Dr. Susmit Kumar, Ph.D.
Table of Contents
(A) Introduction
(B) US Dollar Ponzi Scheme - Biggest Financial Fraud in Post-World War II Era
(C) US is Surviving Mainly Due to the “Dollar Ponzi Scheme”
(D) US Economy (World War II – 1960s)
(E) 1970s US Economy
(F) 1980s US Economic Crisis, 1985 Plaza Accord and Japan’s Lost Decades of 1990s and 2000s
(G) 1990s US Economy
(H) 2000-2007 US Economy
(I) 2008 US Housing Bubble Collapse
(J) US Economy Since 2009
(K) Future of US – 1990s Russian Economy
(A) Introduction
In this paper, we will see that the US economic boom from World War II (WWII) to 1960s was mainly due to the massive expenditure in defense industry to fight the WWII. Then in order to survive, the US reneged on its 1944 Bretton Woods promise to keep its currency pegged to the gold price, paving the “Dollar Ponzi Scheme” in which the US gets most of its currency back (in the form of foreign investments in US Treasury Bills, US real estate and US share markets) which it again uses as payment to the entire world. Since 1980s the US economy is surviving mainly due to this Ponzi Scheme, not because of any so-called “Market-Driven” economic policy.
Instead of using the foreign investment, under the Dollar Ponzi Scam, for lifting all the boats, [every one,] the US administration, in collusion with the US Federal Reserve, has transferred massive amounts of money to the ultra-rich from all others. Or rather, out of America's wealthy, a few have now become so absurdly economically powerful that even the term "ultra-rich" becomes an understatement. The shifting of manufacturing industry overseas, due to Wall Street pressure for increasing quarterly profits, caused a massive loss of good paying jobs during the 1980s which resulted in the early 1990s recession in US. The advent of the information technology industry in the mid-1990s saved the US from a prolonged economic depression. But once the service sector jobs, including the IT industry jobs, went overseas, due to the said Wall Street pressure, the economic boom stemmed from a housing industry bubble, where people made money by selling houses to each other in the period of 2000-2007. Since that housing bubble collapsed in 2008, the economy has been on life-support consisting of rock bottom interest rate of the US Federal Reserve and fake liberalist economic optimism.
One main reason for the rock bottom Fed Rate since the 2008 Great Recession is that for each percent increase in the interest rate, the corresponding US Treasury debt increases by about $250 billion (due to additional interest payment). The Fed rate was about 2% in 2018, 4% in early 2000 and 6% in early 1990s (please see Chart 9 in Section H). Hence if interest rates on US Treasury debt go to 4% or even 6%, the US budget deficit would increase by an additional $500 billion and $1 trillion, respectively, a year. In 2018, the budget deficit will go beyond $1.3 trillion (U.S. borrowing on pace to top $1.3 trillion this year, the highest since 2010, Christopher Ingraham, Washington Post, Oct 30, 2018). Hence at early 2000s and early 1990s US Treasury interest rates, the 2018 budget deficit would have been $1.8 trillion and $2.3 trillion, respectively. If China escalate the current trade war by dumping its treasury holdings, then it would drastically increase the interest rate and the budget deficit would skyrocket beyond $2 trillion a year, resulting in the blowing up of the US budget.
Both China and Japan have sizeable debts too, but most of their debts are internal. On the other hand, a significant portion of the US debt is owned by foreigners.
Here I would like to quote one paragraph from Mr. Viral Acharya’s Government interference undermines RBI’s functional autonomy: Viral Acharya, The Economic Times, Oct 27, 2018.
Excessive lowering of interest rates and/or relaxation in bank capital and liquidity requirements can lead to greater credit creation, asset-price inflation, and semblance of strong economic growth in the short term, but excessive credit growth is usually accompanied by lending down the quality curve which triggers mal-investment, asset-price crashes, and financial crises in the long term;
Mr Acharya wants the RBI to have same independence as the US Fed has. The US Fed works completely independent of the US government. But since late 1980s, the US Fed, especially under Alan Greenspan, Fed Chairman for nearly two decades (1987-2006), has worked in cahoots with the US administration and Wall Street, to transfer huge amount of money to ultra-rich from all others, by manipulating Fed rate so that the economy would just keep on going.
Both Capitalism and Communism have serious defects. The then super-power Soviet Union, despite being a military super-power, with significant number of aircraft carriers, submarines, military aircrafts and tanks, second only to the US, suddenly collapsed in 1991 due to a severe CAD (Current Account Deficit) problem (please read my article Communism Collapsed Due to Collapse in Oil Price in Late 1980’s and German Banks – Not Due to Reagan). It is worth noting that even the CIA had no inkling that the Soviet Union would collapse in 1991. Hence India needs to come up with an “Indian Economic Policy” if it wants to survive.
