US ECONOMY: RUDDERLESS AND REELING FROM DIRECT HITS
By Paul Craig Roberts

Online Journal Sep 17, 2008, 00:26

We were promised a "New Economy" of high-tech tradable services to
take the place of the offshored manufacturing economy. Wondering
what had become of the "New Economy," Duke University's Offshoring
Research Network searched for it and located it offshore. Yes, the
activities of the "New Economy" are also outsourced offshore.

Call centers, IT operations, back-office operations, and manufacturing
have long been moved offshore. Now high-value-added proprietary
activities such as research and development, engineering, product
development, and analytical services are being sent offshore. All
that's left is finance, and it is crumbling before our eyes.

Independent broker-dealers are disappearing: Merrill Lynch, Bear
Stearns, Lehman Brothers. These venerable institutions were too thinly
capitalized for the risks that they took. Merrill Lynch is now part
of the Bank of America, and Lehman Brothers is history.

Ill-advised financial deregulation led to financial concentration and
not to more efficient markets. Independent local banks, which focused
on financing local businesses, and savings and loan associations,
which knew the local housing market, have been replaced with large
institutions that package unanalyzed risks and sell them worldwide.

Regulation overreached. The pendul um swung. Deregulation became an
ideology and a facilitator of greed.

Deregulating electric power gave us Enron.

Deregulating the airlines destroyed famous American brand names such
as Pan Am, shrank the number of companies, and caused a decline in
service. When airlines were regulated, they could afford standby
equipment, and cancelled flights were rare. Today, the bottom
line prohibits standby equipment, and mechanical problems result
in cancelled flights. When economists calculated the benefits of
deregulation, they left out many of its costs.

There are no longer any blue chip companies, which means that investing
for retirement has become a crapshoot. People realize this; thus,
the privatization of Social Security has no support.

If we look realistically at the US economy, we see that what is not
moved offshore is being bailed out. Last year, the US Department
of Energy was authorized to make $25 billion in loans to auto
manufacturing firms and suppliers of automotive parts. Last week the
secretary of the Treasury took $5 trillion dollars in Fannie Mae and
Freddie Mac home mortgages under its wing.

The Congressional Budget Office says this action by the Treasury
means "that the operations of Fannie Mae and Freddie Mac should be
directly incorporated into the federal budget." Their revenues would
be treated as federal revenues, and their expenditures as federal
expenditures. If the former were greater than the latter, there would
be no reason for the takeover.

The open question is: what do these new liabilities do to the
Treasury's own credit standing?

For now, this question is submerged. The traditional practice of
fleeing to the US dollar and US Treasury bonds during periods of
financial stress and uncertainty has boosted the dollar and kept
interest rates low. But sooner or later the large US budget deficit,
worsened by recession and bailouts, and the large trade deficit,
which requires constant recycling of dollars held by foreigners into
US financial and real assets, will result in renewed effort on the
part of foreigners to lighten their dollar holdings.

When this time arrives, US interest rates will have to rise in order
for the government to be able to continue to rely on foreigners to
recycle the dollars acquired in trade to finance the US government's
annual budget deficit.

The current financial problems have pushed into the background
the larger problems of the US budget and trade deficits. Goods and
services for American markets that US corporations outsource offshore
return as imports, which widen the US trade deficit. Moving production
offshore reduces US GDP and employment and increases foreign GDP and
employment. Moving production offshore reduces the export capacity
of the US economy while raising the import bill.

Therefore, how is the trade deficit to be closed? One way is through
the dollar's loss in exchange value, which would reduce American
consumers' real incomes and leave them too poor to purchase the
offshored goods and services.

How is the budget deficit to be closed when jobs are disappearing
and GDP (tax base) is being relocated offshore?

Not by higher taxes. Higher taxes are problematic for a recessionary
economy in which unemployment, properly measured, is already in double
digits (www.shadowstats.com).

Some people have speculated that the budget deficit will be closed by
dismantling entitlement programs such as Medicare. However, considering
the cost of medical insurance, this would be catastrophic for tens
of millions of older Americans.

The more likely avenue will be a raid on private pensions. The Clinton
administration's appointee, Alicia Munnell, as assistant secretary of
the Treasury for Economic Policy, argued that private pensions should
face a capital levy to make up for the fact that their accumulation
was tax free. I expect that the federal government, faced with its
own bankruptcy, will resurrect this argument, as it will be preferable
to printing money like a banana republic or Weimar Germany.

In the 21st century, the US economy has been kept going by debt
expansion, not by real income growth. Economists have hyped US
productivity growth, but there is no sign that increased productivity
has raised family incomes, an indication that there is20a problem
with the productivity statistics. With consumers overloaded with debt
and the value of their most important asset -- housing -- falling,
the American consumer will not be leading a recovery.

A country that had intelligent leaders would recognize its dire
straits, stop its gratuitous wars, and slash its massive military
budget, which exceeds that of the rest of the world combined. But a
country whose foreign policy goal is world hegemony will continue on
the path to destruction until the rest of the world ceases to finance
its existence.

Most Americans, including the presidential candidates and the media,
are unaware that the US government today, now at this minute, is unable
to finance its day-to-day operations and must rely on foreigners to
purchase its bonds.

The government pays the interest to foreigners by selling more bonds,
and when the bonds come due, the government redeems the bonds by
selling new bonds. The day the foreigners do not buy is the day the
American people and their government are brought to reality.

This is not the financial position of a superpower.

Will what happened to Lehman Brothers today be America's fate tomorrow?

Paul Craig Roberts [email him] was Assistant Secretary of the Treasury
during President Reagan's first term. He was Associate Editor of
the Wall Street Journal. He has held numerous academic appointments,
including the William E.

Simon Chair, Center for Strategic and International Studies, Georgetown
University, and Senior Research Fellow, Hoover Institution, Stanford
University. He was awarded the Legion of Honor by French President
Francois Mitterrand. He is the author of Supply-Side Revolution :
An Insider's Account of Policymaking in Washington; Alienation
and the Soviet Economy and Meltdown: Inside the Soviet Economy,
and is the co-author with Lawrence M. Stratton of The Tyranny of
Good Intentions : How Prosecutors and Bureaucrats Are Trampling the
Constitution in the Name of Justice. Click here for Peter Brimelow's
Forbes Magazine interview with Roberts about the recent epidemic of
prosecutorial misconduct.