Fixing the Economy? Like Filling a Leaky Bucket

By Roger Baker / The Rag Blog / December 13, 2009

Is trying to fix the U.S. economy like trying to fill a leaky bucket? So it seems. The money the U.S. government is printing is not getting down to the grassroots to create jobs. The lack of liquidity and credit is creating a deflationary spiral, a self-perpetuating economic contraction.

The financial tools being used to revive the domestic economy are having little effect. The main tools being tried are the Keynesian stimulus aimed at creating domestic jobs; the guaranteeing of existing commitments like bad home loans and social security; and the very low prime rate accessible to major bank lenders for both domestic and international loans.

Keynesian stimulation is primarily a domestic stimulus effort, a policy which by itself and used alone on a large scale could be quite effective in doing things that need to be done. However, the Congressional Republicans are trying to block more stimulus at a time when much more is needed to stop the deflationary spiral. Here is how Nobel prize winning economist Joseph Stiglitz sees the current situation:

Nobel Prize-winning economist Joseph Stiglitz urged U.S. lawmakers to use “overwhelming force” to cut a 10 percent unemployment rate that is forecast to rise…“Unless action is taken, we risk facing a vicious cycle: unemployment contributing to a weak economy, more mortgage foreclosures, more bad debts, lower demand, and possibly more, but certainly not less, unemployment.” Stiglitz said priorities for spending should include extending unemployment benefits, aiding states facing revenue shortfalls, giving tax credits for weatherizing homes, government jobs programs and research and technology initiatives…

The Keynesian stimulus package is at the same time dwarfed by a much bigger pot of money: the global finance system, largely managed by the bankers who got us into trouble. Here is what Stiglitz goes on to say about that:

…Stiglitz, 66, also said the Federal Reserve contributed to the financial crisis by failing to supervise banks or stem the housing bubble. He questioned proposals to give the central bank more authority to supervise firms whose failure might threaten the financial system. “Giving more power to an institution which has failed so miserably, with results that have imposed such costs on all of us, cannot be the right solution unless there are deep and fundamental reforms in the institution, of a kind that are beyond those currently being discussed,” he said.

In other words, the net effect of the amount of Keynesian stimulus we are likely to get is unlikely to do much good if we are not also reforming the banking system. All the money the U.S. government obligates should be pulling in the same direction. At least the immediate prospects for deep reform of the financial system are not good. Matt Taibbi, who just wrote a devastating critique in Rolling Stone titled “Obama’s Big Sellout,” documents the incestuous relationships between the bankers and their government regulators, who are now increasingly associated with the Obama administration.

Why aren’t the bank failures being followed by reform, with bank nationalization as an option? The problem is more one of politics than of economics. The U.S. government through its bailout policies is in real control of the banks through our legal system. This Atlantic article explains the same situation from a slightly different perspective.

And here’s an overview of the economic situation by an IMF banker. It explains how the U.S. adopted a system of political control by the banking oligarchs; the U.S. is beginning to resemble a third world country in its pattern of entrenched corruption. The thesis is that the current entrenched banker-ocracy will do anything to block reform. The bankers and their political allies are unwilling to step aside, thus blocking adoption of a rational economic cooperation policy based on the needs and desires of the vast majority of the public.

Why do we not take full charge of their management in the public interest? Do we want to keep pretending the banks are solvent using phony profits and non-transparent financing? Or do we have the courage to face reality, to declare the likely bankrupt banks like Citibank insolvent, and then get to the heart of fixing the problem with strict controls, much as prominent Keynesians like Krugman and Galbraith advocate?

The TARP bank bailouts greatly favored the banks while obligating future taxpayers to bear the burden, but there as little reform to benefit the taxpayers in return. The policy of cheap and easy Federal Reserve credit remains, with a prime lending rate down around zero percent. Bernanke says he is going to try to keep this going. Meanwhile, the U.S. government, the big investment banks, and the multinational corporations are first in line for low interest rate loans. This is the Wall Street Journal complaining about the situation:

The Federal Reserve implemented an emergency monetary policy after the 2008 Lehman bankruptcy to salvage the world financial system. In his testimony yesterday… Ben Bernanke said, ‘We must be prepared to withdraw the extraordinary policy support in a smooth and timely way as markets and the economy recover.’ This leaves all-out emergency monetary stimulus in place, but with a different, much weaker justification.

