China and elsewhere, Greenspan hid the job loss by creating a real estate bubble. This enabled CEOs and shareholders to reap large gains by laying off American workers and replacing them with lower-paid workers overseas. Executives got huge bonuses for this kind of downsizing.
The second key aspect is the deregulation of the financial system. Over the past decade, rules and operating guidelines have been gradually loosened or scrapped altogether. During the Great Depression the Roosevelt Administration moved to regulate the financial system and segregate commercial from investment banking. The Glass-Steagall Act, passed in 1933, placed limits on how many different functions a bank could engage in. In 1999, Glass-Steagall was repealed. With that vote, Congress started us on the road to disaster.
To make matters worse, Hank Paulson—CEO of Goldman Sachs and later President George W. Bush’s Treasury secretary—convinced the Securities and Exchange Commission to scrap rules for investment banks, meaning the SEC couldn’t regulate how these huge holders of equity handled their cash. Banks and financial companies were given more freedom than ever, based on the ideology that free markets regulate themselves.
Because of deregulation, financial institutions could leverage debt to new heights, meaning they repackaged debt into products they could trade and use to generate capital. AIG, for example, had only $1 of real equity for every $33 of obligation. The moment the market turned, this leveraged debt became unsustainable. By overleveraging debt, the investment banks destroyed themselves. This is how Bear Stearns, Lehman Brothers and Merrill Lynch collapsed.
How does the U.S. trade deficit play into this?
The U.S. currently pays over $50 billion a month more on imports than it makes on exports. This is a massive trade deficit that cannot be closed, because American corporations have moved so much production for the American market to other countries.
When production for U.S. markets is moved offshore, a big chunk goods and services produced—is transferred to some other country along with the American jobs. That causes a plunge in personal and national income. There is less tax revenue for cities, states and the federal government. CEOs and shareholders benefit by cutting labor costs, but everyone else suffers.
The trade deficit also endangers the U.S. dollar’s role as world reserve currency, which is the currency countries use for international transactions. The benefit of being the reserve currency country means that you can pay your international bills in your own currency. If the U.S. doesn’t have enough money from exports to pay for imports, it can just print more money.
Today the combination of large trade deficits and massive government budget deficits makes the dollar unattractive. The world is awash in dollars, and other countries are not happy to acquire the several trillion dollars more in ever-riskier U.S. Treasury bonds that are necessary to finance our annual multitrillion-dollar budget deficits. Treasury bonds are basically government IOUs. China is America’s largest creditor country, since it holds more U.S. debt in the form of U.S.
Treasury bonds than any other nation. Recently, both the premier of China and the head of China’s central bank expressed concerns about China’s investment in dollar assets. When your banker begins to look at you suspiciously, your troubles are beginning.
What would happen if China and the rest of the world dumped the dollar?
If the U.S. dollar loses the reserve currency role, the current crisis will be magnified many times over. The U.S. will not be able to pay for its imports, and the rest of the world will be faced with the failure of the international payments system. The dollar collapse would affect the whole world’s ability to shore up local economies, including World Bank loans and measures used by the International Monetary Fund. It would also devastate America’s ability to influence foreign governments.
It has become impossible to finance the multitrillion- dollar U.S. budget deficits resulting from bailouts, stimulus packages and unaffordable wars. Americans have lost wealth from real estate and stock market declines. Many are losing their jobs, and most are deep in debt with mortgages, credit cards and car payments. Americans cannot provide the trillions of dollars needed to make Treasury bond auctions successful in the U.S. market.
In the past, America’s trade partners have financed our government’s budget by buying our debt, thanks to their trade surpluses with the U.S.—meaning that they sold us more than we sold them, so they could afford to invest in our debt, packaged as Treasury bonds. But now the budget deficits are much larger than can be balanced out by the trade surpluses of America’s creditors. Even if our creditors were still willing, they simply cannot absorb the supply of bonds necessary to finance the U.S. budget deficit.
Is there any way to pay this off?
There are only two ways of financing U.S. budget deficits. One is if investors flee from further stock market declines into supposedly safe Treasury bonds, pushing up their value. That would forestall a budget catastrophe, but the desertion of equities for Treasurys could cause a costly wave of corporate bankruptcies. The other way is for the Federal Reserve to purchase the Treasury bonds that cannot be sold at the quarterly auctions. This is called monetizing the debt or printing money. The Federal Reserve purchases the Treasury bonds from the U.S. Treasury. The money supply— meaning the amount of cash in circulation—grows by the amount of the Federal Reserve’s bond purchase. Currently the U.S. money supply is about $1.4 trillion. If the 2009 and 2010 budget deficits are monetized, the money supply will have tripled in two years. Inflation—perhaps hyperinflation—would break out, and foreigners would dump their dollar holdings and the dollar as reserve currency. The greatest economic crisis in American history would occur.
What should the government be doing to prevent that from happening?
The most important task is not to bail out the banks or to restore bank lending. It is to save the dollar as reserve currency. This requires large reductions in U.S. budget and trade deficits.
We have to stop importing more than we export. To do that, we have to adopt measures that will make it financially sensible for companies to act in America’s interest.
The trade deficit could be reduced over time by changing the corporate tax system and taxing corporations according to whether the economic benefits from production—known as value added—occurs in the U.S. or abroad. A low tax rate could be imposed if value added occurs in the U.S., and a high one if production
is offshored. Companies would migrate back to the lower tax rate, which would bring jobs and GDP back to America and reduce imports by the amount of production that returns to the U.S.
The budget deficit could be reduced by ending the pointless wars in Iraq and Afghanistan and by cutting the U.S. military budget, which is larger than the GDP of some of the countries we are defending ourselves against. The deficit would also be stemmed if we nationalized the banks instead of bailing them out. The U.S. can no longer afford an empire with which to dominate the world.
The U.S. no longer has hundreds of billions annually to hand over to the military industry. Those dollars have to be borrowed, and that undermines the U.S. economy.
Russian presidents have asked for accommodation with Washington, but Washington keeps pursuing aggressive policies toward Russia, putting missile bases in Poland and radar sites in the Czech Republic while attempting to install NATO in former constituent parts of the Soviet Union.
This is madness. When the Romans realized that they were overextended relative to their resources, they pulled back their imperial frontiers. The U.S. has so far refused to bring its imperial pretensions in line with its resources.
Why doesn’t Obama do what FDR did to end the Great Depression?
FDR was faced with a potential contraction of the money supply from bank failures. It is this 1930s problem upon which U.S. policy is currently focused. However, Obama is faced with greater problems than FDR because the government budget deficits could sink the dollar and remove the dollar from its reserve currency role. In the 1930s the U.S. economy was not dependent on imports, and the dollar’s exchange value was not jeopardized by oversupply—meaning there wasn’t an excess supply of dollars to dilute the dollar’s value. FDR had no difficulty keeping the trade balance manageable, but Obama might.
The greatest problem with Obama’s bailouts is that they are being financed by issuing more U.S. Treasury debt, which taxpayers will end up having to pay. Interest will have to be paid on the trillions of borrowed dollars, and this will divert tax revenues from other uses. If the Treasury nationalized the banks, the U.S. government would not have to issue trillions of dollars in new Treasury debt to pay for bailouts and interest.
If government budget deficits are monetized, there’s a real risk of hyperinflation. Since hyperinflation means that the value of the dollar plummets, it could make it impossible for the U.S. to import energy, manufactured goods and advanced technology products. With energy disruptions would come supply disruptions to grocery stores and disrupted heating and electricity supplies. America would quickly learn what it is like to be a Third World country.