Before we dive into today’s topic, let me help ground our understanding of the numbers being bandied about today. For instance, if you were to begin to count one-dollar bills at the rate of one per second, just short of twelve full days later you would have counted one million dollars. Now, to count a billion dollars, you would continue at the same rate, for 31 years. And to proceed to counting one trillion dollars, you continue at the same rate for 31,000 years, or more than 6 times recorded human history. I will never forget the day in September 2008, when I was deployed to south Texas by FEMA in the aftermath of Hurricane Ike, and the Houston newspaper had two stories on the front page: “Ike causes $29 billion in damage” and “Treasury Secretary asks for $700 billion to bail out banks”. A billion of anything hasn’t been the same for most of us, since that day. It is helpful to keep this understanding in mind, as we toss around trillion dollar war-budgets, trillion dollar IOUs, and trillion dollar deficits. And now, on to today’s topic!
It is easy to ignore the current state of affairs in national economies around the globe, especially if you rely upon American media as your source of news. We are informed that the Federal Reserve will create US$600 billion out of thin air and use it to ‘keep interest rates low’, without questioning this premise. We hear vague descriptions of some new kind of war, a ‘currency war’, yet we are so numb to war that we don’t even care to understand what the term means.
If you do have access to international sources, you may know this: Thailand is spearheading a movement to get ASEAN nations to trade among themselves using the Chinese RMB for settlement. The latest proposal in talks aimed at changing the paradigm that has the American dollar as the worldwide foundation of trade, this one has a good chance of working, in part because China has already begun to negotiate individual deals with other nations that ignore the dollar. Couple this with the new tax on Thailand on stock dividends and interest paid to foreigners, instituted to deal with the falling value of the dollar, and we are given a few clues as to what this all means.
It is my hope in this piece to shed light on concepts that are murky at best, and without widely accepted “laws” or absolutes that explain behaviors and results at worst. Economists are one group of experts that rarely agree on anything. We see talking heads constantly trying to parse the latest developments, and predict a future that has a reasonable chance of being accurate, while espousing viewpoints from opposite ends of the spectrum. There are always surprises and unintended consequences, it seems, that derail even the most erudite spokesperson. What is a layperson to do? How can we begin to get our minds around today’s global economic crisis? What can we do, and what does it all mean?
Let’s look first at the US dollar and its international role. Late in World War II, the allied nations effectively decreed that the dollar would be used to settle trade in the world economy that would result following their impending victory. In particular, it was clear that dollars would be the only currency allowed for the purchase of oil. A primary impact of this decision is that nations desiring to import oil must have US dollars available for that purchase. They must manage their exports so that they receive dollars as payment. All nations except the US, that is. The US can just ‘print’ the dollars it needs, so it doesn’t need to manage its trade as tightly. In China, the nation with the most export to the US, its goods are paid for with dollars by the American companies like Wal-Mart. The company receiving the dollars turns them in at the local bank for the Chinese currency it needs to function within the national economy, the local bank in turn exchanges the dollars for RMB at the Chinese Central Bank. The Central Bank holds the dollars, literally hundreds of billions of them each year, because to spend them, to set them free into the global economy and thereby increase their supply, is to weaken the value each one represents. This is inflation, in other words. As long as China constrains the money supply, it is boosting the value of every dollar already circulating. Should we depend on China to keep the value of our own currency high?
China can’t, however, hold the dollars indefinitely. Its conundrum is how to best spend that money, always with an eye on maintaining its value. Its solution in recent decades has been to spend dollars to buy US debt, treasury bonds, IOUs that our federal government issues in order to borrow the money needed to cover our shortfall in revenue collection. This is the foundation of the circular logic that is boiled down in the idea: China funds US consumption by lending us the money we need to buy its products. China sees this use of its dollar holdings as beneficial because, if dollars spent anywhere are to have as small an impact as possible on the value of all dollars, then putting the money to work within the world’s largest national economy is most likely to achieve their goal. “Put the fish into the biggest pond, so they can hide more easily.” It is an admirable strategy, except for where it leads: An ever-increasing amount of US tax revenues are being paid to China, as interest, in its role as our lender. This is money that feeds their economy, not ours. It is money, representing our own workers’ labor, going to China and not to our local neighborhood or community. It is money that builds their infrastructure, not ours. It is money that creates their jobs, not ours. In effect, we are becoming increasingly indentured to China, ‘slaves’ if you will.
China also finds itself in the role of lender, needing to evaluate each loan transaction in light of the borrower’s ability to service the debt, pay interest, and to eventually repay the loan altogether. Of course, lenders don’t want to loan $1,000 today, if it is clear that by the time the borrower repays the $1,000, inflation will have lowered the value of that amount of money significantly, or even catastrophically. Their calculation of the likelihood of this erosion in real purchasing power is what determines the interest rate they demand for the use of the capital. If they consider the risk is high, they will only lend if the interest rate is high. Does it surprise you to know that China has been buying fewer US treasury bonds lately? In late 2009, when President Obama made his first visit to China flowing his election, he was pressured to explain how the US intended to fund its wars in Iraq and Afghanistan; China was concerned about the US just ‘printing’ money for these efforts, and thereby lowering the real value of the money we use to repay our debts, and of the money they already hold.