(B) US Dollar Ponzi Scheme - Biggest Financial Fraud in Post-World II Era
If a businessman needs $3 billion every day (corresponding to $500 billion trade deficit and $500 billion budget deficit a year for the US) to finance his luxuries and he has been doing it for a long time, then people will certainly say that he is using dubious or corrupt means to get $3 billion a day and would not last long (in 2019, this amount would be $5 billion a day as the US budget deficit is going to cross $1 trillion for next several years). Such a person cannot be considered to be a successful businessman.
During WWII, the US and UK deliberated about the future of the global economy, leading to the 1944 Bretton Woods Accord.
(i) At that time, entire Europe was under Hitler and countries like India and China did not have any economy to have a say in the Accord.
(ii) Under British Plan, which was rejected, there would have been one “neutral” Global Currency (say "Bancor") managed by an international bank as well as by an International Clearing House to oversee the export and import of each country.
(iii) The US, on the other hand, made the proposal, which was accepted, of making its currency dollar as the global currency for FOREX reserve and also for financial transactions among the countries by pledging that it would keep its dollar pegged to gold at the rate of $35 for one ounce of gold (please see article for more detail: Chinese yuan replacing US dollar as global currency: A not so distant prospect).
(iv) Without the US pledging to keep the dollar linked to the gold price, the US dollar would never have been accepted as a global currency at Bretton Woods.
(v) But in 1971, the Nixon administration reneged on this pledged by delinking the US dollar from the gold price.
Delinking of dollar from the gold price established the massive “US Dollar Ponzi Scam”, the biggest financial fraud, by far, of the post-WWII era. As shown in Chart 1, the US generated trade surplus from WWII till 1971 and thereafter has run a consistent trade deficit. The US has simply printed its currency, which happens to be the global currency, to fund its trade (and also budget) deficits for last four decades. In return, exporting countries deposit the same paper, i.e. the US dollar, in the US by investing in US Treasury Bills, US real estate and US share markets. According to economist Allan H. Meltzer at Carnegie Mellon University (“U.S. Trade Deficit Hangs In a Delicate Imbalance,” Paul Blustein, Washington Post, November 19, 2005),
“We [United States] get cheap goods in exchange for pieces of paper, which we can print at a great rate.”
(i) This scam is behind the US Economic growth since 1980s.
(ii) Without this scam, the “Reaganomics” would not have been in existence. Neither would "supply-side economics", also referred to as "trickle-down economics" or voodoo economics by political opponents.
(iii) Without the “US Dollar Ponzi Scam”, the US economy would have collapsed even before the collapse of Soviet Union which could not get few tens of billions of dollars to buy food grains from Western countries (The End Of Poverty, Jeffrey Sachs, The Penguin Press, New York, 2005, p. 132; please see article: Communism Collapsed Due to Collapse in Oil Price in Late 1980’s and German Banks – Not Due to Reagan).
Chart 1: US Trade (in Billions of USD) Source: India is a Country, Not a Company: How Anglo-US Imported Economists Misled and Mismanaged Indian Economy, Susmit Kumar, Munshiram Manoharlal Publishers Pvt. Ltd., New Delhi, 2018, p. 41.
Table 1 Source: India is a Country, Not a Company: How Anglo-US Imported Economists Misled and Mismanaged Indian Economy, Susmit Kumar, Munshiram Manoharlal Publishers Pvt. Ltd., New Delhi, 2018, p. 48.
(C) US is Surviving Mainly Due to the “Dollar Ponzi Scheme”
Rather than paying any money towards its principal, which right now amounts to more than $20 trillion, the US has been accumulating additional debt of anywhere from $300 billion to $500 billion each year. While describing the US debt, Niall Ferguson, Laurence A. Tisch Professor of History at Harvard University said (“In China’s Orbit”, Niall Ferguson, December 1, 2010, http://www.niallferguson.com/journalism/finance-economics/in-chinas-orbit):
With a debt-to-revenue ratio of 312 percent, Greece is in dire straits till now. However, the debt-to-revenue ratio of the United States is 358 percent, according to Morgan Stanley. The Congressional Budget Office estimates that interest payments on the federal debt will rise from 9 percent of [2010] federal tax revenues to 20 percent in 2020, 36 percent in 2030, and 58 percent in 2040. Only America’s “exorbitant privilege” of being able to print the world’s premier reserve currency gives it breathing space. But this very privilege is under mounting attack from the Chinese government.
