Creation of Debt As The Basis For Growth

By Bob Chapman

The UK, Europe, the US and Canada are different degrees of welfare states. By way of regulation, government controls via taxation. The states and their inhabitants send taxes to Washington, which takes its cut and sends funds back to the states with strings attached. You either do what we want you to do, or we cut off your funds. The states and the people are subject to extortion with government using their funds to do so. By using regulations, welfare and extortion, the federal government creates dependency.

Another phenomenon that has developed is a second dependency. People in society, not just in the US, but also in many countries, are dependent on their grandparents and parents and as years progress that situation will worsen. Earning power to maintain a previous lifestyle is no longer available with the staggering tax burden. Including income and VAT taxes in Europe, taxation averages 70%. The ability and opportunity to become successful and wealthy is more limited in today’s societies. Even the college degree has been demeaned. Almost anyone who can hold a pencil today is college material, when 60% of attendees shouldn’t even be there. Adding insult, the jobs once available to college attendees are no longer available, because more often then not illegal aliens hold them. As a result, it is far more difficult to work your way through college and as a result one graduates with a loan for $60,000 that will be paid back in many cases over a lifetime. In most cases that means most won’t be able to afford to buy a house until they are in the 30s or 40, if ever.

Since 1913 the basis for growth in America has been creation of debt out of thin air, a product of the privately owned Federal Reserve and a fractional banking system. It is considered prudent under such a system to lend nine times your underlying assets. Several years ago the figure was 70 and today it is still 40 times. Government and citizens purchase economic goods on credit. Government issues bonds and individuals borrow money.

Today money is only a method of exchange; it is not longer a store of value, especially in an environment of zero interest rates. An important characteristic of money to retain its soundness is gold backing. Today only one currency has any gold backing and that is the euro, which has about 5% gold backing. Ten years ago that backing was 15%, but gold was sold off to suppress the price of gold in conjunction with the US government and many other central banks. As a result we have a world of essentially worthless fiat currencies. The world is left with no sound money and as a result gold has again taken its place as the world’s reserve currency. If for no other reason is that it owes no one anything. Occasionally silver fulfills this role as well – both have for the last six centuries.

Financial operations conducted by government and a privately owned Federal Reserve leads to the extended creation of money and credit exceeding revenues. That leads to inflation, perhaps hyperinflation, and some times eventually deflationary depression. This is especially true when currency is not backed by gold. Having a Federal Reserve makes sound money even more difficult, because it can create endless amounts of money and credit as we have witnessed since August 15, 1971. What the banks and the Federal Reserve have done is use the fractional banking system to steal and expropriate the wealth of dollar owners. Such a system by its very nature is unsound. There is no such thing as full faith and credit, because it is not worth the paper it is written on, whether it is issued by a Federal Reserve or by a government, especially if it’s fiat or unbacked by something such as gold. This money leads to servitude because as it carries less value perpetually and the discovery leads to war and totalitarian government.

A recent manifestation of this profligacy is the urging by government for consumers to consume more with their steadily depreciating currency and to stop paying off debt. At the same time interest rates are lowered to zero to encourage consumption. Needless to say, savers are penalized with poor returns. That is for the most part the elderly. Such policy forces savers to become speculators, unless, of course, they have discovered gold and silver related investments. This process reduces the savings base and forces central banks to create more and more aggregates. It also enrages savers. The entire game has been changed and for the most part few have learned how to protect themselves.

The foregoing allows the Dow to sell at higher levels than previously because a part of those savings go into the stock market and bonds. If you haven’t noticed the bond market is in a bubble created by the Fed. You would think there was some kind of safety in stocks and bonds. Then again, desperate people do desperate things. If you want to see what safety in bonds is, just look at Britain’s bond markets since WWII. This is the sort of result you can expect when you marry corporations and government, and you end up with corporatist fascism.

By the time you read this the US congressional elections will be over and the Democrats will have lost about 50 House seats and probably 9 Senate seats. The American people are outraged over what has been done to them by the last three administrations.

As a result gold has been rising strongly, as the dollar remains under pressure. This in part is due to QE2, as well as the systemic problems facing the US economy. Spending the economy into strength again is not working. The only party increasing spending is the government. They also reflect most of the job growth. Private construction was the weakest in a dozen years.

This is reflected as well in government debt up $1.65 trillion to $13.5 trillion. The government is so deep in debt it cannot sell more debt fast enough to keep up with increases and old debt. The Fed has to purchase 80% of that debt, which cannot continue indefinitely. The result of all this is that the US lurches from one crisis to another.

As always bankers have been borrowing short to lend long, a sure recipe for disaster. That leads us to one of the greatest frauds of the century, the collapse of the real estate market and securitized mortgages. In order to survive banks are borrowing from the Fed at zero rates and lending back to them at 2-1/2%. No one says anything because no one wants the banks to fail. No matter what you call it the result is extending the debt timeline hoping something good will happen

Over the past few weeks we have seen the beginnings of trade war, which in reality had been going on for years. The statements by Chairman of the Fed, Bernanke, and statements as well by Treasury Secretary Geithner, started the ball rolling. The discussion of a possible QE2 set off wild currency volatility with the dollar falling the most and the yen, euro and Aussie dollars being the strongest. The Swiss franc shared leadership with the yen. While this transpired Mr. Geithner told the world the government wanted a strong dollar and that its lower level was just about right.

The significance of currency war is that inevitably leads to trade war. You might call it a backdoor entry. The string of competitive devaluations over the years were overlooked and tolerated by the US because cheap foreign goods held down US inflation and the dollars purchased to subdue domestic currency value were used to buy US Treasuries and Agencies. That benefit was now of limited benefit as nations bought less Treasuries and the Fed had to monetize US Treasury debt. This has and will continue to bottle up inflation to a larger degree in the US, as less hot US dollar flow goes into foreign countries. Countries such as Brazil have already implemented a tax on dollar flows into their country. We can expect more countries to follow and that will be followed by US trade taxes on goods and services. We have already started to see this in goods sold in China and the US. The US wants to increase exports and a weaker dollar makes that happen.

