Bretton Woods has not worked well for a long time, despite the best efforts of the world's bankers to pretend that it has. As the charade continues, the economy of the United States and the composition of international trade has grown increasingly artificial and unsustainable.
The dilemma facing us now is what happens when the dollar hegemony finally breaks down and falls apart? Which countries will break ranks and begin offloading their dollar reserves in size into more tangible and less arbitrary stores of value, risking the value of their remaining reserves, in a classic Prisoner's Dilemma? Be assured that this is happening quietly behind the scenes, despite some of the recent financial engineering that has caused a dollar short squeeze, primarily in Europe.
More on this later. But first, here is a major plank in our construct so very well expressed by the classical economist Michael Hudson. What we are approaching is the failure of the Bretton Woods arrangement. How this is accomplished, how it unfolds, will shape at least next several decades of history and the fortunes of our generation.
"What happens in practice is that foreign central banks recycle the dollars that
their exporters and asset sellers receive because their currencies would rise if
they failed to do this. That would price their exports out of world markets,
leading to unemployment. Foreign countries thus are in a dollar trap.
They send their savings to finance the domestic U.S. Government budget deficit
instead of helping their own domestic economics, because they have not been able
to create an alternative to the dollar."
Our Trash for Your Cash
Bankers Shake Down Congress and the G-20
By MICHAEL HUDSON
The financial press has been negligent in reporting how last week’s two top financial stories are linked: first, the testimony by Treasury Secretary Henry Paulson and his evasive Interim Assistant Secretary Neel Kashkari defending why they followed a completely different giveaway plan to the banks (their own Wall Street constituency) than what Congress authorized; and second, the G-20 standoff among the world’s leading finance ministers this weekend.
The dollar glut is one of the key factors that has aggravated the junk-mortgage problem in recent years. Looking forward, if foreign countries are no longer to invest their dollar inflows in Fannie Mae, Freddie Mac and toxic packaged mortgage derivatives, what are they to do with these dollars? The U.S. Government refuses to let foreign government funds acquire anything but financial junk such as the plunging Citibank shares that Arab oil sheikhs have bought.
Here’s the problem that faced global finance ministers this weekend: The U.S. payments deficit has been pumping excess dollars into foreign economies, whose recipients have turned them over to their central banks. These central banks have saved their currencies from rising (and thus losing foreign markets by making their exports more expensive) by buying Treasury bonds so as to support the dollar’s exchange rate by recycling their dollar inflows back to the United States – enough to finance most of our federal budget deficit, and indeed much of Fannie Mae’s mortgage lending as well.
Mr. Bush for his part would like to shape the global financial system so that foreign economies continue giving the United States a free lunch. U.S. officials control the International Monetary Fund and World Bank and use these institutions to impose neoliberal privatization policies on foreign countries, thereby destroying the post-Soviet economies, Australia and New Zealand since the 1990s, just as they destroyed Third World economies from the 1960s through the ’80s.
That’s why, until last month, the IMF had lost its clients and was almost universally shunned. French President Nicolas Sarkozy led foreign calls for a “new Bretton Woods,” by which he meant not just an upgrading of U.S. dollar hegemony but a different world order – more regulated with a fairer quid pro quo. And as the Financial Times reported: “Spain’s governing Socialist party summed up the heady mood in some parts of Europe in an internal document, seen by El Mundo, that identified the summit as a moment of historic change. ‘The origins of this crisis lie in neoliberal and neoconservative ideology,’ it said.”
Mr. Paulson and other U.S. officials have long been promising foreign finance ministers that Fannie Mae and Freddie Mac securities are as good as U.S. Treasury bonds while yielding higher interest. The resulting investment in these two mortgage-packaging agencies was a major factor in their $200 billion bailout. Letting their securities go under would have ended Dollar Hegemony for good. So getting foreign acquiescence in financing future U.S. balance-of-payments deficit is inextricably bound up with how to resolve the U.S. financial and real estate bubble.
Its bursting has prompted Congress to authorize $700 billion supposedly to re-inflate the property market. The Troubled Asset Relief Program (TARP) gives Wall Street money in the hope that it will lend enough to start inflating asset prices again, enable borrowers to get rich by going into debt again – “wealth creation” Alan Greenspan-style. It is as if the neoliberal bubble years 2002-07 were a golden age to be recovered, not the road to financial perdition. In doing this, Mr. Paulson is using junk economics to cope with the junk mortgage problem that in turn was based on junk mathematical models. His problem is to keep the fantasy going.