This concept is key: what happens when borrowers can’t find someone willing to loan them money for low interest rates? They offer to pay more in interest, until finally a lender decides that the now-higher rate is consistent with the risk the borrower poses, and makes the loan. If the US government offers bonds at the current, very low interest rates, and no one buys them, it is clear that they would have to increase the interest rates to find buyers for the bonds. Raising those rates would also raise interest rates charged on most loans within the US, including adjustable-rate mortgages and credit cards. As citizens are required to spend more to pay interest on their existing debt, they are unable to consume other goods and services, and our economy shrinks. Don’t forget, since 1970, real wages, adjusted for inflation, have fallen more than 30%; borrowing and multiple-income households have been the only way that has been hidden from sight. Spending more on interest means more unemployment, fewer dollars available to chase goods, an increasing need for government assistance to the poor and unemployed, and a greater need to borrow from lenders who are increasingly worried about our ability to repay and therefore demand higher interest… You get the point: this is a spiral that leads to no good ending anytime soon. Yet this is precisely why we find ourselves 3 years into this current, deep collapse (let’s not get sidetracked into determining which technical term: depression, recession or recovery, best describes our current crisis) with no end in sight. So now, in steps the Federal Reserve, using the last tool in their toolbox in an attempt to keep the economy from circling the drain the final few times. We are told that they will buy up bonds over the next several months in order ‘to keep interest rates down’. This is in fact, true. If they do not purchase the bonds, the US government will have to offer higher rates in order to find buyers. The Federal Reserve becomes the ‘buyer of last resort’ in other words, buying in order to keep rates low for all of us. We should celebrate this, except for the fact that the Fed doesn’t have $600 billion in a vault somewhere, aching to be spent. Instead, as is normal for our current fiscal paradigm, they will use a few computer keystrokes and the money will magically appear in the government’s bank account. The promise to repay the loan at some future date is all that is needed to ‘create’ the money. But this has the obvious, and previously mentioned, affect of making all dollars worth just a little bit less by increasing the supply. What are the immediate impacts of this? You are already seeing them, in the rise in the price of gasoline. Since dollars are the mandated currency for buying oil, and the oil producers know that the dollar is worth less today than it was yesterday, they demand more dollars for every purchase in order to come out even. Another way we can see this is with Thailand’s new tax on dividends and interest. Because interest is remaining low in the US, money seeking higher returns must go elsewhere. Thailand is seeing more and more money flow into its stock market from outside the country. The foreign money is buying local assets and buying stocks, and driving up the price of both. This has the unintended consequence of making it harder for Thai people to invest (or in many cases, even survive) due to the higher asset prices, and it also sets in place the fear that when the situation changes somewhere else, the money will suddenly flee the Thai market and chase after even higher return elsewhere. This could end up devastating the economy in Thailand, as assets are liquidated and prices fall, and the government sees the tax on profits as a way to make foreign investment less attractive. Not to mention, as the dollar falls in value, the Thai currency, the baht, becomes stronger and this increases the costs of their exports, damaging their export market today. These last two issues, money chasing return and export difficulties, are the core drivers of what the US media terms ‘currency wars’. As the dollar becomes weaker, every other country finds they must export more in order to have enough dollars to buy oil; at the same time as their own currency strengthens and becomes less able to compete in the export market. This is fueling the outcry around the world since the Federal Reserve’s quantitative easing announcement.
European countries have begun what are euphemistically called ‘austerity measures’. Really what they are doing is deficit-reduction, to use the phrase common in American political discourse. Budgets are being slashed, in order to avoid borrowing on the scale we see here in America. Those governments are unwilling or unable to borrow vast sums to allow continued spending, and the only alternatives are raising taxes or cutting spending. Apparently, feeling averse to paying for the goods and services provided by the government is a human condition, not just an American one. Since raising taxes to pay for services the taxpayers demand is out of the question, slashing costs is the only remaining choice they have. Witness the increasingly violent demonstrations in developed countries as welfare programs are dissolved, education costs rise, and government jobs evaporate, and then remember the food riots of 2008 as drought eats into food stocks in developing countries and food prices soar. Oh, that’s right, we don’t hear much about protests outside the US, and even when we do, it’s a 12-second sound bite on the news show or a three paragraph story on page 27 of the local newspaper, never enough to bring home the horror and tragedy of the economic travails of others. (To explain: September 29, 2010 saw millions of people protesting in nearly every European country, yet we heard nothing about it here. In early November, clashes between protestors and police in the UK, over cuts in government funding of education, turned violent.)