Lawrence Summers’ Statement about the Asian Infrastructure Investment Bank:
After all, Western countries, with the exception of the US, Japan and Canada, recently joined the China-led Asian Infrastructure Investment Bank, Lawrence Summers, a noted US economist, ex-President of Harvard University, and the Treasury Secretary during Bill Clinton administration, said (“A global wake-up call for the U.S?” Larry Summers, Washington Post, April 5, 2015):
This past month may be remembered as the moment the United States lost its role as the underwriter of the global economic system. True, there have been any number of periods of frustration for the United States before and multiple times when U.S. behavior was hardly multilateralist, such as the 1971 Nixon shock ending the convertibility of the dollar into gold. But I can think of no event since Bretton Woods comparable to the combination of China’s effort to establish a major new institution and the failure of the United States to persuade dozens of its traditional allies, starting with Britain, to stay out.
As its currency happens to be the global currency, the US is practically in position to print as much as it likes at any given time to fund itself. In this way, the US was able to save itself from entering into prolonged Great Recession as it was able to spend more than $2 trillion in (direct) stimulus. The Federal Reserve had to provide $29 trillion (twice of then US GDP) to large banks in order to save the US economy from the collapsing ($29,000,000,000,000: A Detailed Look at the Fed’s Bailout by Funding Facility and Recipient, Working Paper No. 698, James Andrew Felkerson, University of Missouri–Kansas City, December 2011)
As shown in Chart 2, the budget deficit has increased nearly threefold in 2018 as compared to last year and it is going to be above $1 trillion in next several years. Hence the interest rate payment on Treasury bonds is going to increase at a higher rate than mentioned in Niall Ferguson's paper. Also one point worth noting is that in 2010 when Ferguson wrote the paper, the interest rate on US Treasury bonds stood at rock bottom, about 2% on 10-year bonds whereas the same was nearly twice and thrice times higher in early 2000s and early 1990s as shown in Chart 9 in Section H below.
Chart 2 US Budget Deficit (U.S. borrowing on pace to top $1.3 trillion this year, the highest since 2010, Christopher Ingraham, Washington Post, Oct 30, 2018)
Table 2 Source: India is a Country, Not a Company: How Anglo-US Imported Economists Misled and Mismanaged Indian Economy, Susmit Kumar, Munshiram Manoharlal Publishers Pvt. Ltd., New Delhi, 2018, p. 56.
(D) US Economy (World War II – 1960s)
The United States supplied billions of dollars worth of munitions and foodstuffs to the Allies during World War I, and the Allies had to borrow money on the New York and Chicago money markets to pay it back. The European economies were devastated by the war, which did, however, benefit countries like the United States, Canada, and Australia, which were spared fighting the war on their own soil.
WWII offered the United States the opportunity of becoming a superpower by default both in terms of wealth and military power. During that war, the American industry became military-based. Automobile production lines in Detroit were reconfigured to churn out military tanks, navy battleships, and fighter planes. For the first time, women joined the workforce in droves, as the men had gone to Europe and East Asia to fight. By the late 1940s, the US GDP was almost half of the world’s GDP, and American companies were working at full capacity. This contrasts dramatically with post-war Europe, where most factories lay in ruin. In addition, technological advances in both ocean and air transport during the war made the transportation of goods cheap. This relatively newfound technology drastically reduced transportation time also between the various continents, from months to a few hours, which helped in integrating the American economy with the world economy.
(E) 1970s US Economy
At the end of WWII, the United States completely destroyed Japan's industry and infrastructure by massive bombing. After the Korean War in the early 1950s had ended in a stalemate, the United States had to supply its massive army stationed in South Korea with consumer goods and military items. To accomplish this, it sent state-of-the art machinery to Japan and later to South Korea to take advantage of its cheap labor and proximity to the war theater. This helped Japan get started on the road to becoming the economic superpower it is now, rivaling even the United States. The Korean War was in effect a Marshall Plan for Japan and South Korea. Toyota, for example, was rescued from ruins because of the orders for trucks from the US Department of Defense.
A huge increase in petroleum prices after the 1973 Arab-Israeli War shocked US industry. Arab countries imposed an oil embargo on the United States, raised the price of crude oil, and cut back oil production. Although they eventually ended the embargo, oil prices quadrupled within a few months to $12 a barrel. This led to oil rationing in the United States and inflation. During the 1970s (especially during the Carter period), unemployment and interest rates were both very high, with the latter running into double digits. This caused American industry to start shifting production of consumer items to Third World countries in order to take advantage of their cheap labor. The four Asian Tigers—Taiwan, Hong Kong, South Korea, and Singapore—were the first beneficiaries of this transfer of production.