Congress has caught onto the game being played. Now that the bailout looks like a last-minute giveaway to insiders while the giving is good, Congress held hearings last week to ask why the Treasury abandoned its plan to buy the “troubled assets” (junk mortgages) that Mr. Paulson had originally said was the problem. Why has the Treasury bought $250 billion of ersatz “preferred common stock” in banks at prices far above what private investors such as Warren Buffett paid?
Drawing a picture of a just-pretend world to rationalize Wall Street’s free lunch, Mr. Paulson sought to deflect the issue by postulating a series of “ifs.” The Treasury’s $250 billion in bank stock would give lenders money that might be used to re-inflate the credit supply if banks chose to re-enter the commercial paper market and provide more mortgages on easier terms. This trickle-down patter talk is what passes for neoliberal economic theory these days. The fantasy is for banks to restore “balance” by granting more credit, increasing the indebtedness of bank customers so as to restore the housing market to its former degree of unaffordability.
Congressional interrogators pointed out that banks were not lending more money. Mortgage interest rates have risen, not fallen, even though the Fed is supplying banks with credit at only a quarter of a percentage point (an average of about 0.30 per cent last week). Credit standards (understandably) have been tightened to require prospective buyers to put up more of their own money. Foreclosures and evictions are up and real estate prices continue to plunge. Also plunging almost straight down has been the Dow Jones Industrial Average, sinking below the 8000 mark last week to the lowest levels in years. Nothing is working out the way Mr. Paulson promised.
The word being used most by Treasury officials these days is “unexpected.” At his subcommittee hearing on Friday, Nov. 14, Dennis Kucinich asked Mr. Paulson’s sidekick, Neel Kashkari, whether the Treasury’s lack of realistic foresight was an innocent error or a case of bait and switch. Mr. Kashkari stonewalled by repeating a “talking point” loop-tape claiming that giveaways were the way to get the economy “moving” again. The banks would use their newfound power to help customers run back into debt even more deeply, presumably at the exponential rates needed to re-inflate property and stock prices
Republican Congressman Darrill Issa asked just when the Treasury decided to dump the law as written and pursue an alternative giveaway to Wall Street rather than help defaulting homeowners. Why hasn’t it done what the law that Mr. Paulson himself insisted that Congress agree to – arrange orderly debt write-downs by using the promised $50 billion of public money to buy mortgages headed for foreclosure, and re-set unrealistically high mortgages to reflect current price levels? Renegotiating bad mortgages down to this price for existing owner-occupants – or selling the property to a buyer who could afford fair terms – would avert the distress sales that are poisoning local property markets Isn’t this what the Congressional plan called for, after all?
Mr. Kashkeri kept trying to run out the time clock by explaining rote Treasury procedure. He assured the committee that he worried each night about the fate of homeowners, and said that Mr. Paulson also was wringing his hands in empathy, but they had found it much better to give money to the banks in the hope that they would show similarc concern for their customers. The committee members simply gave up when it became apparent that the Treasury officials were stonewalling, just as the Fed has stonewalled Congress by refusing to give any details of the $850 billion giveaway it’s been conducting under its own cash-for-trash program. On November 12, Mr. Paulson gave his excuse: “We changed our strategy when the facts changed.”
What were these facts? For starters, the Federal Reserve found that it was able to pump an even larger amount into the “cash for trash” program than the Treasury originally was to have provided. The Treasury plan would have obliged the banks to take a loss by selling their “troubled assets” (junk mortgages) at today’s post-bubble prices. Bankers don’t like to take losses. That’s what the government is supposed to do. The Fed can do anything it wants in order to “stabilize markets,” under an umbrella clause inserted into its Act for just such purposes. Applying the “privatize the profits, socialize the losses” rationale that bank lobbyists have polished over the past century, it has decided that the best way to “stabilize the economy” is to swap Treasury bonds for high-risk junk assets at face value, saving the banks from having to take a loss.
The more wealth that is concentrated at the top of the economic pyramid and the more banks that can be consolidated into just a market-setting few, the more “stable” markets will be. This is the neoliberal economic doctrine used to justify the Fed’s purchase of junk mortgages, junk bonds and the bad gambles in insuring derivatives that A.I.G. had drawn up. One can only conclude that Mr. Paulson was knowingly deceptive when he told Congress on November 12 that the government has found a better way for the giveaway to trickle down from the banks to the credit markets than to buy their bad loans. It has indeed been doing just this, but via the Fed at full price and in secret, away from the prying eyes of Congress rather than through the Treasury program that Congress authorized under more current market-oriented terms intended to protect “taxpayer interests.” The Fed values junk mortgages at the high fantasy prices that banks, A.I.G. and other companies had bought them for, saving them from having to take a loss. Hedge funds and speculators who had bought junk-insurance from A.I.G. were made whole, and A.I.G. stockholders were saved by the infusion of government capital so that players would not have to take losses in the Wall Street casino.