With the system stabilized, the Fed hopes that artificially low interest rates and its purchases of mortgage-backed securities [MBS] will spur growth. Instead they are pushing dollars abroad and wasting precious growth capital in asset and commodity bubbles… more than a year after the heart of the panic, the Fed is still promising near-zero interest rates for an extended period and buying over $3 billion per day of expensive mortgage securities… Capital is being rationed not on price but on availability and connections.

The government gets the most, foreigners second, Wall Street and big companies third, with not much left over. The irony of the zero-rate policy, coupled with Washington’s preference for a weak dollar, is a glut of American capital in Asia (as corporations and investors shun the weakening U.S. currency) and a shortage at home… Much of its current stimulus is being diverted to commodities and foreign economies – hence Asia’s complaint about bubbles … Wall Street will threaten a tantrum if the Fed even thinks about damping the air-raid sirens. The Street utterly loves the Fed’s largess …

Under current unreformed and unregulated conditions, no matter how much cheap low interest rate money is available for loaning out, the banks try to seek out their highest profit. Bankers are, after all, in business to make as much money as possible on their loans. A fast return, high profit loan by a bank is always going to win out over a slow return, low-profit-anticipated loan. This will be so until banking is made to change by externally imposed laws and regulations.

The consumer spending portion of the U.S. economy is continuing to deflate with no obvious recovery stage in sight. Consumers spend most of the total U.S. GNP on personal goods, but the high unemployment and consumer debt mean that there are few profitable domestic loan opportunities in the USA anymore, especially for small businesses catering to the consumer economy.

People are only buying what they really need and not much else. Contraction in this Main Street sector is indeed holding wage inflation down, but at a high social cost in what has become an increasingly service-based U.S. economy. Cheaper U.S labor, delivered through increasing poverty and wage competition, does not translate into more profitable bank loan opportunities so long as U.S. wages remain far above Chinese wages.

A new banking reform bill has just made its way through the House of Representatives. However, on close inspection it looks like token reform, falling far short of the reforms suggested above by Stiglitz. As one example, the bill calls for an audit of the Federal Reserve system, but not for another two years. Another mismatch stems from the fact that we live in a world of international banking. A world that needs international banking reform to coordinate the global economy properly, as Financial Times points out here. The U.S. doesn’t dominate the global economy any more, nor can we fix it on our own.

The leaky bucket

Back to the leaky bucket syndrome. Since the domestic economy is no longer a lucrative source of profit, bank loans are no longer attracted toward domestic investments that might create jobs and help restrain deflation. The opportunities for banks to make much profit on traditional domestic investments involving average people are rare.

Given this situation, we can see why making easy money available through the Federal Reserve is like trying to pour money into an old tin bucket. The theory is that the dollars circulate and stimulate additional general consumer demand, called the “multiplier effect.” The problem is that the money tends to head offshore. Not enough stays to revive domestic demand alongside the relatively insufficient Keynesian stimulus.

The easy money and stimulus the government creates is tending to leak outside of the country into foreign loans, equities and commodities. The guys managing private money watch the fed and the treasury extend credit to prop up all sorts of bad investments and government entitlements. They realize that the total accumulation of U.S. treasury debt is so large that it may never be paid back by the aging population of taxpayers. It looks like U.S. debt may have to use shrunken, devalued dollars as a likely alternative to government default.

The banking investment outlook is different with regard to bank investments in foreign debt, foreign equities, and commodities. The biggest U.S. banks often make loans to corporations that then use the money for profitable investments abroad. A lot of production in the U.S. biotech industry is now relocating to China, with the parent companies evolving into domestic sales outlets. Loans to such companies tend to stimulate foreign economies rather than the domestic economy.

If you buy commodities, you are often stimulating foreign mining and manufacture in the country of production; most commodities (where are we competitive except wheat soybeans, and Boeing airliners?) are largely produced outside the USA. We are now seeing broad price inflation of many commodities since about March 2009, with a rise of about 30-40% so far in just this year.

Those who see this handwriting on the wall are clearly buying metals and commodities which tend to preserve wealth, while dumping their dollars. The rising gold prices is a fundamental sign that people don’t trust dollars to hold their value, so they buy gold, which has always held its value and preserved wealth.

