Saturday, June 6, 2009

Reservoir Going Dry

Regarding the ‘reservoir of wealth’ statement I made in my last article a reader asked a question via email which I will respond to.

There is a positive aspect to the immense reservoir of wealth I referred to in the sense of their being a large tranche of money in the hands of many Americans to help keep the economy afloat (even if just barely). However, on the negative side it will merely prolong the day of reckoning.

Another point that maybe wasn’t clear was that the mother of all bubbles refers to inflation and the crash of the dollar.

The US has been living way beyond its means because the dollar’s status as the world’s reserve currency exempts it from the hard choices that every other country has to make under the same spendthrift conditions. Every other country has to raise taxes, cut expenditures and generally tighten its belt. The US only has to print more dollars.

That exemption is soon to be sorely tested since the other countries who’ve been financing America’s debt are beginning to balk. China in particular has begun to fear for the safety of its trillion and a half dollars worth of US investments and rightly so since America’s debt binge is only intensifying in the desperate attempt to restore the old economy.

What a travesty, an embarrassment to see Obama and Geithner obsequiously reassuring China that it’s investments were safe, that America was interested in a strong dollar.

A lot of countries are talking of switching their assets, or parts of them, to more stable and possibly more universal currencies, once again presenting a great challenge to the dollar and the American economy.

A big part of the run up of oil prices last summer was the corresponding fall in the dollar, it hit a low of $1.60 to the Euro. The dollar then, almost counterintuitively, rose in value last winter. With economies crashing everywhere, the dollar seemed a relatively safe bet to many people and it went up to 1.25 to the Euro. That also corresponded to a fall in oil prices down to a low of about $35 per barrel.

Now the dollar is back down to $1.40 against the Euro and still falling and oil prices have surged back to near $70 per barrel. Oil’s rise is based on two other basic reasons besides the fall in the dollar.

One is the inexorable decline in reserves. The fact that oil is currently being used up at a slower pace than during the boom doesn’t change the reality that it’s being used up. China is still growing at 8%, India at 6%. Added together they have about 40% of world population. Since transitioning to a sustainable energy world is today 99% words and 1% deeds, they are doing their best to take up the slack in consumption (and resource depletion) created by the fall in demand in the developed world.

Finally the matter of speculation rears its ugly head. As long as the wealthy are flush they have to find somewhere to play with their money. As long as those types of transactions aren’t taxed, they can play to their heart’s content: to no one’s benefit but their own. If taxed, they would be more cautious and circumspect.

The stage is set for a steep rise in oil prices in the next two or three years.

First a very short description of monetarism; the guiding principal of American economic governance for decades now. Simply put: Inflation means the economy is growing too fast so you raise interest rates to slow it down and thus dampen inflation. High unemployment, which means the economy is in the doldrums, is countered by lowering rates.

The fact that the theory has failed miserably to describe actual events has not deterred its proponents one iota. The Clinton years were characterized by low inflation and low unemployment – wasn’t supposed to happen that way.

Before that during the Carter years there was high inflation and high unemployment, but that 1970’s inflation was caused by a spike in oil prices, not a roaring economy. One way the theory falls down is not recognizing that scarcity completely changes the price paradigm. If a time of inflation is not based in any way on an overheated economy, then raising interest rates can only make it worse.

Interest rates under Carter went up to 17% to counter soaring inflation, but the high rates were themselves fueling same. Maybe interest rates fluctuating between 2 and 6% would not have an effect on underlying inflation, but 17%, for sure.

So here’s the scenario: oil prices spike, triggering inflation, which in turn calls for high interest rates to counter it, which in turn batters the economy further. Meanwhile, the US government will need to raise fantastic amounts of money on the bond market to pay for monster deficits, as well as raise large amounts for bonds that have to be redeemed and refinanced.

To do that it will have to raise the rates it pays in order to entice buyers. They are already wary, so the rates may have to go relatively high. Higher rates also mean a lot more of the budget will need to be devoted to servicing debt. The only other alternative is to print money; either way a surefire recipe for inflation.

To begin to right the budget and the nation’s priorities, the first step has to be higher taxes, including heavy taxes on the wealthy and corporations. This will curb speculation and get the debt onto a manageable level.

It’d be perfectly ok to increase debt if it were going for alternative energies, electric vehicles and fast trains because those types of investments would shield the nation somewhat from higher fossil fuel prices to come.

Raising taxes as high as necessary to insure food, shelter and health care for all should also be a no-brainer. In real life the bankers get their trillions while homeowners facing bankruptcy get almost nothing.

So sorry, but America is addicted to the cheap fix of devil-may-care debt. There’s literally no chance the political establishment would even understand the imperative of raising taxes to tackle the budget deficit, let alone actually make it happen.

So what’s the prognosis? The US will muddle along doing its best to avoid reality until the next crisis, which will be of mega proportions. It will haughtily, arrogantly depend on belief in its own exceptionalism to imagine that it has a cosmic dispensation to be irresponsible without the burden of consequences. Bumpy ride ahead, folks.

1 comment:

Arié said...

In this context I suggest you to watch this film titled "Time to Break Up the Banks" giving some explanation
or read "Securitization: The Biggest Rip-off Ever"