Friday, August 5, 2011

Flirting with the Great Depression 2.0

By Alan Caruba

POLITICO Breaking News:
August 5, 2011

“Credit rating agency S&P has downgraded U.S. debt from AAA, the first debt downgrade in U.S. history, the Associated Press reported.”

When a nation’s debt equals its entire annual gross domestic product, it is bankrupt. It can still produce goods and services, but it will likely encounter fewer customers worldwide as they too are drawn deeper into their own debt crises.

When it must borrow billions daily just to meet its obligations to other nations and individuals who have purchased its treasury notes, it is has reached a point of “moral hazard” that threatens the wealth of every single citizen.

When it raises its “debt ceiling” to $14.58 trillion, the amount its Congress permits, and one day later its Treasury Department announces that its debt reached 100% of its GDP, it is in serious financial difficulty. Not since 1947 when the U.S. was recovering from the cost of World War II have we reached this point.

The nasty “debate” in Washington over the debt ceiling included the Republican demands that we reduce our spending and Democrat demands that we raise taxes. Those advocating sanity were called “terrorists” and “extremists.” The shallow reductions agreed to were stretched over ten years and barely begin to address the immediate financial crisis. Harder decisions were pushed off on a "super committee" that no one expects to agree on anything.

This news is bad enough for the United States of America, but it affects many other nations around the world in exactly the same way the Crash of 1929 did, leading to the Great Depression of the 1930s and putting in motion the events that led to World War II.

Does history repeat itself? Apparently so.

What is happening in America is happening around the world. Greece, a nation of 11 million people, had by 2009 managed to run up its debt to more than $500 billion. Its fellow members of the European Union took notice even though Greece accounted for only two percent of the EU’s economy. A year earlier, the tiny nation of Iceland, population 300,000, had literally bankrupted itself when its debt went from $8 billion in 2001 to more than $48 billion in 2007.

On September 29, 2008, the Irish cabinet held an emergency session by phone because the implosion of its housing market threatened to bring down its financial system. To avoid a bank run, it guaranteed all deposits and, not long after, England did the same thing.

Many people find history boring, but it does provide lessons and what America and its lenders all face is the potential for The Great Depression 2.0. The gyrations on Wall Street and worldwide are evidence of global fears.

In America, the Congress merely applied a band-aid to a gaping wound, the result of the “solutions” instituted during the Great Depression of the 1930s, the entitlement program of Social Security and, in the 1960s, the addition of Medicare. In the 1930s, the federal government guaranteed mortgages by creating Fannie Mae and later Freddie Mac.

When the financial crisis arrived in 2008, they owned half of all the mortgages issued by the nation’s banks. The government was forced to step in and seize both “government sponsored entities” to avoid bringing down the nation’s financial system. At the same time, it agreed to buy up the “toxic assets” owned by a number of banking firms and by the insurance giant, AIG. Billions in public funds were allocated to this.

There probably was no alternative.

In the same way the government in the 1930s initiated all manner of programs to put Americans back to work, the Obama administration created a “stimulus” program while, at the same time, taking ownership of Chrysler and General Motors. The Federal Reserve reduced interest rates close to zero, lending banks and nations billions. By contrast, during the Great Depression the government had allowed hundreds of banks to fail which, in hindsight, contributed the nation's ills.

Franklin D. Roosevelt had been elected to end the Depression, but after nearly eight years of the New Deal has passed, FDR’s Secretary of the Treasury, Henry Morgenthau, Jr., addressed the House Ways and Means Committee on May 9, 1939, to say, “We have tried spending money. We are spending more than we have ever spent before and it does not work.” Unemployment remained high and would remain high until World War II intervened in 1941.

Much has changed since the 1930s, but much has not.

In 2010, power in the House of Representatives was returned to the Republican Party, but the debate over the debt ceiling revealed the difficulty it had marshalling support for raising it. Many new Tea Party caucus Representatives opposed it. Others argued that only massive spending cuts could remedy the growth of the nation’s debt. In the Senate, controlled by the Democrat Party, any deal that did not include raising taxes was dead on arrival.

Other than the so-called “stimulus” programs, the President devoted all of 2009 to legislation dubbed Obamacare that would have created a government takeover of twenty percent of the nation’s economy. By May 2010, a million people marched in Washington, D.C. to protest it. It has since been repealed in the House and has 26 States allied against it in the courts.

In the 1930s, efforts to keep the world’s economy from imploding found little political support for the measures needed to sustain an integrated world economy. In the modern era of globalization, the same problems have been encountered and, sadly, the United States has shown little taste for reducing its spending as it continues to borrow until, at some point, other nations decide to put their money elsewhere. So far that has not happened.

The United States’ financial future is in peril without a significant downsizing of the federal government and the international economy faces similar challenges as nations share similar debt levels that exceed their ability to meet their obligations.

It will take a minimum of a decade to meet the USA’s present need to reduce spending and reduce the burden of its borrowed debt. Let us hope the voters in 2012 take the first steps toward the political resolve needed by returning power to the Republican Party in the Senate and the White House. Then let us hope they show real political courage.

Let us hope it doesn’t take another world war to focus our attention on survival of a different kind.

Editor’s Note: This commentary was greatly aided by data in the “Lost Decades” by Menzie D. Chinn and Jeffry A. Frieden, recently published by W.W. Norton & Company.

© Alan Caruba, 2011


Harry Dale Huffman said...