(F) 1980s US Economic Crisis, 1985 Plaza Accord and Japan’s Lost Decades of 1990s and 2000s
Following the 1979 Iranian Revolution, oil peaked at above $39 a barrel. Subsequently the Reagan administration instituted a policy of massive tax cuts to help counter the inflation but also increased defense expenditures, causing annual growth in the budget deficit. At the same time, American manufacturing jobs started shifting to East Asia, leading to an increase in US trade deficits. In order to reduce or finance its trade deficit, the United States had to either attract foreign investment by increasing interest rates or increase exports by depreciating the dollar. Increases in interest rates would adversely affect the domestic economy; hence, in order to depreciate the dollar, five nations—France, West Germany, Japan, the United States, and the United Kingdom—signed the Plaza Accord in 1985.
During the mid-1980s, when the US BOP (Balance of Payment) started going into what was then uncharted territory, the United States had to sign the 1985 Plaza Accord (shown as the vertical line in Chart 3). This resulted in a controlled depreciation of the dollar in order to increase its exports. At that time, all the main players in the global economy—Japan, West Germany, France, and the United Kingdom—were dependent on the United States for their security and therefore assisted in the endeavor.
As per the accord, the Japanese yen appreciated rapidly, and the dollar depreciated at a rate that led to the shifting of Japanese manufacturing plants to low-labor-cost countries such as Taiwan, Singapore, and then, later on, countries such as Indonesia and Thailand. In the late 1980s, in order to stop a further rise in the yen, the Bank of Japan decided on a low interest rate and spent yen to buy dollars in the currency markets. This resulted in increased Japanese investment in the United States, fueling the “bubble economy” and a collapse of the Japanese economy in the early 1990s. Nevertheless, Japanese money had propped up the Reagan administration, allowing it to operate in spite of budget deficits, as well as the US economy in general. Had Japan not financed the budget and trade deficits at that time, Reaganomics would have collapsed. A similar situation is occurring right now, with China financing US deficits.
Chart 3 Source: Casino Capitalism, Susmit Kumar, iUniverse, 2012, p. 85
Real estate prices in Japan skyrocketed in the late 1980s. The Nikkei (the Japanese stock exchange) average tripled during this period. Total Japanese land values ballooned to a point where they were theoretically four times greater than those of the entire United States, even though the United States is twenty-five times larger and full of the natural resources that Japan lacks (James Fallows, Looking at the Sun, Vintage Books, New York, 1995, p 10).
Due to the Plaza Accord, however, the dollar was continuing to slide in 1987 while the yen and German mark were continuing to appreciate, creating problems in international financial markets. In order to stop its slide, all G-7 members except Italy signed the 1987 Louvre Accord. Private investors exited the US market as a result. In fact, during most of 1987, private capital ceased to flow to the United States on a net basis, and foreign central banks were obliged to finance roughly two-thirds of the $163.5 billion current account deficit. The Federal Reserve raised interest rates in autumn that year in a further effort to stem the dollar’s fall and calm financial markets. The Germans and Japanese offset the Fed’s action, however, by following suit, and the resulting flight of capital from US financial markets triggered the October stock market crash (Robert Brenner, The Boom and the Bubble, Verso, London, 2002, pp 84–85).
The 1990s was called Lost Decade of Japan, a period of economic stagnation in Japan following the Japanese asset price bubble's collapse in late 1991 and early 1992. The term originally referred to the years from 1991 to 2000, but recently the decade from 2001 to 2010 is often included (“UPDATE 2-Japan eyes end to decades long deflation,” Leika Kihara, Reuters, August 17, 2012), so that the whole period is referred to as the Lost 20 Years. Broadly impacting the entire Japanese economy, over the period of 1995-2007, GDP fell from $5.33 to $4.36 trillion in nominal terms (World Bank), real wages fell around 5% (“Waging a new war - Shinzo Abe wakes up to the political risk of higher prices without higher pay,” The Economist, March 9, 2013), while the country experienced a stagnant price level (“Historic inflation Japan - CPI inflation,” http://www.inflation.eu/inflation-rates/japan/historic-inflation/cpi-inflation-japan.aspx).