Now that the Fed is doing this, the Treasury can turn to its own form of giveaway: buying bank stocks at far above their market price (that is, the price paid by investors such as Warren Buffett for Goldman Sachs stock), on terms that permit the banks to turn around and use the money to buy other banks, pay out as dividends to shareholders or pay high executive salaries rather than helping mortgage debtors. “I don’t think the government should put money into failing institutions,” Mr. Kashkari assured Congress, explaining that the bailout of A.I.G., Fannie Mae and Freddie Mac would be in vain without yet further government bailouts. Rep. Kucinich’s final remark to Mr. Kashkari was: “That statement that you just made, you will hear about for the rest of your career.
The internal contradiction here is that why the Republican logic of breaking up Fannie Mae and Freddie Mac into smaller companies does not apply to the commercial banking system. Rather than consolidating the banking system in the hands of New York and East Coast banks, why shouldn’t the government break up financial institutions “too big to fail?" Instead, the Treasury is simply investing in stocks of banks, leaving existing stockholders in place rather than wiping them out.
Mr. Paulson under George Bush in 2008 is looking like the U.S. counterpart to Anatoly Chubais under Boris Yeltsin in 1996. Just as Russian neoliberals led by Chubais were promoted by Clinton Treasury Secretary Robert Rubin of Goldman Sachs, today’s Wall Street power grab to replace the government as the economy’s central planner is being orchestrated by another Treasury Secretary from Goldman Sachs, empowered to decide which kleptocrats are to receive what public resources and on what terms, aided by “Helicopter” Ben Bernanke at the Federal Reserve. Mr. Bernanke’s famous quip about helicopters dropping money to get the economy moving seems to be limited to Wall Street for use in buying financial assets, not real goods and services for the population at large.
The road to G-20
Speaking on Thursday, November 13, before the Manhattan Institute, a lobbying organization for finance and real estate, President Bush repeated the myth that foreign countries recycle so many dollars to America because of our “strong economy” and free markets.
The reality is quite different. There is no such thing as a “free market.” For a few days after announcement of the $700 billion giveaway, some knee-jerk opponents of government spending accused this of being “socialism,” but they quickly discovered that not all government spending is socialist. Regardless of what economic system is followed, all markets are planned, and have been ever since calendars were developed back in the Ice Age. Most market structures throughout history have been organized in a way that provides the vested interests with a free lunch. This remains the essence of post-feudal capitalism – or as some have expressed it, corporativism.
What happens in practice is that foreign central banks recycle the dollars that their exporters and asset sellers receive because (as noted above) their currencies would rise if they failed to do this. That would price their exports out of world markets, leading to unemployment. Foreign countries thus are in a dollar trap. They send their savings to finance the domestic U.S. Government budget deficit instead of helping their own domestic economics, because they have not been able to create an alternative to the dollar.
Next to Treasury debt, real estate mortgages are the only category large enough to absorb the excess dollars being thrown off by the U.S. payments deficit – thrown off, that is, by U.S. military spending abroad, consumer spending to swell the trade deficit, and investment outflows as investors here and abroad diversified their holdings outside of the United States. The upshot is that world monetary reserves have come to consist of central bank loans to finance the U.S. bubble economy. But the knee-jerk deregulatory philosophy of the Clinton and Bush eras has killed the U.S. investment market.
What makes this dynamic unstable is that U.S. exports become even less competitive as higher housing costs and debt-service charges push up the cost of living and doing business. The more dollars foreign countries recycle, the less the U.S. economy will be able to work off its debts by exporting more. So the dynamic is guaranteed to be a losing game for foreign governments – unless anyone can explain how the United States can generate the $4 trillion to repay its debt to the world’s central banks. To make matters worse, the dollar’s downward drift against the euro and sterling obliges foreign creditors to take a loss on their dollar holdings as denominated in their own currencies.
Nobody has found a “market-oriented” solution to this problem. That is what doomed the G-20 meetings this weekend to failure, just as there could be no agreement at the G7 meetings a few weeks ago. In the face of U.S. Treasury dreams of re-inflating the mortgage market, Europe is trying to draw the line at financing a losing proposition.
But now that gold no longer is the means of settling balance-of-payments deficits, foreign central banks lack an alternative to the U.S. dollar to hold their monetary reserves. This leaves them with (1) U.S. Treasury securities, and (2) U.S. mortgage securities. Recent years have seen a further diversification via “sovereign wealth funds” into (3) direct ownership of mineral resources, industrial companies, privatized national infrastructure and other equity investment rather than debt. But rather than welcoming this, the U.S. Government seeks to limit foreign central banks to buying junk mortgages, junk bonds and other financial garbage. To call this “market equilibrium” is to indulge in the feel-good argot that fogs today’s international financial dialogue.
