Retirement Blog

(this is a long post on the economy that is still in the process of being written)

The United States economy is about to enter into recession, in fact the recession is over due, it should have arrived two years ago but was delayed. Decisions and actions are being taken, both politically and economically, that will determine the impact and duration of the coming recession. And determine if this will only be a recession or turn into a depression.

I am going to, in an attempt to try and influence the course of actions, explain how we arrived at this point, what the current situation is, and what the future may hold for the United States of America. What is at stake is more than just the Dow Jones average, or the price of real estate, what is at stake is the future of our country. This is no ordinary recession.

The Past

To understand how we got here, we have to understand where we’ve been, and for that we must travel back in time to the mid 1990’s. The internet was discovered. A new technology that transformed not only communications, but industry, and the United States was the leader in harnessing and applying this new technology. It was a gold rush.

Economies grow when a new resource or technology is found.

The internet brought about great profits and investment, and the U.S. economy took off, up to that point it had been drifting in a post cold war malaise. The Clinton administration, the last conservative presidency, took a laissez-faire approach and wisely used the new found revenue to balance the budget. Interest rates fell, the price of oil was low, the country had the largest surplus in its history, the dollar reigned supreme.

The U.S. economy at the beginning of this century was the strongest it had ever been in its history. Seven short years later, the United States of America stands on the verge of having not only it’s economy destroyed, but also of losing it’s empire. What went wrong?

Dot-com bust, Iraq War, sub-prime mortgages, all had a hand in the un-raveling. But the reasons go even deeper, and in trying to find our way out of the current situation, we must address these and other factors as well.

Seeds of the current economic destruction, can be found at the height of our success, and can be rectified through policy changes. One of the policy changes is to remove corporations fom the democractic process and another is to change our immigration policy.

During the decade of the 1980’s, the decrepit and corrupt U.S. labor movement, which up to that point had been a major player in U.S. politics, was systematically destroyed. And corporations moved in to fill the power vacuum, by the 1990’s during both Democratic and Republican governments, corporations became the de-facto source of power and money to the two party system of governance.

Corporations have no role to play in a democratic government. Democracies are formed by the participation of individuals not corporations. In fact, corporations are inherently un-democratic, democracy is an inefficient form of government, and corporations by nature seek the most efficient use of capital. Facism is the ultimate form of corporate governance. The negative effect can be seen, in the role that corporations played, in contributing to the other seed I mention.

At the height of the internet boom, there occurred a shortage of workers skilled in the new technologies, and as in the past, the United States imported labor. Unlike the past, we did not invite them, to become U.S. citizens. Instead we created a special work visa program called H1-B. Corporations quickly realized that they could employ these workers at lower wages with less benefits, than U.S. citizens, and increase their profits.

The U.S. government, now controlled by corporations, instead of restricting the visa program (thus, forcing corporations to hire and train U.S. born workers, and increase the incomes of Americans), expanded the H1-B visa program. It was a double failure.

Anti-immigration Americans (and what remained of the labor movement) were kept happy, with the knowledge that these foreigners would remain foreigners, and would have to return to their home countries. This was a colossal mistake, a departure from past practice, but one that can be changed.

These workers, from India, China, and the former U.S.S.R, wished to become Americans, but quickly realized that they were not welcome. Some of them were able to start corporations in the U.S., benefiting the economy and become U.S. Citizens, but most were forced to return to their home countries – especially after the dot-com bust. They took with them the entrepreneurial skills they learned in the U.S., the advanced technologies they helped develop, and networks of fellow workers they had met while in the U.S.

They formed corporations of their own, back in their home countries, and because of the nature of the new technology (high speed data exchange), could offer to U.S. corporations a sweet deal. “You do not want to hire us in the U.S., or allow us to become citizens (and quite frankly we prefer Bangalore to the Bay Area), so we offer you this win-win proposition. We can do the technology for you at an even cheaper price in our home country. You save money and don’t have to deal with the folks calling you anti-american every time you try to get us a visa. What do you think?”

The corporations realized even greater profits and the U.S. lost it’s economic source of power. India’s economy would soon take off.

At this point in time, even before the dot-com bust, U.S. corporations had been moving their manufacturing overseas. Most of the manufacturing moved to China, which benefited from not only a manufacturing but also a technology boom. China’s economy would really take off.

Irrational exuberance led to the Dot-Com bust, the internet bubble burst, hyper economic growth stopped. However, the U.S. still had a huge budget surplus, interest rates were at all time lows, and oil was still relatively cheap. A year after the technology bust, the economy hadn’t rebounded, and the U.S. administration was facing a possible recession. Their solution was to basically give the surplus to the rich in the form of tax cuts. The following paragraph comes from the White House website

“Over the past several months, the economy has slowed dramatically. President Bush’s tax cut will give the economy a timely second wind by placing more money in the hands of consumers and entrepreneurs.”

Unfortunately, for an average check of $300, the American people embarked on a sinking ship. Alan Greenspan appeared before congress and told the American people that he supported the tax cut – it would not be the last time he sold out his country. Tax cuts to the rich do not spur an economy. It had been tried in the decade of the 1980’s and proved to be a failure. What created the growth of the 1980’s was Keynsian spending on defense – not tax cuts to the rich. What resulted from that spending, was of course huge defecits, that the technology boom of the 1990’s paid off.

The 911 attack, which followed a few months later, further depressed the economy. The $300 checks, were spent by the American people, and created only a temporary rebound.

Iraq War to the rescue. Wars, if not fought on one’s own soil, can benefit the economy. World War II, Vietnam, Gulf War I, all had a positive effect on the economy, and the Iraq War would be no exception. Defecit spending on homeland security and the war would help re-invigorate the economy. At the same time, low interest rates were causing a housing boom, also inflating the economy. Good times – with disastrous consequences.

