The most worrisome thing about the vulnerability of the U.S. economy circa 2008 is the extent of official understatement and misstatement— the preference for minimizing how many problems there are and how interconnected they are.
This volume amplifies and updates two of the three challenges set out in my 2006 book, American Theocracy: The Perils and Politics of Radical Religion, Oil, and Borrowed Money in the 21st Century. Radical religion got much of its necessary comeuppance in November 2006. The perils of housing and debt, of oil, and of the dollar have, however, only increased.
Whether the U.S. government and the Republican and Democratic parties can remedy the debt- and oil-related transformations of the last two or three decades is dubious enough. Far more worrisome is the possibility that neither Washington nor Wall Street is willing to confront the deeper problem—the ascendancy of finance in national policymaking (as well as in the gross domestic product), and the complicity of politicians who really don’t want to talk about it.
Falling home prices are getting most of the attention now, with pessimists predicting the greatest plunge of our lifetimes. We are told that much of the risk comes from mortgage lenders who signed up too many bad risks. Under normal circumstances, such misjudgments would not be so numerous as to weigh so dangerously.
Ah, but this time there were huge institutional pressures to entice as
many customers as possible, reflecting the enormous profits to be made from taking mortgages and securitizing and repackaging them en masse in what became—most people now recognize these names—mortgage-backed securities and collateralized debt obligations. Lenders needed to woo high-risk borrowers for the good commercial reason that there weren’t enough low-risk borrowers to meet the volume demanded by the big commercial banks, investment fi rms, and other packagers, all pursuing the lucrative fees.
What’s securitization? some will ask. A pompous six-syllable word, to begin with, but also a humongous new business launched by Wall Street in the 1990s. To oversimplify somewhat, sophisticated financial institutions discovered gold in tying together five hundred or five thousand loans, mortgages, or whatever, and then selling fresh securities based and valued on the new assemblage. These securities, issued in pricey amounts, were cut into separate slices, or tranches (French, and suitably expensive sounding), according to degrees of risk. Sure, some of the slices had lower credit ratings, but risk could be spread out and the affected bits of patisserie sold more cheaply. In practice, however, there was less clarity and candor—sometimes considerably less. These ambitious financial organizations were not exactly the brokerages and First National Banks of our parents’ era. But that’s part of the staggering transformation, one of the greatest stories never really told. Between 1987 and 2007, debt—in all flavors, from credit card and mortgage to staid U.S. treasury and exotic Wall Street—became one of the nation’s largest, fastest-growing businesses. Over those two decades, so-called credit market debt roughly quadrupled from nearly $11 trillion to $48 trillion. This was abetted by a revolution in marketing, packaging, and propaganda—in reality, public debt wasn’t the big ballooner, private debt was. Without much publicity, the financial services sector—banks, broker-dealers, consumer finance, insurance, and mortgage finance— muscled past manufacturing in the 1990s to become the largest sector of the U.S. private economy. By 2004–6, financial services represented 20 to 21 percent of gross domestic product, manufacturing just 12 to 13 percent. And finance enjoyed an even bigger share of corporate profits.
“Risky” doesn’t begin to describe this new focus in the American economy. Bingeing on debt is reckless, and financialization has a long record of being an unhealthy late stage in the trajectory of previous leading world economic powers. Moving money around instead of making things is always dicey, and the U.S. transformation has been the most grandiose to date. Since the eighties, three forms of assistance have been sought from Washington (and generally provided): government bailouts when pivotal financial institutions, loans, or profit methodologies got themselves in trouble; liquidity from the Federal Reserve to keep the wealth escalators going; and benign regulation and lawmaking. Favoritism, it used to be called.
One of the myths of the last quarter century has posited a U.S. economy smoother, better run than before, and burdened with only a few minor recessions. That’s bunk. The official downturns—minimized, cynics say, by controversial federal statistics—can be queried on that basis. One section of chapter 3 takes a close look at the case that the federal CPI revisions begun a decade ago understate inflation and overstate growth in the U.S. gross domestic product. Other debatable federal decisions on employment and money-supply measurement also merit reexamination.
More about the need to suppress volatility during the same period can be gleaned from the hair-raising repetition of federal bailouts and financial rescue missions, as well as from the roller-coaster dips in interest rates as the Federal Reserve Board pumps the monetary pedals to save reckless financial institutions or reinvigorate deserving asset classes. Chapter 2 includes a short chronology.
In the meantime, of course, the debt bubble (mostly private debt) has been getting bigger—and then still bigger. Not a few experts consider this a flat-out menace; I concurred in 2006, and agree still more today amid signs that the great bubble blown up over a quarter century is starting to quiver and leak. These are not circumstances in which a nation should put faith in an overgrown and overextended financial-services sector, with its bankrupt mortgage lenders, hotshot hedge funds, and reckless megabanks, several of which (fined years back for colluding with a scheming Enron) wouldn’t know a civic obligation from a parking ticket.
