Alternative Insight

The Economic Crisis
Part 2- New thoughts to the incomplete analyses

The Obama administration proceeds with conventional and debatable techniques for resolving the economic crisis, mirroring some programs of the earlier Roosevelt era. Massive deficit spending to stimulate the energy, educational and health sectors - work projects with social benefits - and providing massive monetary support to financial and automotive industries characterize President Obama's recovery plan. Injecting trillions of dollars into the economy to relieve unemployment, stimulate consumer spending and renew borrowing is the principal effort to revive the economy - to where - the end result is not apparent.

Adopting not entirely proven recovery efforts of past eras as a partial mean to promote recovery efforts in the modern era is a controversial issue of the Recovery Plan. By starting with a dubious thrust, the entire program becomes questionable and its end result problematic. Fresh thoughts are required to complement the conventional thoughts. Innovative thoughts are lacking in the Plan.

Is the Roosevelt era approach to resolving the Great Depression a suitable model for resolving the present downturn?
Roosevelt's administration had many positives; development of new constituencies, expansion of labor power, increase in social awareness, heightening of civic pride, additions to financial regulation, and promotion of more equitable distribution of wealth and power. Nevertheless, it is inconclusive that the economic policies contributed to an economic revival. Due to the states having large surpluses, the entire national stimulus by deficit spending was relatively small. The Democrat President even managed to balance the 1935 budget. More important is that the U.S. economy of 2009 is entirely different from that of 1932. In 1932 agrarian production represented a large part of the total economy, a modified gold standard existed, and U.S. participation in the global economy was not significant. President Obama faces a different world economy and different global rules. Attempting to readjust the U.S. economy without corresponding and mutual recovery plans in the other major economies of the world is counterproductive..

International treaties guided the rules of operation for the global system during its prosperity.
However, the failure of the global economy indicates the rules by treaty demand adjustment. The present rules allow sudden shifts in labor and capital that create instability and dislocations. The rapid shifts promote short term speculative adventures supported by loans that are encouraged by currency carry trades. The carry trade has an investor borrowing at low interest rates in a nation that has a strong currency, such as Japan, and investing in a rapidly growing nation to receive high interest rates. All is well until the rapidly growing economy stagnates and its currency starts to fall. In order to repay the debt, mass selling of securities occurs in the developing country and mass buying of currency occurs in the creditor country. A smoothing of the rapid shifts in labor and capital, although it might slow economic growth, is a high priority for a renovated global system. It is difficult to make recommendations to resolve the huge global problems that create instability, except to highlight that fresh thoughts on additional financial regulations with imposed limits on reckless investments and transactions are necessary .

The stimulus to the labor market is necessary but has its drawbacks.
Pouring money into energy solutions, education and health markets provides employment and attacks major problems. However, the years of subsidy are short and don't have an encore. What happens after the funds are exhausted? Clean energy will probably still remain expensive and not stimulate additional investment or move to dynamic production without continuous government support. Nor does the supported clean energy programs of solar and wind power greatly diminish petroleum imports, which are principally used as an energy source in automobile engines. Additional funding for education, automating health records and providing assistance to the health industry, all admirable projects, don't stimulate production industries; they will either require continuous federal government support or run a course. The short term stimulus projects have long term social benefits but negligible long term financial benefits, which means they need to be re-evaluated.

Long-term financial benefits are best obtained by re-vitalization of industries that can compete with imports, such as automobiles, steel, electronics, apparel, shoes and toys and by strengthening already popular export industries. These type of investments have a triple benefit; manufacturing grows with reinvestment and doesn't require additional government investment, purchasing power is maintained without resorting to credit markets and, by increasing internal purchasing power, more spending is available for services.

American manufacturers who have shifted production overseas to low labor areas, or have retreated from industries whose American labor they claim cannot compete with low cost production nations, should ask their government to examine China's direction for soothing the crisis. The new Asian power has a six hundred billion dollar economic stimulus package whose thrust is to make" its companies better able to compete in markets at home and abroad, to retrain migrant workers on an immense scale and to rapidly expand subsidies for research and development. Construction has already begun on new highways and rail lines that are likely to permanently reduce transportation costs." Although the rate has slowed, China's economy continues growing,

U.S. manufacturers should ask themselves why Germany, whose manufacturing labor rates are 50% higher than those of the United States and whose population is slightly more than 20% of the U.S., and why Japan, whose labor rates are 80% of the U.S. rates and whose population is 40% of the U.S. can export more automobiles and other merchandise products products than U.S. manufacturers. The CIA 2014 factbook lists the U.S. as regaining 2nd in goods exports (China is first) with $1.6T, only slightly more than Germany's $1.5T. Considering U.S. resource and mineral wealth and its extensive transportation, communication, advertising and marketing systems, the U.S. has advantages that should enable it to lead by much more in merchandise exports.

