Somewhere between the $700 Billion bailout and a depression
On the one hand we have those calling foul on the $700 billion proposal. There is a broad range of interests on this side of the fence. There’s ‘Joe Six pack’ who has a disinclination to save the bacon of those Wall Street fatcats who have made it into his consciousness as the beneficiaries of ever greater multi-million dollar bonuses for the past 15-20 years. There are those who have a hardline ideological problem with the idea of the U.S. Government getting involved in the economy. There are those, particularly internationally, who smell hypocrisy on the part of a Government which has rammed economic orthodoxy, in the form of deregulation and freedom from government involvement in the economy, down the throats of numerous other nations and global institutions for a generation. There’s little doubt that these groups have some pretty cogent arguments.
Ordinary individuals have watched in stupefied amazement since the 1980s as executive salaries, particularly those in investment banking, have sky-rocketed. Over the same time, these same people have seen their salaries often reduced in real terms, with the occupations they once had being increasingly outsourced when their salaries made it convenient for apital to shift those jobs anywhere – Mexico, China, India, wherever was cheaper. As far as a lot of ordinary individuals are concerned it made products cheaper for sure, and usually generated bigger profits for shareholders somewhere. But it also made a lot of ordinary lives cheaper on a day-to-day basis, with the benefits which came in form of better pensions fund performance all too often a minor consideration. Fewer and fewer had them, and the benefits accruing to them were controlled by those same Wall Street fatcats. The experience has left some feeling short changed when they balance their pensions with the headline payouts to those that are part of the game.
The proposal does indeed mark a significant step by the U.S. government to the very heart of capitalism as it has been known since the mid 1970s. Those worried by that step have a point, because once the Government steps in its actions become part of a political process, and a process which will consider a broader range of interests than just the fiscal. Issues like labour rights and health insurance, education, and social spending will get a bigger say in a political environment where the government underpins the core of Capital than they have done in a political world where Government has been pushed away from the core, and where its thoughts on these issues have been limited by Capital's control of the money.
The English-speaking world has been more than pushy in promoting deregulation on those nations who have had their economic troubles, for a long time. Anyone recall the Head of the IMF standing behind former Indonesian President Suharto with his arms crossed in 1998? Or some of the advice foisted on Russia throughout the 1990s? Or even the linking of aid to utility privatisation by the World Bank? Those in much of the rest of the world certainly do, and have a reasonable case when thinking that what goes a round comes around. If this is what deregulation and privatisation lead to, then the high priests should wear it.
Where the money comes from…
This latter perspective lies at the heart of another factor to consider when mulling over the $700 billion proposal. To fund this proposal the U.S. Treasury will be going abroad and knocking on doors of nations which have the cold hard. The U.S. taxpayer is simply providing the cash flow, considerable though it will be, to service the loan. It won’t be a shock for either the U.S. Treasury or the funding nations. It’s been knocking and they’ve been funding for some time now, as the U.S. current account and budget have gone deeper and deeper into the red.
But at some point there are a few questions to ask about this process too. Why shouldn’t the U.S. balance its books the way its orthodoxy has preached to others? Why should the world continue to use the U.S. dollar when more and more others are paying to give the dollar the value it has? At what point does the U.S., its currency, and its creed get called to account? With the U.S. budget deficit being measured in trillions, and the current account deficit a disturbingly high 6% this isn’t a simple ideological daydream. It’s a hard-nosed question with trillions of dollars riding on the outcome.
The additional outlays to the U.S. budget this year and the pump priming by the Federal Reserve to stave off financial collapse have seen U.S. Treasury futures ask this question with increasing insistence. At what point does the world need to factor in a possible dollar collapse? And how do those nations who are owed most by the U.S. manage that possibility? Do China and Japan simply hold off on buying more T bills, or do they start divesting themselves of their U.S. dollar holdings. If they even think of divesting then theres a massive global Mexican stand-off in play. Whoever divests first maximises their return, but condemns the rest to an ever diminished result. If China unloads some of its dollars it means that those held by Japan are going to be worth less when it goes to unload. This in turn means that at some point, if or when major central banks decide they can no longer book the massive potential losses on their investment, the potential for a collapse in dollar value is significant, and getting more so.
The major means of fending off this alarming possibility is the use of interest rates. Given the debts at both a budgetary and current account level, the U.S. taxpayers who will service this debt will do so in an environment of higher interest rates, just to keep the global dollars coming in. This in turns mean that those taxpayers will pay their tax in a business environment weighed down by higher interest rates. Adding $700 billion to the servicing requirement may not be immediately noticeable, but may also be something later generations will not be thankful for.
What will the $700 Billion do?