Wars have only a short-term positive effect on an economy. They are not a long-term strategy for economic growth. If war does not result in acquisition of a resource, or is replaced by some other form of growth, it’s effect will not only vanish but also result in worse consequences for the economy.

If I send my ships and soldiers to Mexico, and they come back with gold, the economy is benefited. If I send my ships and soldiers to Mexico, and they are defeated, my economy is destroyed.

We sent our ships and soldiers to Iraq to capture their black gold, they are being defeated, our economy will be hurt. Not only was this defecit spending being wasted on a losing war, our inability to quickly and convincingly capture the oil, led to a dramatic rise in oil prices. A rise in oil prices has a negative effect, on an economy dependent on oil, it is inflationary. So is a housing boom.

The housing boom was a natural response to low interest rates, and would have been sufficient on it’s own, without the necessity of war, to help lift the economy out of the post Dot-com slowdown. With low interest rates, more Americans could afford more house, and so they naturally bought houses. What happened next, and has helped lead us into this disaster, was unexpected. An almost complete elimination of credit standards – thank you Mr. Greenspan. What we got then was not a housing boom – but a housing frenzy.

And the economy grew. Jobs were created, stock markets rose, people were getting rich.

The defecit spending to support the war, the rise in oil prices, and the speculative housing market, should have led to inflation and a rise in interest rates. And they did – but not to the levels they should have – something was going on to keep interest rates low and inflation in check.

The war spending did have an impact on interest rates, but the housing boom and rise in oil prices, did not have as large of an impact on interest rates and more importantly inflation. Why?

Because the U.S. had moved its manufacturing offshore, the rise in oil prices were not reflected in the cost of goods produced, the U.S. doesn’t produce much anymore. The offshoring of manufacturing, actually had an anti-inflationary effect, lower costs of production in China kept prices low. Oil price rises were felt in the transportation sector and at the gas pump, but their effects were absorbed, and the impact was not as large as it should have been. China, not the U.S., is the country that is most affected by high oil prices. They are absorbing the costs in lower profits. Because the Chinese economy lacks transparency – this fact is not apparent.

The housing boom, as well, did not have as large of an inflationary impact as would be expected. Employment in the housing sector boomed, real estate and construction, but the majority of the gains in employment went to illegal immigrants. The elimination of credit standards allowed, more Americans to afford more house than they normally would have been able to, and was the main factor in delaying the recession. Americans used their houses to go on a spending spree. Where did the money go? They ate out. Spending on food exploded, Americans became even more obese, and restaurants hired waiters and bartenders, reducing un-employment. They went on vacation, they bought s.u.v.’s, and they went shopping at wal-mart. Buying big screen t.v.’s, dvd, ipods, and more toys than their children could play with. Stuff manufactured in China.

The American C.E.O’s and top excecutives, of the corporations that manufactured the stuff, that was made in China – became very wealthy as their stock prices rose. Americans were hired to serve food, and illegal immigrants were hired to wash dishes, this kept unemployment and wage inflation down. The wealth that was created by the housing credit boom went to Wall Street and China. China’s economy took off and corporate executives became rich. Average Americans incomes did not rise. Because much of this housing credit wealth left the United States, keeping inflation and interest rates low. What remained in the United States, went into low skill low wage jobs, keeping unemployment low as well.

Technology struggled to recover after the dot-com bust, but recovery did occur, and investment into technology continued. Unfortunately for the U.S. economy, the recovery occurred in India, where high skill yet low wage jobs flourished. The U.S. had, by not investing in it’s own people or by granting citizenship to high skilled immigrants, given up it’s technological lead.

It wasn’t until the creation of “Web 2.0”, and the subsequent investment into the latest internet technologies, did U.S. technology companies regain their stock prices or advantage. Unfortunately, it comes too late, and this new technology primarily serves a consumer demand economy that is collapsing.

Even though inflation and interest rates did not rise to the levels they should have, they did rise, enough to throw an over leveraged economy into crises. Both the American people and U.S. corporations, had leveraged their assets to the maximum, and spent their money. The American people spent their money, on real estate and to a large degree on foreign manufactured goods, and the American corporations on mergers and acquisitons. This fueled stock market prices.

When interest rates finally rose, large numbers of homeowners and corporations, could not afford the extra cost. And so foreclosures and failures occurred. What is the big deal if some low-income homeowners and some real estate hedge funds fail? None. If the fundamentals of the economy are strong then it can be absorbed.

Then why are the financial markets, both in the U.S. and overseas, in a near state of panic? Because the U.S. and overseas markets realize that the fundamentals are not strong.

The U.S. economy is entering recession, the delay is over, it is about to begin. Recessions are corrections to periods of excessive growth. How deep they go, and how long they last, are determined by many factors. In the current situation, we have seen excessive growth in housing and stock market valuations. So we can expect major corrections in both these areas of the economy. As corporate earnings disappear, layoffs will begin, and the downward spiral will commence. Those “experts”, who talk about the “fundamentals” being strong and able to carry us through, are either idiots or liars. The U.S. economy derives it’s growth from consumption. The consumption of the last few years was fueled by housing credit. The housing market is imploding, the budget surplus was given to the rich, and our wars are being funded by government borrowing.

Unfortunately, one of the results of deflating values in both of these parts of the economy, will be high unemployment.

Until the U.S. economy finds a new source of growth we will remain in recession.

What scares me now, what keeps me awake at night, is not that the U.S. economy is going into a recession. It is that there is the potential that we may enter into a depression.

What will turn the recession into a depression? The end of credit. Credit is the lubricant of growth, without it the economy cannot grow, investment will not occur. We are watching the credit markets close. The credit markets have lost faith in the U.S. economy. This goes beyond housing and into every sector of the economy.

To be continued…