In 1995, the Japanese banking system held some 100 trillion yen (20% of their GDP at that time or USD 1 trillion at 1995 exchange rate) in bad loans. Of the top twenty-one Japanese banks, thirteen were effectively bankrupt (Ulrike Schaede,“ The 1995 Financial Crisis in Japan”, School of International Relations and Pacific Studies (IR/PS) BRIE Publication: Working Paper-85, (February 1996), p.1; Dick K. Nanto, specialist in Industry and Trade Economics Division, “Japan’s Banking Crisis: Causes and Probable Effects”, (Congress Research Report 95), (October 6,1995), p.34).
Chart 4: Japan Debt to GDP (in percent) (source: www.tradingeconomics.com)
(G) 1990s US Economy
Shifting of manufacturing industry overseas, due to the Wall Street pressure to have profit each quarter, caused massive loss of good paying jobs during 1980s which led to the early 1990s recession in US. Due to the advent of Information technology industry in mid-1990s, the US was saved for having a prolonged economic depression.
As American productivity increased during the mid-1990s due to the advent of information technology, including the invention of the Internet, created many jobs were created. This upsurge had a downside, however, since anyone anywhere in the world with a computer soon learnt to do the job that an American did in the office on a computer. As labor costs in the Third World are just a fraction of those in America, the United States now started to lose service sector jobs as well. Until the mid-1990s, information technology sector jobs were created in the United States, but henceforth those jobs were outsourced to English-speaking countries such as India and the Philippines in order to fulfill Wall Street’s expectations of quarterly gains. Although Americans were losing jobs, the American economy boomed because of the tech stock bubble during the 1990s. The budget surplus during the Clinton administration’s final years was mainly due to jobs created in the tech sector, which resulted in a rise of revenues.
In the era of the Internet, when more than half of US households had their money on Wall Street and everyone was becoming conscious of various firms’ performance, every CEO came under pressure to show quarterly earnings meeting the predictions of Wall Street pundits. Falling short of expectations would mean losing their jobs. We may call it the “Wall Street Specter.” The main characteristics of this phenomenon include CEO’s sending jobs outside the United States in order to save their own jobs, millions of dollars in CEO bonuses to reward quarterly profits, and the loss of millions of quality American jobs. It also includes record CEO turnover levels—15.3 percent out of the world’s 2,500 largest public companies in 2005, a 4.1 percent increase from 2004 and 70 percent above the 9 percent turnover rate in 1995 (“CEO Churn Hits Record High in 2005,” Reuters, May 18, 2006).
As shown in Chart 5, everyone in US enjoyed nearly equally the economic boom from WWII to 1960s. But due to the shifting of good paying manufacturing jobs overseas, the rich people were benefitted more than others between early 1970s and 2000.
Chart 5. Source: India is a Country, Not a Company: How Anglo-US Imported Economists Misled and Mismanaged Indian Economy, Susmit Kumar, Munshiram Manoharlal Publishers Pvt. Ltd., New Delhi, 2018, p. 100.
(H) 2000-2007 US Economy
Despite the historic loss of millions of middle class jobs since 2000 and job losses related to the record increase in its trade deficit since 1990s, the US economy kept on booming, firstly due to the tech stock bubble, and secondly the real estate price bubble.
Chart 6. Source: India is a Country, Not a Company: How Anglo-US Imported Economists Misled and Mismanaged Indian Economy, Susmit Kumar, Munshiram Manoharlal Publishers Pvt. Ltd., New Delhi, 2018, p. 87.
After the collapse of the tech stocks in the early 2000s, the US economy kept booming because of the housing sector bubble. During the late 1990s and early 2000s, low interest rates and large foreign investments created a housing sector boom in the United States. During this housing boom period, banks were giving housing loans to people whose income was not sufficient to pay the monthly mortgage. However, as home prices were rising every year at a record pace, people were making money by selling homes to each other. When home prices started to collapse, not only people having subprime mortgages but people with prime mortgages found it difficult to pay their mortgages too.
From 1950 to 2000, existing homes grew in value by less than 0.5 percent per year, after adjusting for inflation. From 2000 to 2006, home prices rose at an average annualized rate of 8.2 percent above inflation and peaked with a 12.3 percent jump in 2005 (“Why home values may take decades to recover,” Dennis Cauchon, USA Today, December 12, 2008). According to a Brookings Institution study, prime mortgages dropped to 64 percent of the total in 2004, 56 percent in 2005, and 52 percent in 2006 (Manav Tanneeru, “How a ‘perfect storm’ led to the economic crisis,” CNN.com, January 1, 2009). According to Credit Suisse, 29 percent of new mortgages in 2005 allowed borrowers to pay interest only—not principal—or pay less than the interest due and add the cost to the principal. It was up from 1 percent in 2001. In 2006, half of new mortgages required no or minimal documentation of household income.
