After WWII, America found itself as the largest economic power in the world. Right afterwards, the government largely reduced tariffs and price controls, and ended the massive war budget that consumed nearly 50% of the US economy. Scarce capital was freed up; labour that once worked building bombs could now be hired to build productive economic resources. And like most postwar economies, America saw a massive boom. The growth of the American middle class and industrial base were the hallmarks of its expansion. All this wealth led to ambitious government spending programs, and the 1960's saw the first move towards large government. Medicare for the elderly and Medicaid for the poor, the expansion of New Deal departments, and more bureaucracy were started by Lyndon Johnson. This trend continued, and the tax and spend - guns and butter - policies continued through the seventies. Yet America could no longer rest on its laurels of economic strength. But still, it spent and consumed, printing and borrowing money. This all came to a very sticky conclusion at the end of the 70s with Stagflation. Which caused many economists to cry as the tidy Philips curve which predicted a negative correlation to inflation and unemployment suddenly became a positive correlation.
The solution to this inflation - caused by living beyond the economy's means - was Volker's Disinflation which lasted from 1980-1982. Volker raised interbank lending rates to over 20%, and the banks passed on the heavy cost of borrowing to its customers. Industries (like farming and construction) which heavily depended on short term financing were crushed. But after 1982, America bounced back, with permanently lower inflation and unemployment. The weak industries were out, and the strongest survived. The 80's turned to a boom time. But this boom was different than the postwar boom that occurred last time. When Volcker raised interest rates to 20%, this created a magnet for world deposits to America. Foreigners could gain massive interest on their cash by merely lending it for a short while to an American bank. And even after interest rates were lowered, the cash stayed, and America went from a Current Account Balance (from 1946-1980) to a Current Account Deficit (from the 1980 to here on).
Now as a note, a current account deficit isn't a bad thing. It's just what it is. Whether it is for the best depends on its reasons. From 1865-1914 America maintained a large current account deficit. This was because America lacked domestic capital, and borrowed it from abroad. This borrowed foreign capital was used to build railroads, canals, the first highways, and finance America's burgeoning industries. After it had enough industrial capacity, America paid off its debt and lent its excess capital to the rest of the world (becoming a net lender).
But the current account deficit that began in the 80's wasn't to build infrastructure or strengthen productive American corporations. What began as interest rate manipulations became a global culture. Suddenly everyone wanted to lend to America. The United States government could finance a 30 year bond with an interest of 3%! Never in the history of the world, would anyone lend to another person for such a long period of time with such a low rate of interest. But the real problem began in the 90's.
The 80's really didn't see much of an aggregate change in economic imbalances, it merely began them. When the Berlin Wall fell in '91, the global labour supply doubled. Overnight. Richard Freeman coined the term as the 'Great Doubling'. Suddenly communist posters were replaced with Coca-Cola signs, and the world scrambled to invest in these newly found post-communist countries. It took only around 10 years! But by the year 1999 (reforms in many of these countries began before '91), these new communist countries, became net lenders! What! The economic model was broken! Rich countries, having excess capital, should be lending to poor countries whose growing industrial capacity can repay the debts. But instead, the world, for whatever reason, still saw America as the place to invest. What happened? The tech bubble. American corporations promised light speed internet connections and a futuristic world around the corner. Suddenly everyone wanted to invest in anything that was associated with a '.com'. WorldCom and Enron were the new American industries. Their stocks exploded (as they did eventually). Even though they never paid dividends, and the cash streams still never materialized, they were seen as the future.
Once people realized that a company which paid you nothing, and never made you any money wasn't a good investment, the NASDAQ (the index of technology stocks) crashed, and stocks slumped. But yet! America still remained the global vacuum of capital. This in my opinion was when insanity became the guiding force of global capital.
America had a blank check to do anything. Bush stepped into the White House, and sure enough this happened. First of all, if America could borrow for any reason at low interests rates, why not? The American national debt exploded (doubling under Bush's tenure). As did American corporate debt. Why shouldn't companies follow the government's lead? Then Greenspan lowered interest rates to 1%. So what? Foreigners should be damn pleased to earn less than inflation. And then the subprime mortgage industry sprang up. Why NOT! America was invincible; nothing could ever go down, never, at any point. Housing prices were rocket ships only going more into the stratosphere. So clever bankers like Hank Paulson (know him?), got their banks to buy overvalued homes from mortgage lenders who charged no interest, then packaged them up and sold them at ridiculous prices to foreigners, who up until now, seem to eat anything America shoveled into their mouths. The rest as they say is history.
This all came to a sticky end in 2007. Housing prices slumped; the hundreds of billions of dollars of subprime loans became worthless, and were amplified by even more subprime derivative losses by banks (in layman’s terms, they bet the wrong way). Whereas in the 1980 everyone knew that the economy would go into recession (it was a planned action), the important people (aka the leaders of the major businesses/governments) in 2007 never saw it coming. What has been the response of 2008? The printing, spending, and borrowing orgy that caused the unsustainable economic policies of the 1970s of course. If there is anything positive in this whole mess, it's that we might just learn a lesson or two. Now that the world has lost its naivety, and we realize that we can't walk on water, me might get back to some common sense.
No comments:
Post a Comment