The Fed via stealth has been engaged in QE2 since early June via the bond and repo markets and Wall Street is well aware of that. The easing is talked to in terms of $500 billion over the short term in order to keep the economy level to slightly higher. Some $2.5 trillion will be needed over the next year and another 42.5 trillion the following year. If not forthcoming deflation will rear its ugly head and devour the US and then the world economy. In the meantime the secretive Fed has been surreptitiously lending more funds to Europe to Greece, Ireland, Spain, Portugal and Italy.

The deliberately cheapened Chinese yuan has caused a $260 billion trade deficit with China, or a 20% plus increase. That is a doubling in 10 years from 20% to 40% of its trade deficit. China says it is willing to raise the value of the yuan incrementally over the next several years, but that simply isn’t good enough. We believe trade barriers will become a major issue in the coming session of Congress. The transnational conglomerates know such a move is inevitable. The US has to find a way to solve growing unemployment, which in the real world now stands at 22-3/4%. You cannot have a recovery as long as that many people are unemployed. In addition, those numbers are headed higher, soon to reach 1930’s depression levels. This is something that should have been done long ago, but the elitist forces fought it off as long as possible. The end of free trade and globalization, as we have known it, over the past 20 years will be one of the bigger issues in congress over the next two years. When the yuan is 40% undervalued it becomes a major issue.

The flip side of the immediate problem of QE2 and a lower dollar is higher gold, silver and commodity prices, and an increase in inflation. Mr. Bernanke says we need inflation. Not a lot just a little. Official CPI figures are up 1.6%, whereas real inflation has risen 7% and is headed higher. It’s tough being between the rock and the hard place and that is where the Fed sits. It’s expanded money and credit for banking and Wall Street so no one will be too big to fail.

This issue will hit the streets prior to all the election results being known.

Just as big news will be how much QE2 will be admitted to by the Fed and besides Treasuries and Agencies, how much and what other bonds will the Fed purchase? After we find out how money will be injected into the system we then have to discern how much inflation it will foster.

The truth of the current Keynesian economic system has been taken for granted and it is in the processes of failure. That event demands that the system be purged of its excesses. As we projected back in May, the Fed and the administration will pour $5 trillion into the economy over the next two years just to keep the economy going sideways. This is a staggering amount of money and credit created out of thin air to be monetized, which will certainly depreciate the dollar. We have just seen food and other prices double again. What will happen when all this liquidity hits the economy? You guessed it, more inflation. For some reason the masters of the universe on Wall Street seem to think that somehow inflation and hyperinflation will not appear. They believe in a destructive theory that everything they believe is true. It is part of their misreading of life and its real meaning.

The US would be spending a whopping $200 million per day on President Barack Obama’s visit to the city.

“The huge amount of around $200 million would be spent on security, stay and other aspects of the Presidential visit,” a top official of the Maharashtra Government privy to the arrangements for the high-profile visit said.

About 3,000 people including Secret Service agents, US government officials and journalists would accompany the President. Several officials from the White House and US security agencies are already here for the past one week with helicopters, a ship and high-end security instruments.

“Except for personnel providing immediate security to the President, the US officials may not be allowed to carry weapons. The state police is competent to take care of the security measures and they would be piloting the Presidential convoy,” the official said on condition of anonymity.

Navy and Air Force has been asked by the state government to intensify patrolling along the Mumbai coastline and its airspace during Obama’s stay. The city’s airspace will be closed half-an-hour before the President’s arrival for all aircraft barring those carrying the US delegation.

The personnel from SRPF, Force One, besides the NSG contingent stationed here would be roped in for the President’s security, the official said.

The area from Hotel Taj, where Obama and his wife Michelle would stay, to Shikra helipad in Colaba would be cordoned off completely during the movement of the President.

Shares of Ambac Financial Group Inc. (ABK 0.50, -0.32, -39.23%) were down 49% in Monday’s premarket trading after the company in a regulatory filing said its board has decided not to make a regularly scheduled interest payment on notes due in 2023. If the interest is not paid within 30 days of the scheduled interest payment date of Nov. 1, an event of default will occur under the indenture for the notes, Ambac said. The firm has been unable to raise additional capital as an alternative to seeking bankruptcy protection and is currently pursuing with an ad hoc committee of senior debt holders a restructuring of its outstanding debt through a prepackaged bankruptcy proceeding, according to the filing. If Ambac is unable to reach agreement on a prepackaged bankruptcy in the near term, it intends to file for bankruptcy prior to the end of the year. “Such filing may be with or without agreement with major creditor groups concerning a plan of reorganization,” Ambac said.

[When Ambac insures, mostly municipal bonds, they transfer their own rating to the bonds so if a municipal has a rating of BBB and Ambac is AAA, the municipals assume a Triple A status. If Ambac goes out of business the bonds lose their AAA status and revert to their normal rating status, which might be B or BBB or AA, the bottom line is munis are going to fall in value and we predicted this would happen two years ago, and as usual few were listening. Bob]

The Transportation Security Administration is implementing an enhanced pat-down procedure at national airport security checkpoints, including in Greater Rochester International Airport.

Last week the Dow fell 0.1%, S&P was unchanged, the Russell 2000 was unchanged and the Nasdaq 100 gained 1%. Banks fell 1.1%; broker/dealers rose 0.6%; cyclicals fell 0.4% and transports were unchanged. Consumers fell 0.5%; utilities fell 0.6%; high tech rose 1.6%; semis surged 4.4%; Internets rose 3.2% and biotechs rose 1.4%. Gold bullion rose $30.00, the HUI rose 4.4% and the USDX fell 0.4% to 77.04.

The 2-year T-bills fell 2 bps to 0.33% and the 10-year T-notes rose 4 bps to 2.60%. The 10-year German bunds gained 4 bps to 2.52%.

Freddie Mac 30-year fixed rate mortgages rose 2 bps to 4.23%, the 15’s rose 2 bps to 3.66%, one-year ARMs were unchanged at 3.30% and the 30-year fixed rate jumbos fell 6 bps to 5.18%.

Fed credit fell $1 billion. Fed foreign holdings of Treasury, Agency debt rose $12.9 billion to $3.294 trillion. Custody holdings for foreign central banks rose Year-to-date to $339 billion, or 13.9% annualized.

M2, money supply, expanded $13 billion to $8.873 trillion, that is up 3.5% annualized and yoy it is up 3.3%.

Total money market fund assets rose a large $24.6 billion to $2.807 trillion. YOY assets have fallen $487 billion.