According to John D. Parsons, a supervisor at a Washington Mutual mortgage processing center, almost all were granted mortgage loans irrespective of their real incomes. Parsons said that it was normal to see babysitters claiming salaries worthy of college presidents, and school teachers with incomes rivaling stockbrokers. Interviews with two dozen employees, mortgage brokers, real estate agents, and appraisers revealed the relentless pressure to churn out loans (Peter S. Goodman and Gretchen Morgenson, “Saying Yes, WaMu Built Empire on Shaky Loans,” New York Times, December 28, 2008).
Suppose you buy a house worth $200,000 with a down payment of $10,000, and the price of the house increases by 10 percent in a year. By selling the house, you can make say about $10,000 after deducting transaction costs (i.e., you can get 100 percent return in a year; or after a year you can get a $20,000 home equity loan to spend). According to the National Association of Realtors, the average down payment for the first-time home buyers was 10 percent in 1989, whereas in 2007, it was only 2 percent (“Why home values may take decades to recover,” Dennis Cauchon, USA Today, December 12, 2008). Hence for a 2 percent down payment (i.e., $4,000 down payment for a $200,000 home), you could have had 500 percent return in a year. In case of sale, the $10,000 transaction cost is paid to the real estate agents and the banks involved in the transaction. Although this $20,000 would be immediately spent in the economy, raising the spending level by $20,000, on the negative side this also increased the overall debt by $20,000, which would be paid by the next owner. Apart from home loans, banks were showering Americans with several other kinds of loans also, such as for appliances, furniture, and cars. Hence these two bubbles kept the US economy booming although the people had lost quality jobs. People were using their homes as ATM cards.
During the housing sector bubble, individuals were making money in tens of thousands of dollars due to the rise in home prices. At the same time, hedge funds were making hundreds of millions of dollars in the commercial real estate sector bubble, which started to crash in 2009. Job losses resulted in closures of stores, malls, and offices, which caused a significant drop in commercial real estate prices. The commercial real estate market always lags behind the general economy. Between 2005 and 2007, $1.5 trillion in commercial property traded hands. The volume of sales soared from $78 billion in 2001 to $498 billion in 2007. Between 2005 and 2008, nearly three quarters of San Francisco’s top downtown office buildings were bought and sold. Scott Lawlor, a hedge fund manager doing business in commercial real estate, was producing more than 40 percent a year for investors from 2000 to 2007. For example, he bought a building in hedge-fund haven Greenwich, Connecticut, in 2003, brought in tenants at higher rents and sold it for twice the purchase price in 2006. But Lawlor had to bite the dust once the economy crashed in 2008. He was forced to foreclose on the Hancock Tower, a sixty-two-story building in Boston’s Black Bay, which was under its fourth owner in six years in 2009 after his foreclosure. Due to the crash of the commercial real estate market, its value dropped by more than half in just two years—from $1.7 billion in 2007 to $700 million in 2009 (Daniel Gross, “Boston’s Incredible Shrinking Skyscraper,” Newsweek, September 4, 2009). The commercial real estate crash dealt another blow to the already struggling financial industry. In 2009, banks had about $1 trillion of commercial real estate loans and an additional $530 billion in construction loans (Pallavi Gogoi, “Failing loans for commercial real estate threaten small banks,” USA Today, September 10, 2009).
Hence, the late 1990s and 2000s economy presented a bubble economy funded by borrowed money. In 1990, the average American household’s debt was 83 percent of its income and in 2000 it was 92 percent of its income. In 2007 it had gone up to 130 percent of income (“Block those metaphors,” Paul Krugman, The New York Times, December 12, 2010) as shown in Chart 7. Therefore, although Americans were able to immediately spend money worth 38 percent of their household’s income during 2000 and 2007, they had increased their debt by the same amount. The prosperity during the 2000s was based on borrowed money.
As shown in Charts 8 and 12, nearly everyone in the US had negative income growth rate during 2000-05 because the economic growth in the US was due to asset bubble.
Chart 7 US Household Debt to Income Ratio (Source: US Federal Reserve, https://www.federalreserve.gov/econres/notes/feds-notes/household-debt-to-income-ratios-in-the-enhanced-financial-accounts-20180109.htm)
Chart 8. Source: India is a Country, Not a Company: How Anglo-US Imported Economists Misled and Mismanaged Indian Economy, Susmit Kumar, Munshiram Manoharlal Publishers Pvt. Ltd., New Delhi, 2018, p. 100.
Chart 9.