Which brings us to oil—or the combination of petroleum and the embattled, oil-connected dollar—as the second perilous component of the twenty-first-century economy. One would think that with two former oilmen as president and vice president over the last seven years, these anxieties would have been brought under control, but obviously not. One essence of today’s crisis is that since the early 1970s, oil and the dollar have slowly changed from being powerful strategic enablers of the United States to being incipient strategic albatrosses. U.S. oil production peaked in 1971 and has declined since then, so that more than 60 percent of what is needed must be imported. The U.S. dollar, which was partly supported by gold until 1971, in 1974 became partly tied to oil. In return for a major oil price increase, Saudi Arabia and the Persian Gulf oil states unofficially agreed first to require that oil be paid for in dollars, and second to recycle much of the payment received back to the United States through investment in treasury debt.
This loose deal began to come undone in 2002 and 2003 as the United States maneuvered to invade and then did attack and occupy Iraq, at least in part to control Iraqi oil. The annoyed Saudis began cutting the amount of petroleum they shipped to the United States in 2002, and continued to do so after the United States took over in Baghdad. Between 2002 and 2004, the members of the Organization of Petroleum Exporting Countries (OPEC) reduced the percentage of their foreign-currency reserves kept in dollars from 75 percent to 61.5 percent. In the meantime, the OPEC nations abandoned their earlier $22- to $28-a-barrel price range for oil and by 2006 let an unfettered price climb over $70.
In consequence, as the costs the United States faced for imported oil ballooned, the value of the dollar swooned against major currencies like the euro and the pound. To be sure, more was involved than oil producers’ growing disillusionment with Washington. A thesis known as “peak oil”—the notion that oil’s finite production was close to a global peak, with shortages looming thereafter—gained considerable ground between 2002 and 2006 and played a role in rising prices. As Washington lost control over global oil affairs, the dollar began to move inversely with the oil price. Aggressive producers like Iran and Venezuela began selling their oil in euros and yen and urging OPEC to do likewise.
This transformation intensified during 2007, overlapping with the high-profile emergence of the housing, mortgage, and credit crisis. Both situations, I believe, related to what the United States in recent years had ceased to do—produce enough of its own manufactures and oil—as well as what it had started to do: fantasize about military and financial imperialism, about exporting mortgage-backed securities and collateralized debt obligations to a grateful world. Few miscalculations have been so tragic. Having written three books about history and political economics, for the election years of 2002, 2004, and 2006, I did not, back in early 2007, expect to write another volume for the upcoming presidential election year. Too little had changed. Besides, who wanted to keep up with the eighteen, twenty-three, or however many Democrats and Republicans who were running for president? George W. Bush would be replaced by somebody who was better, I assumed. I also feared that the winner would probably be elected without the serious national debate needed to position a new chief executive to confront the domestic and international problems bearing down like an express train.
Then came the economic eruptions of August 2007, with their timely confirmation—more evidence, yes, but also the smell of fear supplanting greed—of the economic realignment and unfortunate dynastic politics I had discussed in the three books. It was a tempting, even compelling pitch at which to swing another election-year literary bat. This is not a forecast of mayhem. Possibly the financial disorder expected by many—the forced economic deleveraging of a giant two-decade buildup of debt and liquidity—will come quickly and painfully over a year or two. But it also may occur slowly, the seriousness of its damage to the markets and households disguised by a decade of stagflation (as between 1973 and 1982). Nobody knows; I certainly don’t, and this book makes no prediction. Nevertheless, the nature of the crisis, as opposed to its probable duration, was defining itself. In which case, I hoped, the politicians and opinion molders would not be able to play another game of ostrich in the mode of 2000 and 2004. I could give it a try.
I had been following the scary intersection of oil, debt, and religion over the course of my last three books. In the introduction to the 2007 paperback edition of American Theocracy, I reviewed the stunning repudiation delivered to the religious Right in the November 2006 elections. The late-twentieth-century rise of radical religion and its role within the South and the Republican Party had the principal spotlight in the initial hardcover edition. But that November, controversies like evolution, abortion, sexual abstinence, stem cell research, the Schiavo life-support case, gay rights, and Republican church-state collaboration theology had come to the fore in high-profile statewide races in two swing states, Pennsylvania and Ohio. In both cases, extreme-seeming Republican nominees were beaten by three-to-two margins.
The economic predicaments simply got worse. Early 2007 brought no break points but several glimmers of excitement. Oil looked like it might hit $80 a barrel, the peak-oil theory seemed to prove out more each year, and rival petroleum-producing and petroleum-consuming nations—Russia, China, Iran, Venezuela, and others—had been emboldened by the embarrassment of the Bush administration. Moves to undercut Washington oil diplomacy or weaken the global primacy of the U.S. dollar cropped up everywhere. Some of this was high drama, but few high officeholders seemed willing to discuss it with the American electorate.
