Readers ask if the financial crisis is over, if the recovery
is for real and, if not, what are Americans� prospects. The short answer is
that the financial crisis is not over, the recovery is not real, and the U.S.
faces a far worse crisis than the financial one.
Here is the situation as I understand it: The global crisis
is understood as a banking crisis brought on by the mindless deregulation of
the U.S. financial arena. Investment banks leveraged assets to highly
irresponsible levels, issued questionable financial instruments with fraudulent
investment grade ratings, and issued the instruments through direct sales to
customers rather than through markets.
The crisis was initiated when the U.S. allowed Lehman
Brothers to fail, thus threatening money market funds everywhere. The
crisis was used by the investment banks, which controlled U.S. economic policy,
to secure massive subsidies to their profits from a taxpayer bailout and from
the Federal Reserve. How much of the crisis was real and how much was hype is not
known at this time.
As most of the derivative instruments had never been priced
in the market, and as their exact composition between good and bad loans was
unknown (the instruments are based on packages
of securitized loans), the mark-to-market rule drove the values very low,
thus threatening the solvency of many financial institutions. Also, the rule
prohibiting continuous shorting had been removed, making it possible for hedge
funds and speculators to destroy the market capitalization of targeted firms by
driving down their share prices.
The obvious solution was to suspend the mark-to-market rule
until some better idea of the values of the derivative instruments could be
established and to prevent the abuse of shorting that was destroying market
capitalization. Instead, the Goldman Sachs people in charge of the U.S.
Treasury and, perhaps, the Federal Reserve as well, used the crisis to secure
subsidies for the banks from U.S. taxpayers and from the Federal Reserve. It
looks like a manipulated crisis as well as a real one due to greed unleashed by
The crisis will not be over until financial regulation is
restored, but Wall Street
has been able to block re-regulation. Moreover, the response to the crisis has
planted seeds for new crises. Government budget deficits have exploded. In the
U.S., the fiscal year 2009 federal budget deficit was $1.4 trillion, three
times higher than the 2008 deficit. President Obama�s budget deficits for 2010
and 2011, according to the latest report, will total $2.9 trillion, and this
estimate is based on the assumption that the Great Recession is over. Where is
the U.S. Treasury to borrow $4.3 trillion in three years?
This sum greatly exceeds the combined trade surpluses of
America�s trading partners, the recycling of which has financed past U.S.
budget deficits, and perhaps exceeds total world savings.
It is unclear how the 2009 budget deficit was financed. A
likely source was the bank reserves created for financial institutions by the
Federal Reserve when it purchased their toxic financial instruments. These
reserves were then used to purchase the new Treasury debt. In other words, the
budget deficit was financed by deterioration in the balance sheet of the
Federal Reserve. How long can such an exchange of assets continue before the
Federal Reserve has to finance the government�s deficit by creating new money?
Similar deficits and financing problems have affected the
EU, particularly its financially weaker members. To conclude, the initial
crisis has planted seeds for two new crises: rising government debt and
A third crisis is also in place. This crisis will occur when
confidence is lost in the U.S. dollar as world reserve currency. This crisis
will disrupt the international payments mechanism. It will be especially
difficult for the U.S. as the country will lose the ability to pay for its imports
with its own currency. U.S. living standards will decline as the ability to
The financial crisis is essentially a U.S. crisis, spread
abroad by the sale of toxic financial instruments. The rest of the world got
into trouble by trusting Wall Street. The real American crisis is much worse
than the financial crisis. The real American crisis is the offshoring of U.S.
manufacturing, industrial, and professional service jobs, such as software
engineering and information technology.
Jobs offshoring was initiated by Wall Street pressures on
corporations for higher earnings and by performance-related bonuses becoming
the main form of managerial compensation. Corporate executives increased
profits and obtained bonuses by substituting cheaper foreign labor for U.S.
labor in the production of goods and services marketed in the U.S.
Jobs offshoring is destroying the ladders of upward mobility
that made the U.S. an opportunity society and is eroding the value of a
university education. For the first decade of the 21st century, the U.S.
economy has been able to create net new jobs only in domestic nontradable
services, such as waitresses, bartenders, sales, health and social
assistance and, prior to the real estate collapse, construction. These jobs are
lower paid than the jobs were that have been offshored, and these jobs do not
produce goods and services for export.
Jobs offshoring has increased the U.S. trade deficit,
putting more pressure on the dollar�s role as reserve currency. When offshored
goods and services return to the U.S., they add to imports, thus worsening the
The policy of jobs offshoring is insane. It is shifting U.S.
GDP growth to the offshored locations, such as China, thus halting growth in U.S.
consumer incomes. For the past decade, U.S. households substituted an increase
in indebtedness for the lack of growth in income in order to continue
increasing their consumption. With their home equity refinanced and spent, real
estate values down, and credit card debt at unsustainable levels, it is no
longer possible for the U.S. economy to base its growth on a rise in consumer
debt. This fact is a brake on U.S. economic recovery.
Stimulus packages cannot substitute for the growth in real
income. As so many high value-added, high productivity U.S. jobs have been
offshored, there is no way to achieve real growth in U.S. personal incomes.
Stimulus spending simply adds to government debt and pressure on the dollar,
and sows seeds for high inflation.
The U.S. dollar survives as reserve currency because there
is no apparent substitute. The euro has its own problems. Moreover, the euro is the currency of
a non-existent political entity. National sovereignty continues despite the
existence of a common currency on the continent (but not in Great Britain). If
the dollar is abandoned, then the result is likely to be bilateral settlements
in countries� own currencies, as Brazil and China now are doing. Alternatively,
John Maynard Keynes� bancor
scheme could be implemented, as it does not require a reserve currency
country. Keynes� plan is designed to maintain a country�s trade balance. Only a
reserve currency country can get its trade and budget deficits so out of balance
as the U.S. has done. The prospect of U.S. default and/or inflation and decline
in the dollar�s exchange value is a threat to the reserve system.
The threats to the U.S. economy are extreme. Yet, neither
the Obama administration, the Republican opposition, economists, Wall Street,
nor the media show any awareness. Instead, the public is provided with spin
about recovery and with higher spending on pointless wars that are hastening
America�s economic and financial ruin.
Craig Roberts [email
him] was Assistant Secretary of the Treasury during President
Reagan�s first term. He was Associate Editor of the Wall Street Journal. He has
held numerous academic appointments, including the William E. Simon Chair,
Center for Strategic and International Studies, Georgetown University,
and Senior Research Fellow, Hoover Institution, Stanford University. He was
awarded the Legion of Honor by French President Francois Mitterrand. He is the
author of Supply-Side
Revolution : An Insider�s Account of Policymaking in Washington; Alienation
and the Soviet Economy and Meltdown:
Inside the Soviet Economy, and is the co-author with Lawrence M.
Stratton of The
Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the
Constitution in the Name of Justice. Click here for
Peter Brimelow�s Forbes Magazine interview with Roberts about the recent
epidemic of prosecutorial misconduct.