How the Economy Was Lost


The American economy has gone
away.  It is not coming back until free trade
myths are buried six feet under.

America`s 20th century economic
success was based on two things.  Free trade
was not one of them.  America`s economic
success was based on protectionism, which was
ensured by the Union victory in the

Civil War
, and on British indebtedness, which
destroyed the British pound as world reserve
currency.  Following World War II, the US
dollar took the role as reserve currency, a
privilege that allows the US to pay its
international bills in its own currency.

World War II and socialism
together ensured that the US economy dominated the
world at the mid 20th century.  The economies
of the rest of the world had been destroyed by war
or were stifled by socialism.  

The ascendant position of the
US economy caused the US government to be relaxed
about giving away American industries, such as
textiles, as bribes to other countries for

cooperating with America`s cold
war and foreign policies. For example, Turkey`s US
textile quotas were increased in exchange for
over-flight rights in the Gulf War, making lost US
textile jobs an off-budget war expense. 

In contrast, countries such as
Japan and Germany used industrial policy to plot
their comebacks.  By the late 1970s, Japanese
auto makers had the once dominant American auto
industry on the ropes.  The first economic act
of the "free
market"
Reagan administration in 1981 was to put
quotas on the import of Japanese cars in order to
protect Detroit and the United Auto Workers.

Eamonn Fingleton, Pat Choate,
and others have described how negligence in
Washington DC aided and abetted the erosion of
America`s economic position.  What we didn`t
give away, we let be taken from us while preaching a
"free trade"
doctrine at which the rest of the world scoffed.  

Fortunately, our adversaries at
the time, the Soviet Union and China, had unworkable
economic systems that posed no threat to America`s
diminishing economic prowess. 

The proverbial hit the fan when
Soviet, Chinese, and Indian socialism collapsed
around 1990, to be followed shortly thereafter by
the rise of the high speed Internet.  Suddenly,
American and other first world corporations
discovered that a massive supply of foreign labor
was available at practically free wages.  

To get Wall Street analysts and
shareholder advocacy groups off their backs, and to
boost shareholder returns and management bonuses,
American corporations began moving their production
for American markets offshore.  Products that
were made in Peoria are now made in China.  

As offshoring spread, American
cities and states lost tax base, and families and
communities lost jobs.  The replacement jobs,
such as selling the offshored products at Wal-Mart,
brought home less pay.

"Free market
economists"
covered up the damage done to the US
economy by preaching a New Economy based on services
and innovation.  But it wasn`t long before
corporations discovered that the high speed Internet
let them offshore a wide range of professional
service jobs.  In America, the hardest hit have
been software engineers and information technology
(IT) workers. 

The American corporations
quickly learned that by declaring
"shortages"
of skilled Americans, they could get from Congress
H-1b work visas for lower paid foreigners with whom
to replace their American work force.  Many US
corporations are known for forcing their US
employees to train their foreign replacements in
exchange for severance pay.

Chasing after shareholder
return and "performance bonuses," US corporations deserted their American
workforce.  The consequences can be seen
everywhere.  The loss of tax base has
threatened the municipal bonds of cities and states
and reduced the wealth of individuals who purchased
the bonds.  The lost jobs with good pay
resulted in the expansion of consumer debt in order
to maintain consumption.  As the offshored
goods and services are brought back to America to
sell, the US trade deficit has exploded to
unimaginable heights, calling into question the US
dollar as reserve currency and America`s ability to
finance its trade deficit.

As the American economy eroded
away bit by bit,
"free market"
ideologues produced endless reassurances that
America had pulled a fast one on China, sending
China dirty and grimy manufacturing jobs.  Free
of these "old
economy"
jobs, Americans were lulled with
promises of riches.  In place of dirty
fingernails, American efforts would flow into
innovation and entrepreneurship.  In the
meantime, the
"service economy"
of software and communications
would provide a leg up for the work force.  

Education was the answer to all
challenges. This appeased the academics, and they
produced no studies that would contradict the
propaganda and, thus, curtail the flow of federal
government and corporate grants.

The
"free market"
economists, who provided the propaganda and
disinformation to hide the act of destroying the US
economy, were well paid.  And as Business Week

noted
,
"outsourcing`s inner circle has deep roots in GE
(General Electric) and McKinsey,"
a consulting
firm.  Indeed, one of McKinsey`s main
apologists for offshoring of US jobs, Diana Farrell,
is now a member of Obama`s White House National
Economic Council.  