Total commercial paper outstanding jumped $22.8 billion to $1.168 trillion, a high for the year.

Economist Stiglitz: We need stimulus, not quantitative easing

Joseph Stiglitz, the Nobel prize- winning economist at Columbia, disagrees. He thinks it can hurt, and it also won’t do very much.

Joseph Stiglitz: The Fed, and the Fed’s advocates, are falling into the same trap that led us into the crisis in the first place. Their view is that the major lever for economic policy is the interest rate and if we just get it right, we can steer this. That didn’t work. It forgot about financial fragility and how the banking system operates. They’re thinking the interest rate is a dial you can set and by setting that dial, you can regulate the economy. In fact, it operates primarily through the banking system, and the banking system is not functioning well. All the literature about how monetary policy operates in normal times is pretty irrelevant to this situation.

The point is the stimulus did work. They made a very big mistake in underestimating the severity of the downturn and asked for too small of a stimulus, and they didn’t do enough in the design.

http://www.washingtonpost.com/wp-dyn/content/article/2010/10/30/AR2010103004612.html

Stiglitz, Nobel or not, is recycling Keynesian remedies that are the cause of US economic and financial problems; and his logic is faulty.

Joe says QE is undesirable because it will intensify ‘currency wars’. But the currency wars are a direct result of US reliance on Keynesian economics that have pushed the US toward bankruptcy and forced the Fed to paper over the enormous Keynesian deficits. [‘Tis why most economists aren’t money managers.]

The cost of tires, gloves and condoms is set to rise following a 65 per cent jump in the price of natural rubber in the past year.

Yves Smith op-ed in NY Times: How the Banks Put the Economy Underwater – When mortgage securitization took off in the 1980s, the contracts to govern these transactions were written carefully to satisfy not just well-settled, state-based real estate law, but other state and federal considerations. These included each state’s Uniform Commercial Code, which governed “secured” transactions that involve property with loans against them, and state trust law, since the packaged loans are put into a trust to protect investors. On the federal side, these deals needed to satisfy securities agencies and the Internal Revenue Service.

This process worked well enough until roughly 2004, when the volume of transactions exploded. Fee- hungry bankers broke the origination end of the machine. One problem is well known: many lenders ceased to be concerned about the quality of the loans they were creating, since if they turned bad, someone else (the investors in the securities) would suffer.

A second, potentially more significant, failure lay in how the rush to speed up the securitization process trampled traditional property rights protections for mortgages.

Business inventories increased $115.5B, which is far more than expected. The inventory binge contributed 1.44% to GDP growth. Final sales (GDP less inventories) increased 0.6%. Final sales to domestic purchasers increased 2.5%. This is down significantly from the 4.3% increase in Q2.

The measure is in place for travelers who choose not to go through the imaging technology devices known as the full-body scanners.

Passengers always have had the option to walk through the metal detectors and be patted down, but there will be some change to the latter procedure. The enhanced pat-down, which TSA officials tested in Boston and Las Vegas airports and which officials say adds another detailed layer of security, uses a front-of-the-hand, slide-down technique on passengers’ bodies.

“If you refuse to go through the full body scan, you are going to be subject to a physical pat-down of your person,” said David Damelio, Greater Rochester International Airport director. “In Rochester, we only have one machine, so we are not always going to be able to get everyone through that machine.”

Damelio said passengers will be able to request a pat-down from someone of the same gender.

“TSA constantly evaluates and updates screening procedures to stay ahead of evolving threats,” said TSA spokesperson Ann Davis. “While we cannot share specific details of our procedures for security reasons, pat-downs are designed to address potentially dangerous items, like improvised explosive devices and their components, concealed on the body.”

Sixty-five airports use the body scan imaging technology, with the device coming soon to four more major airports: Chicago Midway Airport, Dulles International Airport in Washington, D.C., William P. Hobby Airport in Houston and LaGuardia Airport in New York City.

The body scan has been known to speed up security procedures by producing images in seconds and reducing the need for additional screening.

Images are transferred to monitors in another room, where they are viewed by security personnel.

The images are disposed of immediately after they are evaluated, and facial features are blurred.

“I’ve gone through the scan before, and it takes seconds and doesn’t bother me,” Damelio said. “But I know it does bother some people. The more you travel, the more you are going to be impacted by these changes because they are happening nationwide.”

One of our contacts in the oil and gas business says that oil will move up $30 to $50 a barrel over the next 8 months; that means that those in that business should take action to protect themselves.

“Indianapolis Workforce Development spokesman Marc Lotter said the agency is merely being cautious with the approach of an early-December deadline when thousands of Indiana residents could see their unemployment benefits end after exhausting the maximum 99 weeks provided through multiple federal extension periods.

“Given the upcoming expiration of the federal extensions and the increased stress on some of the unemployed, we thought the addition of 36 armed guards would provide an extra level of protection for our employees and clients,” he said.

Senate Majority Leader Harry Reid this weekend promised to force the Senate to vote on an immigration bill, the Dream Act, in a lame-duck session of Congress next month.

Mr. Reid, a Nevada Democrat who is in a desperate battle to keep his Senate seat, told Univision’s “Al Punto,” a Sunday political talk show, that he has the right as majority leader to decide what legislation reaches the floor, and said he is “a believer in needing to do something” on immigration.

In doing so, he elevated immigration to join jobs, spending and tax cuts — the issues most lawmakers expect to dominate Congress when they reconvene in November.

“I just need a handful of Republicans. I would settle for two or three Republicans to join with me on the Dream Act and comprehensive immigration reform, but they have not been willing to step forward,” Mr. Reid said. “They want to keep talking about this issue, and I say [it] is demagoguery in its worst fashion and is unfair to the Hispanic community.”

The Dream Act would grant legal status and a path to citizenship to illegal immigrant schoolchildren and to illegal immigrants who agree to serve in the U.S. military.

In September, just before Congress adjourned for two months, Mr. Reid tried to attach the Dream Act to the annual defense policy bill, which already was loaded down with language laying out a path for gays to serve openly in the military. But Republicans blocked the defense bill, arguing that Mr. Reid was playing politics just before the election.

The immigration issue has been dominant in the Nevada Senate race, which pits Mr. Reid against Republican nominee Sharron Angle, who has been running ads accusing Mr. Reid of being a friend of illegal immigrants.