Housing, obviously, had become the lit fuse of a potential debt and credit explosion. Weak winter home sales and price data worsened with spring. Dozens of mortgage lenders were going out of business, and even the politics of the home-foreclosure charts demanded scrutiny. If Republican presidential prospects in pivotal Ohio hadn’t been sufficiently scorched in 2006 when voters rejected the party’s seeming merger with the local religious Right—the so-called Patriot Pastors— mortgage trauma bid to finish the job. Ohio and Florida, along with pivotal southwestern states like Nevada, Arizona, and New Mexico, found themselves on the front lines of U.S. home-price decline. That wouldn’t encourage voters to support another GOP president.
Let me underscore: except tangentially, this book is not about elections. It is about the insecurity of America’s future as the leading world economic power, given a debt-gorged and negligent financial sector, and the vulnerability caused by the nation’s expensive dependence on imported oil. Even readers of my last book may be surprised by the subsequent acceleration of events. These economic interests do have influential political constituencies—for oil, mostly Republican, and badly represented by the Bush dynasty. By contrast, links to the ascendant financial sector are bipartisan, and for the Democrats, increasingly tied to New York and the Clinton dynasty. These coalitions, ideologies, and inheritances are discussed in a small, introductory way in chapter 1 and at length in chapter 6. They are at the root of my skepticism that a new administration will be able to strike successfully at the two Gordian knots.
There’s also more than a little history involved. Were the United States the first and only leading world economic power, with no precedents or historical warnings available, the average American might be forgiven for thinking that (1) oil can be replaced by new energy sources during the 2010s with no real hegemonic consequences to the United States; (2) the evolution of the United States into a nation dominated by finance is nothing to worry about; and (3) the fact that finance overshadows other sectors may really be a hallmark of what will ensure success in the twenty-first century.
History argues otherwise. Those who have read American Theocracy may recall one chapter emphasizing how the three most recent leading world economic powers had special, almost idiosyncratic relationships with key energy sources—wind and water for the Netherlands, coal for Britain, and oil for America. The earlier two proved unable to maintain their global preeminence when a new energy regime emerged, and now Americans must worry. Collaterally, the fate of the U.S. dollar as the world’s reserve currency is doubly linked to its support by the Persian Gulf oil producers and its semiofficial role in international oil purchases.
As for the pitfalls of the domination of the United States by finance, both Wealth and Democracy and American Theocracy dwelled at length on the unnerving precedents of what that meant for the Dutch and British. Part of what Bad Money deals with that I have not touched on before is the financial sector’s massive use of private debt and leverage during the 1990s and then again in the first decade of the twenty-first century to expand its size, global reach, and extraordinary profitability. This is less a market-based Adam Smith brand of triumph than a mercantilist joint venture with U.S. government authority, strategic direction, funding support, and periodic Federal Reserve or U.S. Treasury bailouts of overextended financial institutions. This is certainly in keeping with the mercantilist flavor of policies gaining traction elsewhere in the world.
Some have labeled these apparent policies the “socialization of risk” or “Wall Street socialism.” I think a better explanation is that elements of the U.S. government decided, back in the late 1980s, that finance, not manufacturing or even high technology, had to be the sector on which Washington would place its strategic chips—would “pick as a winner” in the parlance of that era. Farms and factories were expendable, but certain banks and other financial institutions could not be allowed to fail. The coordinating body, handed its government franchise in 1988, following the October 1987 stock market crash, was the President’s Working Group on Financial Markets, built around the secretary of the treasury and the chairman of the Federal Reserve Board. Its existence has never been secret, only the record of its discussions and the nature of its occasional interventions in the financial markets.
Press coverage of the Working Group has clustered in three broad time periods: the 1997–98 Asian and Russian currency crises, the 2001 terrorist attack on the World Trade Center and its aftermath, and the revitalization of the group in 2006 under the chairmanship of Treasury Secretary Henry Paulson, followed by its mention from time to time during the August 2007 housing panic and credit maelstrom. Presumably these three periods were when the rumors were thickest and most credible. This book will not try to prove or disprove any particular backstage role played by the group; it will simply assume that a more or less visible hand of financial mercantilism favored (and helped to explain) the rise of the U.S. financial sector over the last two decades. This much, I think, must be true.
Making all of these risky gambits succeed is the global challenge that confronts American capitalism. In a sense, it confronts not only U.S. capitalism but the larger continuum of Western speculative and stock market capitalism that flowered in the Dutch Republic and then Britain, reaching its zenith in the recent U.S.-dominated financial heyday. Canada, Australia, New Zealand, and Ireland are also part of the same cultural economy, but in contrast to the British ascendancy after the Dutch and then the American succession, no new English-speaking power committed to that speculative brand of capitalism waits in the wings. Asian capitalism would be different: state capitalism, mercantilism, even Confucianomics, if, as seems likely, it turns out to be Chinese-dominated.
This is the transformation that may lie in wait behind the new skylines, stock and commodity exchanges, and sovereign wealth funds of Asia. And it could be especially painful if the vulnerable homes of the overmortgaged Anglosphere turn out to no longer be castles and moats of a no-longer-trusted brand of economic ideology.
Monday, May 26, 2008
The State To Which Our Leaders Have Brought Us