One means for lowering overall labor rates is to shift the burdens of health and pension costs from corporations to the federal government. A national health system and national pension plan, both subsidized by tax revenues, which spread the burdens throughout the economy, can lower labor costs. The Patient Protection and Affordable Care Act is proving that point. Those who believe low taxes elevate the GDP and those who believe government operations are inefficient should examine the benefits - spreading costs of vital social issues to increase competitiveness of vital industries, increasing exports and decreasing imports, which increases domestic purchasing power and lessens reliance on credit for consumption, will more than overcome tax burdens and unproven inefficiencies. Add to the mix, the decrease in stress on individuals due to the knowledge they are covered by national pension and health plans, both of which will greatly increase health. It is overlooked that the security felt by national pension and health systems lead to improved national health and less costs for managing the health system.

Stimulating exports is one factor in rejuvenating the economy. Lowering imports is another factor.
Petroleum imports are a major component of the import markets, which has been partially relieved by shale oil production, and an unstable feature of the import market. Oil prices are highly elastic and uncontrollably rise and fall. Due to an exaggerated dependence of price upon demand, during prosperous times when oil demand is high, petroleum prices are elevated. The exaggerated demand for oil leads to shifts in capital from industrialized nations to resource rich nations, followed by rapid economic decline of the industrial nations. An economic crisis has temporarily lowered oil demand and oil prices. Some conventional means, such as more efficient automobiles, use of alternative fuels, conservation and increased domestic oil production have been proposed to decrease U.S. dependence on foreign oil. Nevertheless, although long range plans consider clean energy for electrical production, no proven long range plan exists to assure replacement of petroleum for automobile use and for greatly decreasing the import bill for foreign oil.

Even if the foreign oil imports are totally eliminated, the U.S. still had, in 2013, another $2.0 trillion dollars of imports that demand reduction. One obvious reduction method is to shift offshore industrial production and services back to the United States. A company by company evaluation might indicate that this isn't as extreme as believed. It might only involve a slight loss of profit or a slight increase in price or for a company to be patriotic. Student loan company Sallie Mae has announced it "plans to move its overseas operations back to the United States, creating 2,000 domestic jobs, in what analysts called an attempt to curry favor with the Obama administration."

U.S. multi-national corporations, of which Apple is an example, send dollars overseas by importing much more than they export to affiliates ($50 billion in 2006) and non-affiliates ($98 billion in 2006). These corporations add some tax revenues to the U.S. Treasury, but they essentially only benefit their stockholders and slowly drain purchasing power for domestic production by supplying merchandise to which there is no domestic replacement. U.S. consumer purchases of the foreign made products of domestic multi-national corporations profit these corporations and their foreign workers. If the U.S. government would use stimulus funds to subsidize research on replacements for overseas manufactured components for many industries the economic recovery might be more pronounced and longer lasting.

Apple computer's manufacturing of one of its iPods indicates how it is possible to transfer overseas value added back to to the United States. One particular iPod had a sales price of $299 of which $80 was Apple's profit and $144 was manufacturing cost; almost all by overseas suppliers. Marketing, distribution and sales profit added to the final price. if Apple replaced either a display module ($20) or the hard drive ($53), which due to its miniature size is undoubtedly special and might be replaced by a solid state memory, by domestic manufacture, then an equivalent drop in imports would occur. Detailed examination of Apple's costs and those of myriads of overseas manufactures might reveal that the differences between using domestic or foreign manufacture might only reflect a few more dollars in profits or a few more dollars in price. Lowering profit or increasing prices; the latter being a competition decision, might accommodate domestic labor, lower the trade deficit and add purchasing power to the domestic economy.