Then, Mr. Reid last week had to fire a staffer after it was revealed she had entered into a sham marriage to help a man stay in the United States.

The Justice Department is sending a small pack of election observers to Arizona as Hispanic groups sound the alarm over an anti-illegal immigration group’s mass e-mail seeking to recruit Election Day volunteers to help block illegal immigrants from voting.

Hispanic voting rights groups say the e-mail is just an attempt to intimidate minority voters. But election fraud monitors say that there are hundreds of examples of duplicate registrations, wrong information and past unregistered voters getting ballots.

http://www.foxnews.com/politics/2010/10/29/justice-dept-send-election-observers-arizona-group-seeks-crack-illegal-voters/

The New York Times said in an editorial Sunday that Secretary of Homeland Security United States, Janet Napolitano, should eliminate the costly and inefficient virtual fence that has tried to build on the border with Mexico.

Napolitano, who slowed this year, new works of Secure Border Initiative Network (SBInet) and allocated 50 million of its funds to other programs, you should delete “once and for all” when the contract expires with the Boeing company late next month recommended.

The SBInet program, consisting of towers with radar and cameras to curb illegal immigration along the three thousand 200 kilometers of border “is a costly failure” and it is time to “disconnect the virtual fence,” the newspaper said New York.

The project initially estimated at seven thousand 600 million dollars was driven in 2006 by former President George W. Bush and continued by his successor, Barack Obama, but has been plagued by software defects.

With over a billion dollars already spent, barely have covered 80 kilometers from the border to date, to which is added critical reports on Government Oversight Office (GAO), which questioned the failure to meet deadlines already established.

The GAO also criticized Boeing for providing evaluation data “incomplete and abnormal”, which has prevented the Department of Homeland Security asked for an accounting firm for its cost control and timeliness, said The New York Times.

He said the virtual fence was a malconcebida idea based on the false premise that immigration control is achieved by closing the border, with more sensors, fences and “boots on the ground.”

As long as the demand for cheap labor, the need for better jobs and legal impediments to enter the country, people continue to seek ways of crossing the border, the newspaper said.

Urged a comprehensive immigration reform that allows for greater border security.

The Institute for Supply Management’s factory index rose to 56.9 in October from 54.4 a month earlier, the Tempe, Arizona-based group said today. Readings greater than 50 signal growth.

Economists forecast the ISM manufacturing gauge would decline to 54, according to the median of 75 projections in a Bloomberg News survey. Estimates ranged from 52 to 56.8.

U.K. factory growth unexpectedly accelerated as hiring and export orders improved, other reports showed today.

A China purchasing managers’ index released by the logistics federation rose to 54.7 last month from 53.8. A second PMI, from HSBC Holdings Plc and Markit Economics, jumped to 54.8 from 52.9.

Consumer spending rose less than forecast in September as incomes dropped for the first time in more than a year, a sign Americans may keep rebuilding savings and paring debt as the economy is slow to recover.

Purchases increased 0.2 percent, the smallest gain in the third quarter, Commerce Department figures showed today in Washington. Incomes fell 0.1 percent, the first drop since July 2009, and the Federal Reserve’s preferred measure of inflation stagnated, capping the smallest 12-month gain in nine years.

Construction spending in the U.S. unexpectedly rose in September, led by increases in homebuilding and public projects.

The 0.5 percent gain brought spending to $801.7 billion after a revised 0.2 percent drop in August that was previously reported as a 0.4 percent gain, Commerce Department figures showed today in Washington.

Homebuilders are recovering from a slump in demand following the expiration of a government tax break and still face the challenge of mounting foreclosures that are adding to the housing inventory. While rising profits may help corporate spending on structures grow next year, government construction outlays may slow as federal stimulus funds fade and state and local municipalities cut budgets.

“Construction is still a very low- to no-growth scenario for the next nine months at least,” Russell Price, a senior economist at Ameriprise Financial Inc. in Detroit, said before the report. “There’s still a lot of capacity out there to be absorbed. We’ve already been seeing some hit to infrastructure spending from budget cuts on the state and local governments especially as the federal stimulus eases.”

Economists forecast construction spending would decrease 0.5 percent, according to the median projection in a Bloomberg News survey. The 50 estimates ranged from a drop of 1.2 percent to a 0.5 percent increase.

Other figures from the Commerce Department today showed consumer spending rose less than forecast in September as incomes dropped for the first time in more than a year, a sign Americans may keep rebuilding savings and paring debt as the economy is slow to recover.

Purchases advanced 0.2 percent, the smallest gain of the third quarter. Incomes fell 0.1 percent, the first drop since July 2009, and the Federal Reserve’s preferred measure of inflation stagnated, capping the smallest 12-month increase in nine years.

Construction spending was down 10 percent in the year ended in September, today’s report showed.

Private construction spending was unchanged. A 1.8 percent increase in homebuilding was offset by a 1.6 percent drop in commercial projects as fewer factories were put up. Non- residential construction decreased to the lowest level since January 2005.

Public construction climbed 1.3 percent following a 2.2 percent gain in August. Federal construction outlays increased 6.1 percent, while state and local government spending rose 0.8 percent. New transportation grids and schools accounted for most of the gains.

State and local debt sales swelled to an 18-month peak of $13.8 billion, overwhelming investor demand and sending municipal bond yields to the highest level in more than two months.

The Federal Reserve will probably introduce an unprecedented second round of unconventional monetary easing tomorrow by announcing a plan to buy at least $500 billion of long-term securities, according to economists surveyed by Bloomberg News.

Policy makers meeting today and tomorrow will restart a program of securities purchases to spur growth, reduce unemployment and increase inflation, said 53 of 56 economists surveyed last week. Twenty-nine estimated the Fed will pledge to buy $500 billion or more, while another seven predicted $50 billion to $100 billion in monthly purchases without a specified total. The remainder said the Fed would buy up to $500 billion or didn’t quantify their forecast.

The varied responses reflect differences among Fed officials over the total amount of purchases needed to bolster the recovery. Policy makers, pursuing unprecedented stimulus, have cut the benchmark rate almost to zero and bought $1.7 trillion in securities without generating growth fast enough to bring down unemployment from near a 26-year high.