Here in America, we may finally begin to have a discussion about this, hence my desire to help people understand the landscape that will frame the discussion. A commission appointed to point the way out of the morass we call a tax system has just released the ‘terms of discussion’ that may or may not lead to radical, fundamental change. Why might fundamental change, not just another tax reform package like what we’ve seen in recent years, be necessary? Two thoughts come immediately to mind. First, in our current budget, military spending, interest on the national debt, Social Security and Medicare are all considered by politicians to be sacred cows; in other words, untouchable when spending cuts are being considered. Yet these programs constitute 88% of our spending, meaning that even if we cut every other government program, we would save a mere 12% of spending. Imagine, no more Justice Department or Supreme Court, no more Congress (OK, that might be a good thing!), no more FDA, FCC, education spending, EPA, you see the point. Second, why is cutting 12% not enough? It’s because in late 2010 we are borrowing 42% of what we spend. That’s right, the government’s income is only 58% of spending. And since we don’t control the decision to change the interest payments on the national debt, short of deciding to allow our debt to go into default, that particular 28% of the budget is truly untouchable. Equal reductions to the budgets of all other government programs, aside from interest payments, would amount to cutting every department budget by 58%. Across the board means: military? Cut by 58% Social Security disbursements? Cut by 58%. EPA? Cut by 58%. That is what it would take to get to a balanced budget, without raising taxes. Frankly, I find it nearly impossible to see how we can get to a balanced budget anytime soon; we need to look at what happens as we continue to borrow, and that is what scares me most.
At some point, and I am no more able to say how close that point is than you are, the government has to borrow so much, the Federal Reserve creates so much money out of thin air, that we enter a spiral known as hyperinflation. It begins with costs rising 30% a year, then 30% a month, and in the blink of an eye, people begin to use the paper bills to clean up after using the toilet, literally. There are historical examples of this, throughout modern history: stories of people paying for their meal before they sit down, because it will cost more by the time they finish eating. People using wheelbarrows to bring along the paper money needed to buy the day’s food. Governments printing one million dollar bills. I had one of those when I was a kid, it was hard to get my mind around a nine-digit figure back then. Unlucky me, that bill was as worthless then as it would be today, if things come to that.
One more point that I feel needs to be in the mix: government spending today; federal, state and local, makes up 45% of America’s Gross Domestic Product (GDP), the measure of the output of the economy. Health care makes up another 20%. This means that all the other businesses make up just one-third of our economy. And as anyone who has experienced a bonus plan at work knows, what you measure is what you get. Our formula for GDP includes costs for cleaning up after the oil spill, but there is no subtraction for the loss of wildlife, wetlands, or jobs that resulted as a consequence of the spill. It counts the cost of payroll at your work, but not the value provided by a mother who cares for her young children at home. It counts the cost when an oil company buys and imports petroleum from a country that funds terrorism, and it counts the cost of the security personnel that fight that terrorism. But what GDP does not measure, is our quality of life. It does not indicate if we might have better lifestyles if we were to stop sending US$1 billion dollars a day overseas, never to return, for oil. It does not measure the improvement in our well being when a family member or neighbor cares for us when we are ill. It does not track the improvement in our society when a bright child from an inner city ghetto gets the opportunity to attend college, the first in his family tree to do so. It does not measure the loss to society when someone has no health care insurance, and dies prematurely and unnecessarily because they knew they couldn’t afford the emergency room and stayed home.
As a culture, and as a supposedly caring society, we need to have a frank discussion about we desire from our selves, from our neighbors, and from our government. We cannot continue indefinitely, this paradigm of expecting lower taxes while at the same time, increasing government spending. The US Post Office, not a department of government but still required to get government approval for business decisions, just announced 2010 losses of over $8 billion. Its operational loss was just under $3 billion. It has requested an increase in the cost of postage, to raise its revenue in order to balance its budget, and Congress denied it. It requested to be able to close on Saturdays, to cut costs in order to balance its budget, and congress rejected that idea, too. This is symptomatic of how our government works today. The politicians offer “cutting waste” as the sum total of their ideas for balancing the budget. Raising taxes can’t even be discussed, enough legislators hold their breath until that idea gets tabled. Our only option is to borrow at the federal level, decimate our schools and programs that assist the increasing numbers of people in poverty at the state level, and close our parks and our homeless shelters at the local level. A person who works what we determine to be a “full-time” job must earn enough to support a family. Our children need to be educated. Someone who is ill needs medical attention so that they don’t spread a communicable disease or die from neglect. None of these issues are adequately addressed by our current financial system, a system that values corporate profits above Nature and above human life. Our discussion focus has to be on these issues. Can we bring democracy to the workplace: allowing workers to control what is made, when and where it is made, and what is done with the profits? By making decisions on the site where the work, and possibly the damage, is done, we care for what happens as a result of those decisions, and we tend to make decisions that support the environment and our neighbors. Decisions made far away, by people unattached to the outcome, tend to favor profit over people. Who says democracy, everyone having a say in collective decisions, can only operate in politics, not in economics? Isn’t the well being of our community, a better future for our grandchildren, and a beautiful, sustainable local ecology the profit we truly seek through our work? For business, and therefore society, to survive and prosper, we can only raise revenue, cut costs, or borrow. Today we refuse to raise revenue, we reject cutting costs, and we don’t understand the implications that arise from borrowing. This is a recipe for disaster of Titanic proportions. Say, can you move that chair, the one right next to you, right over here by me?