The pressure of jobs
offshoring, together with massive imports, has
destroyed the economic prospects for all Americans,
except the CEOs who receive
"performance"
bonuses for moving American jobs offshore or giving
them to H-1b work visa holders.  Lowly paid
offshored  employees, together with H-1b visas,
have curtailed employment for older and more
experienced American workers.  Older workers
traditionally receive higher pay. However, when the
determining factor is minimizing labor costs for the
sake of shareholder returns and management bonuses,
older workers are unaffordable.  Doing a good
job, providing a good service, is no longer the
corporation`s function.  Instead, the goal is
to minimize labor costs at all cost.  

Thus,
"free trade"
has also destroyed the employment prospects of older
workers.  Forced out of their careers, they
seek employment as shelf stockers for Wal-Mart.

I have read endless tributes to
Wal-Mart from
"libertarian economists,"
who sing Wal-Mart`s
praises for bringing low price goods, 70% of which
are made in China, to the American consumer. 
What these "economists" do not factor into their analysis is the diminution of
American family incomes and government tax base from
the loss of the goods producing jobs to China.
Ladders of upward mobility are being dismantled by
offshoring, while California issues IOUs to pay its
bills.  By shifting production offshore,
offshoring reduces US GDP.  When the goods and
services are brought back to America to be sold,
they increase the trade deficit.  As the trade
deficit is financed by foreigners acquiring
ownership of US assets, the change in ownership
means that profits, dividends, capital gains,
interest, rents, and tolls leave American pockets
for foreign ones.

The demise of America`s
productive economy left the US economy dependent on
finance, in which the US remained dominant because
the dollar is the reserve currency.  With the
departure of factories, finance went in new
directions.  Mortgages, which were once held in
the portfolios of the issuer, were securitized. 
Individual mortgage debts were combined into a
"security." 
The next step was to strip out the interest payments
to the mortgages and sell them as derivatives, thus
creating a third debt instrument based on the
original mortgages.  

In pursuit of ever more
profits, financial institutions began betting on the
success and failure of various debt instruments and
by implication on firms.  They bought and sold
collateral debt swaps. A buyer pays a premium to a
seller for a swap to guarantee an asset`s value. If
an asset
"insured"
by a swap falls in value, the seller
of the swap is supposed to make the owner of the
swap whole. The purchaser of a swap is not required
to own the asset in order to contract for a
guarantee of its value. Therefore, as many people
could purchase as many swaps as they wished on the
same asset. Thus, the total value of the swaps
greatly exceeds the value of the assets.  (An
excellent explanation of swaps can be found

here
.)

The next step is for holders of
the swaps to short the asset in order to drive down
its value and collect the guarantee.  As the
issuers of swaps were not required to reserve
against them, and as there is no limit to the number
of swaps, the payouts can easily exceed the net
worth of the issuer.

This was the most shameful and
most mindless form of speculation.  Gamblers
were betting hands that they could not cover. The US
regulators had abandoned their posts.  The
American financial institutions abandoned all
integrity. As a consequence, American financial
institutions and rating agencies are trusted nowhere
on earth. 

The US government should never
have used billions of taxpayers` dollars to pay off
swap bets as it did when it bailed out the insurance
company AIG.  This was a stunning waste of a
vast sum of money.  The federal government
should declare all swap agreements fraudulent
contracts, except for a single swap held by the
owner of the asset.  Simply wiping out these
fraudulent contracts would remove the bulk of the
vast overhang of
"troubled"
assets that threaten financial markets.

The billions of taxpayers`
dollars spent buying up subprime derivatives were
also wasted.  The government did not need to
spend one dime.  All government needed to do
was to suspend the mark-to-market rule.  This
simple act would have removed the solvency threat to
financial institutions by allowing them to keep the
derivatives at book value until financial
institutions could ascertain their true values and
write them down over time.

Taxpayers, equity owners, and
the credit standing of the US government are being
ruined by financial shysters who are manipulating 
to their own advantage the government`s commitment
to mark-to-market and to the
"sanctity of
contracts."
  Multi-trillion dollar
"bailouts"
and bank nationalization are the result of the
government`s inability to respond intelligently.

Two more simple acts would have
completed the rescue without costing the taxpayers
one dollar:  an announcement from the Federal
Reserve that it will be lender of last resort to all
depository institutions including money market
funds, and an announcement reinstating the uptick
rule.

The uptick rule was suspended
or repealed a couple of years ago in order to permit
hedge funds and shyster speculators to rip-off
American equity owners. The rule prevented
short-selling any stock that did not move up in
price during the previous day.  In other words,
speculators could not make money at others` expense
by ganging up on a stock and short-selling it day
after day.  