“There’s no silver bullet right now” and central bankers have “very few options left in terms of lowering interest rates,” said John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina. He predicted $500 billion of Treasury and mortgage-backed securities purchases in the next six months.

U.S. “Quantitative Easing” is Fracturing the Global Economy

By Michael Hudson

Great structural changes in world trade and finance occur quickly – by quantum leaps, not by slow marginal accretions. The 1945-2010 era of relatively open trade, capital movements and foreign exchange markets is being destroyed by a predatory financial opportunism that is breaking the world economy into two spheres: a dollar sphere in which central banks in Europe, Japan and many OPEC and Third World countries hold their reserves the form of U.S. Treasury debt of declining foreign-exchange value; and a BRIC-centered sphere, led by China, India, Brazil and Russia, reaching out to include Turkey and Iran, most of Asia, and major raw materials exporters that are running trade surpluses.

What is reversing trends that seemed irreversible for the past 65 years is the manner in which the United States has dealt with its bad-debt crisis. The Federal Reserve and Treasury are seeking to inflate the economy out of debt with an explosion of bank liquidity and credit – which means yet more debt. This is occurring largely at other countries’ expense, in a way that is flooding the global economy with electronic “keyboard” bank credit while the U.S. balance-of-payments deficit widens and U.S.  official debt soars beyond any foreseeable means to pay. The dollar’s exchange rate is plunging, and U.S. money managers themselves are leading a capital flight out of the domestic economy to buy up foreign currencies and bonds, gold and other raw materials, stocks and entire companies with cheap dollar credit.

This outflow from the dollar is not the kind of capital that takes the form of tangible investment in plant and equipment, buildings, research and development. It is not a creation of assets as much as the creation of debt, and its multiplication by mirroring, credit insurance, default swaps and an array of computerized forward trades. The global financial system has decoupled from trade and investment, taking on a life of its own.

In fact, financial conquest is seeking today what military conquest did in times past: control of land and basic infrastructure, industry and mining, banking systems and even government finances to extract the economic surplus as interest and tollbooth-type economic rent charges. U.S. officials euphemize this policy as “quantitative easing.” The Federal Reserve is flooding the banking system with so much liquidity that Treasury bills now yield less than 1%, and banks can draw freely on Fed credit. Japanese banks have seen yen borrowing rates fall to 0.25%.

This policy is based on a the wrong-headed idea that if the Fed provides liquidity, banks will take the opportunity to lend out credit at a markup, “earning their way out of debt” – inflating the economy in the process. And when the Fed talks about “the economy,” it means asset markets – above all for real estate, as some 80% of bank loans in the United States are mortgage loans.

One-third of U.S. real estate is now reported to be in negative equity, as market prices have fallen behind mortgage debts. This is bad news not only for homeowners but also for their bankers, as the collateral for their mortgage loans does not cover the principal. Homeowners are walking away from their homes, and the real estate market is so thoroughly plagued with a decade of deception and outright criminal fraud that property titles themselves are losing security. And despite FBI findings that financial fraud is found in over three-quarters of the packaged mortgages they have examined, the Obama Justice Department has not sent a single bankster to jail.

Instead, the financial crooks have been placed in charge– and they are using their power over government to promote their own predatory gains, having disabled U.S. public regulatory agencies and the criminal justice system to create a new kind of centrally planned economy in the hands of banks. As Joseph Stiglitz recently observed:

In the years prior to the breaking of the bubble, the financial industry was engaged in predatory lending practices, deceptive practices. They were optimizing not in producing mortgages that were good for the American families but in maximizing fees and exploiting and predatory lending. Going and targeting the least educated, the Americans that were most easy to prey on.

We’ve had this well documented. And there was the tip of the iceberg that even in those years the FBI was identifying fraud. When they see fraud, it’s really fraud. But beneath that surface, there were practices that really should have been outlawed if they weren’t illegal.

… the banks used their political power to make sure they could get away with this [and] … that they could continue engaging in these kinds of predatory behaviors. … there’s no principle. It’s money. It’s campaign contributions, lobbying, revolving door, all of those kinds of things.

… it’s like theft … A good example of that might be [former Countrywide CEO] Angelo Mozillo, who recently paid tens of millions of dollars in fines, a small fraction of what he actually earned, because he earned hundreds of millions.

The system is designed to actually encourage that kind of thing, even with the fines. … we fine them, and what is the big lesson? Behave badly, and the government might take 5% or 10% of what you got in your ill-gotten gains, but you’re still sitting home pretty with your several hundred million dollars that you have left over after paying fines that look very large by ordinary standards but look small compared to the amount that you’ve been able to cash in.

The fine is just a cost of doing business. It’s like a parking fine. Sometimes you make a decision to park knowing that you might get a fine because going around the corner to the parking lot takes you too much time.

I think we ought to go do what we did in the S&L [crisis] and actually put many of these guys in prison. Absolutely. These are not just white-collar crimes or little accidents. There were victims. That’s the point. There were victims all over the world. … the financial sector really brought down the global economy and if you include all of that collateral damage, it’s really already in the trillions of dollars.[2]

This victimization of the international financial system is a consequence of the U.S. Government’s attempt to bail out the banks by re-inflating U.S. real estate, stock and bond markets at least to their former Bubble Economy levels. This is what U.S. economic policy and even its foreign policy is now all about, including de-criminalizing financial fraud. As Treasury Secretary Tim Geithner tried to defend this policy: “Americans were rightfully angry that the same firms that helped create the economic crisis got taxpayer support to keep their doors open. But the program was essential to averting a second Great Depression, stabilizing a collapsing financial system, protecting the savings of Americans [or more to the point, he means, their indebtedness] and restoring the flow of credit that is the oxygen of the economy.”[3]

Other economists might find a more fitting analogy to be carbon dioxide and debt pollution. “Restoring the flow of credit” is simply a euphemism for keeping the existing, historically high debt levels in place rather than writing them down – and indeed, adding yet more debt (“credit”) to enable home buyers, stock market investors and others to use yet more debt leverage to bid asset prices back up to rescue the banking system from the negative equity into which it has fallen. That is what Mr. Geithner means by “stabilizing a collapsing financial system” – bailing banks out of their bad loans and making all the counterparties of AIG’s fatal financial gambles whole at 100 cents on the dollar.