The proposal which goes before the House basically involves storing a large amount of ‘toxic’ derivatives in a publicly backed vehicle. The derivatives are toxic because they are partly backed by mortgages which are unlikely to be repaid, with the assets backing the mortgages – the houses – falling in value in a way they haven’t done in a lifetime. The argument goes that currently there are two problems facing global financial markets, one that banks don’t have money to lend, and the other that they are not lending to one another when they do. The reasons for this are generally considered to be that so many banks, particularly those in the English speaking world, have bought and sold so many of these derivatives, and are using them as assets against which to borrow, that these same banks don’t trust one another (or their asset bases) enough to continue lending. At the same time the derivatives are being trashed to the extent that write downs attributable to the sub prime crisis are now being measured in trillions of dollars.
It is here that the crisis links into the rest of the world, including Russia. Banks across the world have been part of the buying and selling of these derivatives, with massive write downs coming from British, European, Asian and Australian banks already – although none from Russia – and banks around the world are being hit by the seizing up of the money markets. It doesn’t matter if their asset bases are 100% square and they have never seen a derivative in their life. Libor is Libor, and if its hitting borrowers for 2.5% just for knocking on the door, when it used to hit them for just 0.2 or 0.4%, then its hitting all borrowing. The wild fluctuations in both Libor and Euribor over the last six weeks make any planning for recurrent funding of companies with large borrowings extremely difficult. And it is for this reason that Central Banks around the world have been pumping liquidity into their systems, and making guarantees that funding will be available for their large borrowers.
The proposal which will be voted on in the House will essentially enable banks to move these derivatives off their balance sheets by selling them to the Treasury. It is expected that this will engender greater confidence in the system's assets and promote more lending. At the same time it is hoped that it will enable the rout which has engulfed both house prices and the derivatives to slow down enough to stabilise, and at least enable these parts of the system to even think of buying again. If they start borrowing and lending again, then there's more money in circulation, economic growth starts moving, and we can all breathe a sigh of relief.
Will it work?
There is little guarantee that even a $700 billion bailout will actually work. That isn’t to say it certainly won't, but that the size of derivatives market dwarfs the $700 Billion. What it will do for sure is load up on the additional debt needing servicing by the U.S. and add to concerns about the U.S. dollar. More importantly, for some of the House members voting on Friday evening, it will bail out those people who have got the system into this mess in the first place with no guarantee that they won't face a recession, or worse, anyway. That’s without even considering whether there are better uses which could be made of $700 billion worth of expenditure. That’s a lot of hospitals and schools, or pension benefits.
But, despite the great unknown the proposal represents, it does represent an attempt at making sure the U.S. economy doesn’t grind to a halt. Those calling for increases in deposit insurance, or measures to help people remain in their houses with mortgage holidays, or even incentives to spend in other areas of the economy, aren’t really saying that their proposals will enable the U.S. to avoid a recession. They are saying it will enable smaller sections of society to weather the immediate future, or aspects of it, better than they otherwise might.
This is why those wanting a 'no' vote need to think carefully. Are they really prepared to see the world's largest economy go into a recession? For no matter how deserved the comeuppance may be for a range of players, the simple fact of the matter is that a U.S. recession would be painful for nearly everyone, and may take forms which could bring about the very disasters everyone wants to avoid. Would China continue to run massive current account surpluses with the U.S. if the latter was in recession? Would it continue to drive commodity and oil prices the way it has done in recent years if it wasn’t running those surpluses? If China isn’t going to continue to drive global economic expansion then who else is? A febrile Eurozone? A Japan which is barely fending off deflation? What would be the implications for not just the U.S. but for almost every other nation in the world if the world's major economic engine stops?
And what is being proposed to make sure it doesn’t stop?
It may be ugly philosophically, and reward the wrong people first up. It may be complete rubbish coming from those who have preached about keeping government out of the market. It may not even work and give almost incomprehensible powers to a U.S. Treasury Secretary who has been one of those fatcats and is a Wall Street insider. But the plan being voted on is one which is pitched at the main game, and gives the chance of further economic growth – and possibly preventing a global economic meltdown.
For sure, the system needs to change, and government needs to move closer with regulation to the heart of capital. For sure, ordinary citizens need to have their concerns given a bigger say in Congress, and, for sure, they have a load of legitimate grievances which have been building for a generation. For sure, the high priests of capitalism need to show a little more sensitivity when considering opinions other than their own, both at home and internationally.
But the system will be best changed in the context of continuing economic growth. Change the proposal, add to it whatever is needed. But it might be best if the legislators keep their focus on maintaining growth, assuming it hasn’t stopped, and starting it again real quick if it has. Voting the Paulson proposal down without something better to generate growth may come back to haunt.
James Blake, RT