To put matters bluntly, the issue at the G-20 meetings is mistrust of the unregulated U.S. banking system and, behind it, government “regulators” who refuse to regulate. China and other foreign dollar recipients have been treating the dollar like a hot potato, trying to spend it on buying foreign minerals, fuels and other assets from any country that will accept payment in dollars. Most of the takers are third world countries still committed to paying the heavy dollarized debts owed to the World Bank and other global creditors. The price of their remaining in the Bretton Woods system is to sacrifice their public domain in a kind of pre-bankruptcy sale rather than repudiating their debts under the “odious debt” and “fraudulent conveyance” escape valves. What is needed is not to “reform” the World Bank and IMF, but to replace them. But that is another story, one that other countries dared not even bring up at the November 15-16 meetings.
Euroland is officially in a recession for the first time since the birth of the single currency. Part of the reason is that its member countries have felt obliged to use their monetary surpluses to support the dollar – and hence, the U.S. Treasury’s budget deficit – instead of supporting their own domestic economies. Just before flying to America this weekend, French President Nicolas Sarkozy announced his position: “‘The dollar, which at the end of World War II was the only world currency, can no longer claim to be the sole world currency … What was true in 1945 can no longer be true today.’” Stating this fact was not a matter of ‘courage,’ but ‘good sense.’” Italian Prime Minister Silvio Berlusconi made a point of defending Russia, criticizing the US for “provoking” Moscow with its missile defense shield. But Mr. Paulson insisted that the global financial crisis was “no nation’s fault.”
U.S. officials chose to brazen it out, including a new wave of American protectionism for the auto industry in what may be a foretaste of economic nationalism to come. “Bankers complain that the financial rescue plans put in place in many countries distort competition because they operate on very different terms while others say that the bail-outs under consideration for U.S. carmakers represent a classic effort to protect national champions that could inspire copycat efforts elsewhere.”. So wrote Krishna Goha in the Financial Times, describing why, when G-20 finance ministers reaffirmed their support for free trade, they were talking largely at cross-purposes.
The past eight years have demonstrated the folly of imagining that the stock market and real estate can provide steady rates of return that compound into exponential increases in savings sufficient to pay retirement income and make homeowners and small investors rich without really having to work. Money managers advertise “Let your money work for you,” but only people actually work. Financial returns are paid in the form of command over labor power – workers “doing time.” What banks do provide is debt, and this remains in place after the force of asset-price inflation is spent and market prices fall below liabilities to cause Negative Equity. That is how economic bubbles operate. But to hear Wall Street’s neoliberals tell the story, it is not necessary to pay retirees out of what is produced. Finance capitalism can replace industrial capitalism without a “real” economic base at all.
Who Really Gets the “Free Lunch”?
So much for the material conditions of production! We can all live free as financial engineering replaces industrial engineering. The Treasury is now reported to be discussing bailouts for credit card issuers by taking over their bad debts. The banks presumably would even be able to charge the government for the accumulation of exorbitant penalty fees.
The banks and Wall Street are threatening to wreck the economy by “going on strike” and creating a credit squeeze forcing foreclosures and economic collapse, if Congress and the Federal Reserve don’t save them from taking a loss on their bad loans and financial derivatives. Foreigners also must play a subordinate role in this game, or the international financial system itself will be collapsed. Financial customers must absorb the loss.
The most reasonable response to this brazen stance may be to return the Federal Reserve’s monetary functions to the U.S. Treasury. This is where they were conducted with great success prior to 1913. Back in the 1930s the “Chicago Plan,” put forth in the wreckage of the banking system’s and Wall Street misbehavior that aggravated the Great Depression, proposed to turn commercial banking into classic-style savings banks with 100 per cent reserves. A modernized version is put forth in the American Monetary Institute’s proposed Monetary Reform Act as an alternative to the dysfunctional high finance that Wall Street lobbyists have created as a Frankenstein debt-selling machine. The U.S. economy has been living on a combination of foreign dollar recycling and bank credit that has been used simply to “create wealth” by inflating asset prices, not by financing new capital formation.
As matters have turned out, the banks have gone broke doing this. The Treasury has given them trillions of dollars of aid, and even more as special tax favoritism, loan and deposit insurance guarantees. This can only continue as long as banks can make the inevitable collapse of compound interest schemes appear to be unthinkable. That attempt is what doomed the G-20 meetings this weekend, and it will doom any future U.S. administration that tries to follow in its footsteps.