The Fed theorizes that if it provides nearly free liquidity in unlimited amounts, banks will lend it out at a markup to “reflate” the economy. The “recovery” that is envisioned is one of new debt creation. This would rescue the biggest and most risk-taking banks from their negative equity, by pulling homeowners out of theirs. Housing prices could begin to soar again.

But the hoped-for new borrowing is not occurring. Instead of lending more – at least, lending at home – banks have been tightening their loan standards rather than lending more to U.S. homeowners, consumers and businesses since 2007. This has obliged debtors to start paying off the debts they earlier ran up. The U.S. saving rate has risen from zero three years ago to 3% today – mainly in the form of amortization to pay down credit-card debt, mortgage debt and other bank loans.

Instead of lending domestically, banks are sending the Fed’s tsunami of credit abroad, flooding world currency markets with cheap U.S. “keyboard credit.” The Fed’s plan is like that of the Bank of Japan after its bubble burst in 1990: The hope is that lending to speculators will enable banks to earn their way out of debt. So U.S. banks are engaging in interest-rate arbitrage (the carry trade), currency speculation, commodity speculation (driving up food and mineral prices sharply this year), and buying into companies in Asia and raw materials exporters.

By forcing up targeted currencies against the dollar, this U.S. outflow into foreign exchange speculation and asset buy-outs is financial aggression. And to add insult to injury, Mr. Geithner is accusing China of “competitive non-appreciation.” This is a euphemistic term of invective for economies seeking to maintain currency stability. It makes about as much sense as to say “aggressive self-defense.” China’s interest, of course, is to avoid taking a loss on its dollar holdings and export contracts denominated in dollars (as valued in its own domestic renminbi).

Countries on the receiving end of this U.S. financial conquest (“restoring stability” is how U.S. officials characterize it) understandably are seeking to protect themselves. Ultimately, the only way this serious way to do this is to erect a wall of capital controls to block foreign speculators from deranging currency and financial markets.

Changing the international financial system is by no means easy. How much of alternative do countries have, Martin Wolf recently asked. “To put it crudely,” he wrote:

the US wants to inflate the rest of the world, while the latter is trying to deflate the US. The US must win, since it has infinite ammunition: there is no limit to the dollars the Federal Reserve can create. What needs to be discussed is the terms of the world’s surrender: the needed changes in nominal exchange rates and domestic policies around the world.[4]

Mr. Wolf cites New York Federal Reserve chairman William C. Dudley to the effect that Quantitative Easing is primarily an attempt to deal with the mortgage crisis that capped a decade of bad loans and financial gambles. Economic recovery, the banker explained on October 1, 2010, “has been delayed because households have been paying down their debt – a process known as deleveraging.” In his view, the U.S. economy cannot recover without a renewed debt leveraging to re-inflate the housing market.

By the “U.S. economy” and “recovery,” to be sure, Mr. Dudley means his own constituency the banking system, and specifically the largest banks that gambled the most on the real estate bubble of 2003-08. He acknowledges that the bubble “was fueled by products and practices in the financial sector that led to a rapid and unsustainable buildup of leverage and an underpricing of risk during this period,” and that household debt has risen “faster than income growth … since the 1950s.” But this debt explosion was justified by the “surge in home prices [that] pushed up the ratio of household net worth to disposable personal income to nearly 640 percent.” Instead of saving, most Americans borrowed as much as they could to buy property they expected to rise in price. For really the first time in history an entire population sought to get rich by running to debt (to buy real estate, stocks and bonds), not by staying out of it.

But now that asset prices have plunged, people are left in debt. The problem is, what to do about it. Disagreeing with critics who “argue that the decline in the household debt-to-income ratio must go much further before the deleveraging process can be complete,” or who even urge “that household debt-to-income ratios must fall back to the level of the 1980s,” Mr. Dudley retorts that the economy must inflate its way out of the debt corner into which it has painted itself. “First, low and declining inflation makes it harder to accomplish needed balance sheet adjustments.” In other words, credit (debt) is needed to bid real estate prices back up. A lower rather than higher inflation rate would mean “slower nominal income growth. Slower nominal income growth, in turn, means that less of the needed adjustment in household debt-to-income ratios will come from rising incomes. This puts more of the adjustment burden on paying down debt.” And it is debt deflation that is plaguing the economy, so the problem is how to re-inflate (asset) prices.

(1) How much would the Fed have to purchase to have a given impact on the level of long-term interest rates and economic activity, and, (2) what constraints exist in terms of limits to balance-sheet expansion, and what are the costs involved that could impede efforts to meet the dual mandate now or in the future?[5]

On October 15, 2010, Fed Chairman Ben Bernanke explained that he wanted the Fed to encourage inflation – his of program of Quantitative Easing – and acknowledged that this would drive down the dollar against foreign currencies. Flooding the U.S. banking system with liquidity will lower interest rates, increasing the capitalization rate of real estate rents and corporate income. This will re-inflate asset prices – by creating yet more debt in the process of rescue banks from negative equity by pulling homeowners out of their negative equity. But internationally, this policy means that foreign central banks receive less than 1% on the international reserves they hold in Treasury securities – while U.S. investors are making much higher returns by borrowing “cheap dollars” to buy Australian, Asian and European government bonds, corporate securities, and speculating in foreign exchange and commodity markets.

Mr. Bernanke proposes to solve this problem by injecting another $1 trillion of liquidity over the coming year, on top of the $2 trillion in new Federal Reserve credit already created during 2009-10. The pretense is that bailing Wall Street banks out of their losses is a precondition for reviving employment and consumer spending – as if the giveaway to the financial sector will get the economy moving again.

The working assumption is that if the Fed provides liquidity, banks will lend it out at a markup. At least this is the dream of bank loan officers. The Fed will help them keep the debt overhead in place, not write it down. But as noted above, the U.S. market is “loaned up.” Borrowing by homeowners, businesses and individuals is shrinking. Unemployment is rising, stores are closing and the economy is succumbing to debt deflation. But most serious of all, the QE II program has a number of consequences that Federal Reserve policy makers have not acknowledged. For one thing, the banks have used the Federal Reserve and Treasury bailouts and liquidity to increase their profits and to continue paying high salaries and bonuses. What their lending is inflating are asset prices, not commodity prices (or output and employment). And asset-price inflation is increasing the power of property over living labor and production, elevating the FIRE sector further over the “real” economy.