I consider your last sentence an increasingly faint hope. The Insane Left (as I have learned to call it) has priced itself out of the marketplace of ideas, and even the Right thinks its traditional answers are sufficient, even though it is quick to point out itself that the USA didn't come out of the first "Great Depression", until World War II exploded the old order in countries around the world. And today science is stagnant and even deeply incompetent, as shown in the "global warming" debacle (and the preceding "Intelligent Design" debacle, which was a clear loss for our collective reason) and in science's vicious attacks on any who dare to criticize it, however cogently. Technology cannot be expected to explode in our favor as it did before, because science (as distinguished from technology) has not progressed as it should have, over the decades since World War II. There is no general reserve of true forward thinking, and forward learning, as preceded WWII, as science has become merely algorithmic (the scientific counterpart of ritualistic). This time around, it is ALL about mankind's addiction to unrealistic, inevitably divisive, and religiously-held dogmas, across the board. A greater power is showing mankind what children we all are, in the face of the greater reality that must play out (however it will in fact play out).

J Johnston said...

I see where banks are now charging customers fees to deposit money in their bank. This will probably start off being limited to large deposits and trickle down to include fees on your deposits and my deposits. We used to deposit money in a bank and receive interest. We now are going to deposit money in a bank and pay interest? Yes, that is negative interest. The up side to this; the profit motive still works. A large depositor puts money in a bank and the bank pays him say 5% negative interest. This means I can go down and apply for a mortgage and get a 3% negative interest rate. Great! I will now pay back less than I borrowed. The bank will have made 2% real profit.

Somewhat along the same line of reasoning there is a rumor going about that indicates proposed legislation is being studied for the ramifications of charging a 1% fee on all financial transactions. Your SS check is direct deposited...... a 1% fee comes out. You use some of your SS money to buy a new suit...... a 1% fee comes out. You treat your wife to dinner...... a 1% fee comes out. This will not be so bad since there will be a nonrefundable tax credit given to off set the first $2000 in fees.

What the hell is everyone worried about?....... this is all going to work out, don't you think?

TexasFred said...

Monday could very well be the most decisive, or destructive day in the history of American finance...

The Great Depression in 1929 was bad, but the USA wasn't inundated with ILLEGALS of all ilks... We weren't inundated with TAX cheats and welfare slugs...

When the illegals, cheats and slugs miss their 1st unemployment, Social Security or welfare check, they will all be raising hell...

This could get VERY ugly... And bloody...

Alan Caruba said...

Actually, the market has undergone a "correction" which will make many stocks more attractive and is a normal part of life on Wall Street.

For what it's worth, I do not see any rioting in the streets. Most Americans seem too lethargic at this point to do anything at this point. And the gov'mint will continue to send out 80 million checks. It has the money. Or it can print it!

Rich Kozlovich said...

The left isn't really out of ideas. You have to have had some in the beginning. Let's not confuse the liberals of today with what is referred to as classical liberals of the beginning of the last century. Republicans of today would more readily fit the original definition of a classical liberal. The left, especially the greenies only have criticisms, they have no solutions.

Everything they impose only makes everything worse, while using the values of society against us with rhetoric that is designed to engender guilt in order to justify larger more intrusive government.

They constantly demand a mythical perfection that they say can only be created by government which must impose it on society. When in reality the best any society can hope for is the most acceptable imperfection. And when their policies are imposed on an unsuspecting society what they end up with is dystopia.

Let’s take two areas as an example:

How do we fix education? Ask a liberal and he says raise teacher’s salaries and give unions more control. Ask a conservative. He says allow competition.

How do we fix our energy problems? Ask a liberal and he says use food as an energy source, wind, and solar. Ask a conservative and he says drill!

In just these two areas alone, which does anyone think will work? The liberal solutions have consistently been failures….so they embrace these failures of their own creation because they have no real solutions. The conservative solutions actually have been successful so the liberals hate it. They hate it because it doesn’t create a society enslaved by bureaucracy.

They must be insane.

Unknown said...

Excellent, thoughtful post.

Unknown said...

In addition to our enormous fiscal problems is that our infrastructure is a wreck. Our industry is non-existent or non-competitive for whole sectors. What remains of our economy is based on cheap oil. We are far less competitive and far more vulnerable than we were in the 1930s. Only smoke and mirrors will save our economy from catastrophic implosion.

Alan Caruba said...

@Unknown: The US has a strong agricultural sector and can hold its own with pharmaceuticals, high tech innovation, etc. We have, however, lost many manufacturing firms. It is hard to compete with low wages paid to Asian workers, etc. Auto manufacturers in right to work Southern states (foreign owned) are doing well, too.


Excellent post. I agree Alan that the USA still has some aces in the hole as we have abundant fresh water and a strong agriculture. We still have abundant resources but will we use them? We still have some competitve areas as you mentioned but gradually we are losing out in almost every area for manufacturing. I was struck by the fact, while at recent Bizmart, that almost all the pens were made abroad -even the Sanford pens and even the Cross pens and their refill cartridges. Some pencils were still made in the USA but ceding the entire market of pens cannot be good for the nation or its employment.

LarryOldtimer said...

Alan, I greatly fear that all hope is gone.

There are a large number of financial holding companies, including retirement funds, which have by-laws which prevent said companies from holding securities with less than an AAA rating. Matter of fact. AA+ simply isn't allowed.

So then, how can those companies divest themselves of securities with a not-allowed AA+ rating, and replace said securities with AAA rated securities?

LarryOldtimer said...

Alan, the projection of the amount of agricultural production is a well-before planting time report (required by federal law)of the intention of what the farmers intend to plant, and how many acres of each crop planned to be planted.

I saw a very recent report on an agricultural channel of how existing crops are doing. Dated about Jul 25th. Having been a farm lad myself, the adage was that corn had to be "Knee high on the 4th of July". The corn plants that were shown were far, far lower than that in size.

I would have to think that those projections by farmers in the fertile Mississippi Valley were before tens of thousands of square miles of fertile farm land were well underwater.

Both corn and soya beans are well behind usual schedules for size. This bodes not well for the autumn harvest this year in this nation.