Chart 10. Source: India is a Country, Not a Company: How Anglo-US Imported Economists Misled and Mismanaged Indian Economy, Susmit Kumar, Munshiram Manoharlal Publishers Pvt. Ltd., New Delhi, 2018, p. 55.
Chart 11. Source: Pew Research Center (US).
Chart 12. Source: India is a Country, Not a Company: How Anglo-US Imported Economists Misled and Mismanaged Indian Economy, Susmit Kumar, Munshiram Manoharlal Publishers Pvt. Ltd., New Delhi, 2018, p. 101.
(I) 2008 US Housing Bubble Collapse
The 2008 US Great Recession was triggered by the defaults of record numbers of subprime mortgages. Investment banks were securitizing the mortgages, including the subprime mortgages, and selling them all over the world (i.e., the mortgages were sold as securities to investors). Typically, a bundle of say one hundred home mortgages was sold as securities to investors.
In finance, a security is an instrument representing financial value. When the subprime mortgage market started to collapse in 2007, the investment banks, that had sold these securities, started to lose money. Although the mortgage-based securities affected by the subprime crisis was said to be less than $2 trillion, the collapse of the US housing sector affected non-subprime mortgages too, leading to further losses in mortgage-based securities. Bank officials were under pressure from their higher-ups to give mortgages, and, in turn, they as well as the top officials were getting huge year-end bonuses. At investment banks also, officials were putting pressure on workers to churn out securities that packaged mortgages and other forms of debt into bundles for resale to investors all over the world. The officials, including the CEOs at these investment banks, were making millions of dollars in bonuses due to the profit related to the sale of these securities. These officials were taking huge risks for their bonuses to show short-term gains for their financial institutions, and many of those gains turned out to be huge losses.
In short, banks gave home loans to people based on fictitious paper. Bank officers as well as investment bankers made hundreds of millions of dollars in salaries and bonuses because of them. Later on, common people lost money in shares, but hedge funds made a lot of money bringing down the shares of these banks. It all boils down to the fact that the whole mechanism, or dynamics, if you like, created a domino effect leading taxpayers to pay trillions of dollars for the bankers’ misdeeds and exacerbating the economic recession of the country as well as that of the entire world.
In US, banks and financial institutions, including the US Federal Reserve Bank (US equivalent of the Reserve Bank of India) are in private hands. The bank officials and Wall Street bankers were responsible of the 2008 Banking Crisis in the US, which created the 2008 Great Recession in the US and world-wide recession, but as the US banks are “too big to jail/fail,” not a single bank official was prosecuted despite having documentary proofs of illegal means (which can be termed as day-light robberies), used by the bank officials and the Wall Street bankers. These bankers made hundreds of billions of dollars by using illegal practices. Since early 2000s, bank officials in US started creating shading mortgages and the Wall Street bankers created shady derivatives on the top of these mortgages. The ultimate losers were the ordinary Americans, who were tricked into purchasing these shady mortgages, and also people, both in US and throughout the globe, who were tricked into purchasing these shady derivatives. The US government had to spend trillions of dollars (several thousand times the $2 billion PNB Scam) to overcome the 2008 banking crisis created by these corrupt bankers. Just a decade ago before the US bankers started creating shady mortgages in early 2000s, the US had to spend taxpayers’ $132 billion (trillions of dollars in current US dollars) to overcome the 1990s Savings and Loan Crisis, caused by the US bankers. It is worth noting that nearly a thousand bank officials were sent to jail for their part in the Savings and Loan Crisis. The Savings and Loan crisis was one of the reasons for the early 1990s recession in the US.
The Following New York Times article compared the details of prosecutions in these two crises:
“Two Financial Crises Compared: The Savings and Loan Debacle and the Mortgage Mess” – New York Times, April 13, 2011
http://www.nytimes.com/interactive/2011/04/14/business/20110414-prosecute.html
“Savings and loan crisis” - wikipedia
https://en.wikipedia.org/wiki/Savings_and_loan_crisis
When the real estate bubble burst in 2008, the Bush administration (and later the Obama administration) had to spend trillions of dollars to prop-up the banking and real estate sectors. The US Fed reduced its rate during recession to spur consumer spending. Once a significantly lower interest rate was able to kick-start the economy, the US Fed used to raise the rate within few years. Before the 2008 Great Recession, the US had recessions in the early 1990s and again in the early 2000s. As shown in Chart 9, the Fed reduced the rate to about 3% for about a year and a half at the onset of the early 1990s recession and then again it reduced the rate to about 1% for a year and a half at the onset of next recession which occurred in early 2000s, i.e. the Fed had to lower the bar for its rate in early 2000s recession from the previous recession. After the 2008 Great Recession, the US Fed has had to go down to ZERO percent for nearly 7 to 8 years and it has only inflated the assets like stock market, with no job recovery in sight. The reason for its failing is that this time banks are not finding enough people, with good credit rating (as they do not have good paying jobs), to provide loans to. The US economy has a deadly cancer (massive loss of good paying jobs) whereas the zero interest rate is just a pain-killer. The low interest rate is not the cure this time.