This is an obvious sign that the psychology of the rich guys who run the world is shifting away from the U.S. service economy, to favor the emerging economies of Asia, etc. There is now a global asset bubble that attracts speculative investments in commodities.

This applies to oil too. With annual global oil depletion of about 5%, and a production cushion of perhaps 5 million barrels a day of spare capacity (we have to guess the number), we are probably due for another economy-crippling oil price spike within just a few years. This will happen sooner if the global economy “recovers.” However oil dependence is so basic to the global economy that a tight market and another oil price spike probably cannot be delayed much in any case.

Hope for change?

Not facing reality with regard to the finance system and turning to printing money and phony bank profits could be extremely destructive before long, probably within the next few years. This will most likely be reflected in higher federal interest rates. Why not simply mandate that the banks that get government bailouts must do the stuff that really needs to get done, like setting up nationwide medical clinics, or cooperative community gardens, or homeless relief centers?

The public is now figuring out some of the right answers on its own. People say what they want when they are asked in the polls. The fact that the politicians, who determine how the banks are regulated, are resisting making these changes points to the heart of the problem.

Americans want their government to create jobs through spending on public works, investments in alternative energy or skills training for the jobless.

They also want the deficit to come down. And most are ready to hand the bill to the wealthy.

A Bloomberg National Poll conducted December 3-7 shows two- thirds of Americans favor taxing the rich to reduce the deficit.

Even though almost 9 of 10 respondents also say they believe the middle class will have to make financial sacrifices to achieve that goal, only a little more than one-fourth support an increase in taxes on the middle class. Fewer still back cuts in entitlement programs such as Social Security and Medicare or a new national consumption tax…

If this is what most of the public wants, why is bank nationalization not an option? The problem is more one of politics than of economics.

The government through its bailout policies is in real control of the banks, so why do we not take full charge of bank management in the public interest? Do we need to keep pretending that the banks are solvent or do we have the courage to face reality? Why not declare key banks insolvent, and get to the heart of fixing the problem through strict bank controls, much as prominent Keynesians like Krugman and Galbraith advocate?

If by some political miracle progressives had been put in charge of dealing with the U.S. economic crisis in mid 2008, what might they have done differently? Probably the initial acute part of the current crisis should have been treated with an injection of liquidity and deficit spending along Keynesian stimulus lines to prevent a chain reaction banking panic. This did happen. But there was little followup in terms of fixing the policies that caused the problem.

Given a U.S. political system polarized between two parties, and one in which political influence peddling and lobbying influence plays a large and ongoing role, the bankers have been able politically to resist banking reform. This is now widening into a deep and fundamental conflict between a wealthy oligarchy, with its power centered on finance, and the broad economic interests of the American public.

Why no trials for the most culpable bankers? If Citibank cannot survive without phony profits, why not nationalize it? Unreformed, poorly regulated banks too big to fail are probably a bigger threat than foreign terrorists. I think the proper smart solution is either to break up or to nationalize too-big-to-fail banks so the money gets spent on the low profit things we need in this country. This would send a sign that the public is in charge, and not the banker-ocracy that caused the problems.

If Karl Marx were still around as an observer, I think he would see this as the historically defining class struggle of our times. A conflict between the bankers and their private but destructive interests, in opposition to the public interest of the vast majority, both domestic and globally.

Call it what we will, there is a deep and fundamental problem that our current political institutions seem unable to resolve. This situation is unlikely to change. Not without broad public pressure and political organization generated by most of the 6 billion of us trying to survive in a world run by bankers; those taught to profit by trying to perpetuate infinite growth on our finite planet.

[Roger Baker is a long time transportation-oriented environmental activist, an amateur energy-oriented economist, an amateur scientist and science writer, and a founding member of and an advisor to the Association for the Study of Peak Oil-USA. He is active in the Green Party and the ACLU, and is a director of the Save Our Springs Association and the Save Barton Creek Association. Mostly he enjoys being an irreverent policy wonk and writing irreverent wonkish articles for The Rag Blog.]

Also see:

• Roger Baker: Can the Economy Recover? by Roger Baker / The Rag Blog / December 4, 2009
• Economy and Unemployment : Real Recovery a Long Shot by Roger Baker / The Rag Blog / December 6, 2009

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