These problems are topped by the international repercussions that Mr. Dudley referred to as the “limits to balance-of-payments expansion.” Cheap electronic U.S. “keyboard credit” is going abroad as banks try to earn their way out of debt by financing arbitrage gambles, glutting currency markets while depreciating the U.S. dollar. So the upshot of the Fed trying save the banks from negative equity is to flood the global economy with a glut of U.S. dollar credit, destabilizing the global financial system.

Can foreign economies rescue the U.S. banking system?

The international economy’s role is envisioned as a deus ex machina to rescue the economy. Foreign countries are to serve as markets for a resurgence of U.S. industrial exports (and at least arms sales are taking off to India and Saudi Arabia), and most of all as financial markets for U.S. banks and speculators to make money at the expense of foreign central banks trying to stabilize their currencies.

The Fed believes that debt levels can rise and become more solvent if U.S. employment increases by producing more exports. The way to achieve this is presumably to depreciate the dollar – the kind of “beggar-my-neighbor” policy that marked the 1930s. Devaluation will be achieved by flooding currency markets with dollars, providing the kind of zigzagging opportunities that are heaven-sent for computerized currency trading, short selling and kindred financial options.

Such speculation is a zero-sum game. Someone must lose. If Quantitative Easing is to help U.S. banks earn their way out of negative equity, by definition their gains must be at the expense of foreigners. This is what makes QE II is a form of financial aggression.

This is destructive of the global currency stability that is a precondition for stable long-term trade relationships. Its underlying assumptions also happen to be based on Junk Economics. For starters, it assumes that international prices are based on relative price levels for goods and services. But only about a third of U.S. wages are spent on commodities. Most is spent on payments to the finance, insurance and real estate (FIRE) sector and on taxes. Housing and debt service typically absorb 40% and 15% of wage income respectively. FICA Wage withholding for Social Security and Medicare taxes absorb 11%, and income and sales taxes another 15 to 20%. So before take-home pay is available for consumer spending on goods and services, these FIRE-sector charges make the cost of living so high as to render American industrial labor uncompetitive in world markets. No wonder the U.S. economy faces a chronic trade deficit!

The FIRE sector overhead has become structural, not merely a marginal problem. To restore its competitive industrial position, the United States would have to devalue by much more than the 40% that it did back in 1933. Trying to “inflate its way out of debt” may help bank balance sheets recover, but as long as the economy remains locked in debt deflation it will be unable to produce the traditional form of economic surplus needed for genuine recovery. A debt write-down would be preferable to the policy of keeping the debts on the books and distorting the U.S. economy with inflation – and engaging in financial aggression against foreign economies. The political problem, of course, is that the financial sector has taken control of U.S. economic planning – in its own self-interest, not that of the economy at large. A debt write-down would threaten the financial sector’s creditor power over the economy.

So it is up to foreign economies to enable U.S. banks to earn their way out of negative equity. For starters, there is the carry trade based on interest-rate arbitrage – to borrow at 1%, lend at a higher interest rate, and pocket the margin (after hedging the currency shift). Most of this financial outflow is going to China and other Asian countries, and to raw materials exporters. Australia, for example, has been raising its interest rates in order to slow its own real estate bubble. Rather than slowing speculation in its large cities by fiscal policy – a land tax – its central bank is operating on the principle that a property is worth whatever a bank will lend against it. Raising interest rates to the present 4.5% reduces the capitalization rate for property rents – and hence shrinks the supply of mortgage credit that has been bidding up Australian property prices.

This interest-rate policy has two unfortunate side effects for Australia – but a free lunch for foreign speculators. First of all, high interest rates raise the cost of borrowing across the board for doing business and for consumer finances. Second – even more important for the present discussion – high rates attract foreign “hot money” as speculators borrow at low interest in the United States (or Japan, for that matter) and buy high-yielding Australian government bonds.

The effect is to increase the Australian dollar’s exchange rate, which recently has achieved parity with the U.S. dollar. This upward valuation makes its industrial sector less competitive, and also squeezes profits in its mining sector. So on top of Australia’s rising raw-materials exports, its policy to counter its real estate bubble is attracting foreign financial inflows, providing a free ride for international arbitrageurs. Over and above their interest-rate arbitrage gains is the foreign currency play – rising exchange rates in Australia and many Asian countries as the U.S. dollar glut swamps the ability of central banks to keep their exchange rates stable.

This foreign-currency play is where most of the speculative action is today as speculators watching these purchases have turned the currencies and bonds of other raw-materials exporters into speculative vehicles. This currency speculation is the most aggressive, predatory and destructive aspect of U.S. financial behavior. Its focus is now shifting to the major nation that has resisted U.S. attempts to force its currency up: China. The potentially largest prize for U.S. and foreign speculators would be an upward revaluation of its renminbi.

The House Ways and Means Committee recently insisted that China raise its exchange rate by the 20 percent that the Treasury and Federal Reserve have suggested. Suppose that China would obey this demand. This would mean a bonanza for U.S. speculators. A revaluation of this magnitude would enable them to put down 1% equity – say, $1 million to borrow $99 million – and buy Chinese renminbi forward. The revaluation being demanded would produce a 2000% profit of $20 million by turning the $100 million bet (and just $1 million “serious money”) into $120 million. Banks can trade on much larger, nearly infinitely leveraged margins.

Can U.S. banks create enough electronic “keyboard credit” to buy up the whole world?

The Fed’s QE II policy poses a logical question: Why can’t U.S. credit buy out the entire world economy – all the real estate, companies and mineral rights yielding over 1%, with banks and their major customers pocketing the difference?

Under current arrangements the dollars being pumped into the global economy are recycled back into U.S. Treasury IOUs. When foreign sellers turn over their dollar receipts to their banks for domestic currency, these banks turn the payment over to the central bank – which then faces a Hobson’s Choice: either to sell the dollars on the foreign exchange market (pushing up their currency against the dollar), or avoid doing this by buying more U.S. Treasury securities and thus keeping the dollar payment within the U.S. economy. Why can’t this go on ad infinitum?

What makes these speculative capital inflows so unwelcome abroad is that they do not contribute to tangible capital formation or employment. Their effect is simply to push up foreign currencies against the dollar, threatening to price exporters out of global markets, disrupting domestic employment as well as trade patterns.