(J) US Economy Since 2009
As shown in Charts 13 and 14, everyone except the ultra-rich are worse off now than before the 2008 real estate collapse, mainly because the economic growth after 2008 Great Recession is because of asset bubble due to rock bottom interest rate. Between 2007 and 2016, home ownership fell 12 percentage points among the middle class, 9 percentage points of which was due to people who had never owned a home in the past never buying one during that time. The housing crash, in other words, turned more people into renters, so the housing comeback hasn’t helped nearly as many people as had been hurt.
The Federal Reserve’s large-scale asset purchases between 2009 and 2014 may have done little to move the US economy out of recession and into lasting recovery, research suggests. As long-term economic stimulus, quantitative easing may also have been a bust, according to findings presented at Chicago Booth’s US Monetary Policy Forum (Trillions of dollars from the Fed had little effect, Dee Gill, March 28, 2018).
Chart 13. Source: India is a Country, Not a Company: How Anglo-US Imported Economists Misled and Mismanaged Indian Economy, Susmit Kumar, Munshiram Manoharlal Publishers Pvt. Ltd., New Delhi, 2018, p. 101.
Chart 14 Source: The bottom 90 percent are still poorer than they were in 2007, Matt O’Brien, Washington Post, Oct. 1, 2018.
Indeed, according to numbers put together by researchers at the Federal Reserve (Chart 14), the top 10 percent of working-age households were the only ones who, adjusted for inflation, were richer on average in 2016 than they were in 2007. Everyone else, as you can see above, was somewhere between 17 to 35 percent poorer than they’d been almost a decade before.
So why hasn’t the recovery, which has seen housing prices rebound by 26 percent and stocks by 160 percent from their post-crisis lows, reached less exclusive income groups, too? Well, the question answers itself: Because they don’t own as many houses or stocks as they used to. Part of that, of course, is due to the fact that middle-class families were more likely to have lost their homes during the crash — that’s why their wealth fell further than anyone else’s in the years immediately after — but not as much as you might think.
(K) Future of US – 1990s Russian Economy
Till now the US has been surviving due its over-valued dollar. When the US dollar goes down to its Purchasing Power Parity (PPP) value, there will be a complete collapse of the US economy, akin to the Russian economy during 1990s. If you take Delhi Metro to go from Connaught Place/Rajiv Chowk to Dwarka (30 km) it will cost you 35 rupees, i.e. about half of a dollar whereas for same distance in Bay Area, California, the Metro will cost you 8 dollars. In PPP terms one dollar is 12 to 13 rupees only, i.e. the US dollar is five times over-valued vis-à-vis the Indian rupee. Right now even after massive loss of manufacturing jobs, the living standard of even an hourly wage American is very high as compared to the rest of the world. At even $10 an hour, working in a restaurant, they make $1600 a month, out of which they spend $200-$300 on food, $700 on the room rent (with a/c) and $300 to $400 on a very good car; he can buy a brand new 48” LED TV for less than $400 which is just one-fourth of his monthly income; he can buy a round-trip air ticket to India in less than $700 in off-season and in $1200 in peak season which are less than 50% and 75%, respectively, of monthly income. If two persons (wife & husband) work, then they can have a life better than a middle class Indian family. But if the dollar goes down to its PPP value, there will be complete chaos in the US. Then a brand new Toyota Camry in US would cost $125,000 instead of $25,000, its present price, and it will be out of bound even for the middle class in US. Right now, the moment a person in US gets a $50,000 a year job, he buys a brand new car like Camry.
Once China pulls the carpet underneath the US dollar as discussed, the US median household income (for a family of four), standing at around $56,000 annually as per 2016, would go down to less than $11,000 a year in terms of purchasing power. Half of US households would then be homeless and would find it hard to even survive as all their money would be good only for food with nothing left for housing, car and health care.
“10 Ways Life Will Change If China Becomes The World’s Superpower”, MARK OLIVER JUNE 18, 2018
http://listverse.com/2018/06/18/10-ways-life-will-change-if-china-becomes-the-worlds-superpower/