As a former Treasury official,
I am amazed that the US government, in the midst of
the worst financial crises ever, is content for
short-selling to drive down the asset prices that
the government is trying to support.  No
bailout or stimulus plan has any hope until the
uptick rule is reinstated.

The bald fact is that the
combination of ignorance, negligence, and ideology
that permitted the crisis to happen is still present
and is blocking any remedy.  Either the people
in power in Washington and the financial community
are total dimwits or they are manipulating an
opportunity to redistribute wealth from taxpayers,
equity owners and pension funds to the financial
sector.  

The Bush and Obama plans total
1.6 trillion dollars, every one of which will have
to be borrowed, and no one knows from where. 
This huge sum will compromise the value of the US
dollar, its role as reserve currency, the ability of
the US government to service its debt, and the price
level.  These massive costs are pointless and
are to no avail as not one step has been taken that
would alleviate the crisis.

If we add to my simple menu of
remedies a ban, punishable by instant death, for
short selling any national currency, the world can
be rescued from the current crisis without years of
suffering, violent upheavals and, perhaps, wars.

According to its hopeful but
economically ignorant proponents, globalism was
supposed to balance risks across national economies
and to offset downturns in one part of the world
with upturns in other parts.  A global
portfolio was a protection against loss, claimed
globalism`s purveyors.  In fact, globalism has
concentrated the risks, resulting in Wall Street`s
greed endangering all the economies of the world.
The greed of Wall Street and the negligence of the
US government have wrecked the prospects of many
nations.  Street riots are already occurring in
parts of the world.  On Sunday February 22, the
right-wing TV station, Fox
"News,"
presented a

program that
predicted riots and disarray in the
United States by 2014. 

How long will Americans permit
"their" government to rip them off for the sake of the financial
interests that caused the problem?  Obama`s
cabinet and National Economic Council are filled
with representatives of the interest groups that
caused the problem.  The Obama administration
is not a government capable of preventing a
catastrophe. 

If truth be known, the
"banking
problem"
is the least of our worries.  Our
economy faces two much more serious problems. 
One is that offshoring and H-1b visas have stopped
the growth of family incomes, except, of course, for
the super rich.  To keep the economy going,
consumers have gone deeper into debt, maxing out
their credit cards and refinancing their homes and
spending the equity.  Consumers are now so
indebted that they cannot increase their spending by
taking on more debt.  Thus, whether or not

the banks resume lending is
beside the point.

The other serious problem is
the status of the US dollar as reserve currency. 
This status has allowed the US, now a country
heavily dependent on imports just like a third world
or lesser-developed country, to pay its
international bills in its own currency.  We
are able to import $800 billion annually more than
we produce, because the foreign countries from whom
we import are willing to accept paper for their
goods and services. 

If the dollar loses its reserve
currency role, foreigners will not accept dollars in
exchange for real things.  This event would be
immensely disruptive to an economy dependent on
imports for its energy, its clothes, its shoes, its
manufactured products, and its advanced technology
products.  

If incompetence in Washington,
the type of incompetence that produced the current
economic crisis, destroys the dollar as reserve
currency, the
"unipower"
will overnight become a third world
country, unable to pay for its imports or to sustain
its standard of living.

How long can the US government
protect the dollar`s value by leasing its gold to
bullion dealers who sell it, thereby holding down
the gold price? Given the incompetence in Washington
and on Wall Street, our best hope is that the rest
of the world is even less competent and even in
deeper trouble.  In this event, the US dollar
might survive as the least valueless of the world`s
fiat currencies.

Paul Craig Roberts [email
him
] was Assistant
Secretary of the Treasury during President Reagan`s
first term.  He was Associate Editor of the
Wall
Street Journal.  He has held numerous academic
appointments, including the William E. Simon Chair,
Center for Strategic and International Studies,
Georgetown University, and Senior Research Fellow,
Hoover Institution, Stanford University. He was awarded
the Legion of Honor by French President Francois
Mitterrand. He is the author of


Supply-Side Revolution : An Insider`s Account of
Policymaking in Washington
;
 Alienation
and the Soviet Economy
and

Meltdown: Inside the Soviet Economy
,
and is the co-author
with Lawrence M. Stratton of


The Tyranny of Good Intentions : How Prosecutors and
Bureaucrats Are Trampling the Constitution in the Name
of Justice
. Click

here
for Peter
Brimelow`s
Forbes Magazine interview with Roberts
about the recent epidemic of prosecutorial misconduct.