The beyond bailout incentives to the financial system are contradictory, dubious and strange.
Citizens own the government when its suitable to remind its citizens of their democratic rights. When government spending is mentioned, then the government is made to appear as an amorphous entity hidden from the people. Nevertheless, taxpayers are responsible for government debt and its interest and all government spending is citizens' spending. In the bailouts, the U.S. government is borrowing at low interest rates and temporarily lending the borrowed money to the bank, who then extend credit at higher rates to the public. The U.S. public (government) borrows at a cost, provides funds to the banks and then the public borrows from these same banks at higher interest rates. Bank lending from deposits reflects a personal decision by the depositor, who realizes he/she is receiving lower interest than at which the bank lends the deposit. Government funding the banks with capital to increase lending reflects a common decision of the public and many don't approve of the transactions. Banks need more capital and additional liquidity, but is it fair that U.S. taxpayers finance bank profits at taxpayer expense? An interviewed demonstrator at London's G-20 meeting echoed that proposition, which shows the proposition has affirmation and is provoking the international community.
Question: Why doesn't the government temporarily nationalize troubled banks and directly lend to the public at low rates?

Many banks that received bailouts to motivate consumer loans opted to purchase treasury bills. Instead of using the money to make loans, banks bought ultra- safe investments to assure their balance sheets would not deteriorate. The government supplies bailout money to the banks and then pays a slight interest to borrow the same funds it sent to the banks. What type of stimulus is that?

AIG, a recipient of a mere $185 billion in government bailouts, has used a substantial portion of the funds to pay for guarantees of credit default swaps to foreign (Societie General, Credit Agricola, Deutsche bank) and domestic (Goldman Sachs, Merrill Lynch) investment banks at full contract price. Maybe, there were good reasons to not permit AIG to go bankrupt ( bankruptcy would not have interrupted AIG's operations) and oblige the contracts in full, but if AIG were allowed to do what they were headed for and go bankrupt, its credit default swaps contracts could have been negotiated at much lower prices. From Trading Markets: "In bankruptcy,...the swaps might have been settled at 20 cents on the dollar. In other words, the government had leverage and chose not to use it.... there has been an absence of hard bargaining here, and it is because the Fed puts its highest priority on its loyalty to the banking system and tends to subordinate economizing with taxpayer dollars."

Similarly baffling operations have the Federal Reserve spending up to $300 billion over the next six months to buy long-term government bonds and increase purchases of $1.25 trillion of mortgage-backed securities, which are guaranteed by Fannie Mae and Freddie Mac. The Fed regularly buys and sells short-term Treasury bills to set the overnight federal funds rate, but rarely intervenes in long-term markets or attempts to determine long-term rates. Its unusual arrangements are intended to lower mortgage and consumer interest rates, which means encouraging more mortgage and consumer loans - notable maneuvers with contradictory consequences.

In order to purchase long-term government bonds, the Federal Reserve will monetize the debt by printing money. Is it that easy? Can the Federal Reserve, a central bank for other banks, simply print money to monetize debt without consequences? The government (the public) will sell debt at lower interest rates and the public will eventually pay more for goods and services due to expected inflation that results from printing money. How much money can the government borrow from a central bank that monetizes the debt? Has anyone determined the tradeoffs?

The entire plan for rescuing delinquent mortgage holders is exemplary, except it is also contradictory. The plans essentially prop up prices of speculative investment properties that had reached unsupportable price levels, and whose purchases were made mostly by those who could not afford the properties and behaved carelessly. The public pays for the errors of others and for the rescue of the mortgage holders by not permitting the prices to fall to historical trend levels. Overlooked is that although Interest rates have fallen, those who wisely did not purchase properties at inflated values and are prospective buyers remain wary and fear they are buying overpriced houses. The delinquents are rewarded and the honest citizens are denied. How can the housing market recover if buyers conclude prices are still too high?

The incomplete analysis leaves much unanswered.
Did the U.S. recover from the 1982 and 2002 recessions due to its own initiatives or were there other factors that enabled recovery? Note that in the 1980s and at the beginning of this century, Asian nations; Japan during the 1980s and China and India in this century, exhibited tremendous economic growth that stimulated world trade and capital expansion. This phenomenon does not exist today; some slight growth but not the tremendous growth that is necessary to reinvigorate the global economic system.

So, we have the U.S. government escalating its deficit spending and the Federal Reserve Bank printing money to stimulate borrowing with limited approval of other central banks. If the Fed continues with its monetary expansion, will it essentially manage to cancel debt by increased inflation, cause a dollar decline to stimulate exports and pauperize those on fixed incomes? And what will be the end result? Will it be only a temporary return to a limited prosperity based on fiat money and followed by another credit crunch?

Go To
The Economic Crisis
Part 3- Towards a Solution

alternative insight
april, 2009
slight update september 2014

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