These financial gambles are setting today’s exchange rates, not basic production costs.
In terms of relative rates of return, foreign central banks earn 1% on their U.S. Treasury bonds, while U.S. investors buy up the world’s assets. In effect, U.S. diplomats are demanding that other nations relinquish their trade surpluses, private savings and general economic surplus to U.S. investors, creditors, bankers, speculators, arbitrageurs and vulture funds in exchange for this 1% return on U.S. dollar reserves of depreciating value – and indeed, in amounts already far beyond the foreseeable ability of the U.S. economy to generate a balance-of-payments surplus to pay this debt to foreign governments.

The global economy is being turned into a tributary system, achieving what military conquest sought in times past. This turns out to be implicit in QE II. Arbitrageurs and speculators are swamping Asian and Third World currency markets with low-priced U.S. dollar credit to make predatory trading profits at the expense of foreign central banks trying to stabilize their exchange rates by selling their currency for dollar-denominated securities – under conditions where the United States and Canada are blocking reciprocal direct investment (e.g., Potash Corp. of Saskatchewan in Canada and Unocal in the United States.).

The road to capital controls

Hardly by surprise, other countries are taking defensive measures against this speculation, and against “free credit” takeovers using inexpensive U.S. electronic “keyboard bank credit.” For the past few decades they have stabilized their exchange rates by recycling dollar inflows and other foreign currency buildups into U.S. Treasury securities. The Bank of Japan, for instance, recently lowered its interest rate to just 0.1% in an attempt to induce its banks to lend back abroad the foreign exchange that is now coming in as its banks are being repaid on their own carry-trade loans. It also offset the repayment of past carry-trade loans extended by its own banks in yen by selling $60 billion of yen and buying U.S. Treasury securities, of which it now owns over $1 trillion.

Foreign economies are now taking more active steps to shape “the market” in which international speculation occurs. The most modest move is to impose a withholding tax on interest payments to foreign investors. Just before the IMF meetings on October 9-10, 2010, Brazil doubled the tax on foreign investment in its government bond to 4%. Thailand acted along similar lines a week later. It stopped exempting foreign investors from having to pay the 15% interest-withholding tax on their purchases of its government bonds. Finance Minister Korn Chatikavinij warned that more serious measures are likely if “excessive” speculative inflows keep pushing up the baht. “We need to consider the rationality of capital inflows, whether they are for speculative purposes and how much they generate volatility in the baht,” he explained But the currency continues to rise.

Such tax withholding discourages interest-rate arbitrage via the bond market, but leaves the foreign-currency play intact – and that is where the serious action is today. In the 1997 Asian Crisis, Malaysia blocked foreign purchases of its currency to prevent short-sellers from covering their bets by buying the ringgit at a lower price later, after having emptied out its central bank reserves. The blocks worked, and other countries are now reviewing how to impose such controls.

Longer-term institutional changes to more radically restructure the global financial system may include dual exchange rates such as were prevalent from the 1930 through the early 1960s, one (low and stable) for trade and at least one other (usually higher and more fluctuating) for capital movements. But the most decisive counter-strategy to U.S. QE II policy is to create a full-fledged BRIC-centered currency bloc that would minimize use of the dollar.

China has negotiated currency-swap agreements with Russia, India, Turkey and Nigeria. These swap agreements may require exchange-rate guarantees to make central-bank holders “whole” if a counterpart currency depreciates. But at least initially, these agreements are being used for bilateral trade. This saves exporters from having to hedge their payments through forward purchases on global exchange markets.

A BRIC-centered system would reverse the policy of open and unprotected capital markets put in place after World War II. This trend has been in the making since the BRIC countries met last year in Yekaterinburg, Russia, to discuss such an international payments system based on their own currencies rather than the dollar, sterling or euro. In September, China supported a Russian proposal to start direct trading using the yuan and the ruble rather than pricing their trade or taking payment in U.S. dollars or other foreign currencies. China then negotiated a similar deal with Brazil. And on the eve of the IMF meetings in Washington on Friday, Premier Wen stopped off in Istanbul to reach agreement with Turkish Prime Minister Erdogan to use their own currencies in a planned tripling Turkish-Chinese trade to $50 billion over the next five years, effectively excluding the dollar.

China cannot make its currency a world reserve currency, because it is not running a deficit and therefore cannot supply large sums of renminbi to other countries via trade. So it is negotiating currency-swap agreements with other countries, while using its enormous dollar reserves to buy up natural resources in Australia, Africa and South America.

This has reversed the dynamics that led speculators to gang up and cause the 1997 Asia crisis. At that time the great speculative play was against the “Asian Tigers.” Speculators swamped their markets with sell orders, emptying out the central bank reserves of countries that tried (in vain) to keep their exchange rates stable in the face of enormous U.S. bank credit extended to George Soros and other hedge fund managers and the vulture funds that followed in their wake. The IMF and U.S. banks then stepped in and offered to “rescue” these economies if they agreed to sell off their best companies and resources to U.S. and European buyers.

This was a major reason why so many countries have tried to free themselves from the IMF and its neoliberal austerity programs, euphemized as “stabilization” plans rather than the economic poison of chronic dependency and instability programs. Left with only Turkey as a customer by 2008, the IMF was a seemingly anachronistic institution whose only hope for survival lay in future crises. So that of 2009-10 proved to be a godsend. At least the IMF found neoliberal Latvia and Greece willing to subject themselves to its precepts. Today its destructive financial austerity doctrine is applied mainly by Europe’s “failed economies.”

This has changed the equation between industrial-nation creditors and Third World debtors. Many dollar-strapped countries have been subject to repeated raids on their central banks – followed by IMF austerity programs that have shrunk their domestic markets and made them yet more dependent on imports and foreign investments, reduced to selling off their public infrastructure to raise the money to pay their debts. This has raised their cost of living and doing business, shrinking the economy all the more and creating new budget squeezes driving them even further into debt. But China’s long-term trade and investment deals – to be paid in raw materials, denominated in renminbi rather than dollars – is alleviating their debt pressures to the point where currency traders are jumping on the bandwagon, pushing up their exchange rates. The major international economic question today is how such national economies can achieve greater stability by insulating themselves from these predatory financial movements.