Global financial fiasco: End of the age of US economic dominance

Published: January 2, 2012
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A look at why the US economy is on a one-way trip to disaster. DESIGN: MAHA HAIDER

A look at why the US economy is on a one-way trip to disaster. DESIGN: MAHA HAIDER

MUNICH: 

In the spring of 2008, the real estate bubble popped in the United States and it triggered a financial tsunami that engulfed the entire globe. This catastrophe provided an opportunity for change, change that was necessary to restructure the economic architecture of the US Despite the hefty promises made by President Obama during his election campaign, upon taking office he did the complete opposite of what was expected, or to be precise, hoped for, and succumbed, as his predecessors did, to the same interests that were responsible for the catastrophe.

Instead of seizing the opportunity, all policies implemented after 2008, were geared towards maintaining the status quo. These polices have exacerbated the magnitude of a crisis that will take effect anytime after 2012.

After the 1907 panic, influential bankers agreed to establish the Federal Reserve by 1914. The Fed is a “private” central bank that controls U.S monetary policy, acts as the lender of last resort and its shareholders consists of corporate banks. In addition, it is excluded from independent audits and congressional oversight. The monetary policy of the Fed is the core factor why the US economy is currently on an unsustainable path.

The Fed currently holds fractional reserve at 10%. For example, when ‘Bank ABC’ borrows $10,000 from the Fed it deposits $1,000 and is able to loan out $9,000. Let say that $9,000 is then loaned out to an individual who needs a car. After purchasing the car, the $9,000 is transferred to the seller and deposited in Bank ‘XYZ’. Under a 10% fractional reserve, ‘Bank XYZ’ deposits $900 and is able to loan out $8,100. In total, banks combined lend out $17,100 with deposits of only $1,900.This policy benefits lenders handsomely whereas the savers are at risk. In addition, systematic risk increases significantly when the investment arm of the bank is included that speculates on derivatives with a leverage of 40:1on capital. Currently, the total aggregate derivates market is 12 times of global GDP at $701 trillion traded by a handful of corporate banks.

And then we have the FIAT System. In 1963 the Fed abolished the gold/silver standard and violated the US constitution (Article 1, Section 10) that prohibited states from using anything other than gold and silver for the repayment of debts. An elastic money supply known as the FIAT system was established in which currency could be created without restraint (gold reserves). This system does not constitute any cost or liability to the issuer, only to the borrower. The fractional reserve principle combined with an elastic money supply primarily benefits the financial sector as they are on the top of money issuing pyramid.

Artificially low interest rates

The Federal reserve uses credit inflation  to prop up the FIRE (Finance, Insurance and Real Estate) economy. Cheap credit creates both an artificial demand and misleading price signals, for example, before the 2008 collapse, due to cheap credit flooding into the housing market, housing price kept rising creating a false perception of an improvement in the economic and productive environment causing an overinvestment in the industry. Speculators on Wall Street profiteered from this asset price inflation. The economy didn’t.

A prolonged low interest rate policy discourages and diminishes savings. Savings are vital for capital formation that will be invested in the future. Since the FIRE economy took off in the 1970’s, the US saving rate has declined rapidly whereas the debt culture has grown exponentially.

Special interest capturing politics

The FIRE economy is, by far, the largest spender when it comes to shaping US Politics. It has contributed over $1.9 Billion since the 1990’s in political affairs, which includes donations to President Obama. Through intense lobbying it has managed to deregulate the market by repealing the Glass-Steagall Act and push the Commodity Futures Modernization Act of 2000 into law.

The modern economic philosophy needs to go back to the classical view which states:

Finance cannot substitute production.  The productive (manufacturing & export) is the real economy and should be at the forefront, not the FIRE economy. Credit cannot replace savings. Speculation is not the same as sound investment. Issuing more debt is not the solution to grow out of existing debt.

The writer is a freelance journalist and works for Muffathalle

Published in The Express Tribune, January 2nd,  2012.

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Reader Comments (8)

  • Not me
    Jan 2, 2012 - 7:56AM

    Let us talk about the mess the Pakistan economy is in and further mess it will get into in next 6 months.
    US economy will hurt and so will the Euro zone but my major worry is Pakistan economy as we will hit run away inflation,have balance of payment problems and major economic downturn driven by gas and power shortages.

    Can someone share the figures of FDI in past 3 years…….Recommend

  • Admire
    Jan 2, 2012 - 8:45AM

    Then I suggest you load up on euros and the the PAK rupee

    Recommend

  • Cautious
    Jan 2, 2012 - 5:57PM

    This article is worse than the one he wrote which blamed Pakistan’s economic woes because the World prefers the US Dollar vs the Gold Standard.

    Recommend

  • Meekal Ahmed
    Jan 2, 2012 - 9:58PM

    Rather one-sided. Truths are there but many false-hoods and perfunctory analysis as well.

    It is only QE1 and QE2 and “Operation Twist” that have helped keep interest rates down in the present environment. The yield on the 10-year Tresasury is still around 2%. Obviously the bond markets feel something we don’t. The downgrade of the credit rating had NO impact whatesoever.

    The US economy is expected to pick up steam in 2012 with growth of around 2.5% or better but unemployment may still be stuck at 8%.

    My greater worry is Europe. The ECB needs to act like the classic lender of last resort and push those interest rates DOWN by a more aggressive program of bond purchases. NO country, not even Italy, can borrow at 7%!

    Recommend

  • Logistics
    Jan 2, 2012 - 10:49PM

    US constitution (Article 1, Section 10) prohibits states not the federal govt from this activity.Recommend

  • Falcon
    Jan 2, 2012 - 10:52PM

    Contrary to writer’s opinion, what if the US monetary policy is not the source of the problem, rather too many expectations from the Federal Reserve that are source of the problem. It is as if everybody thinks they have a magic wand that can fix everything by mere changes in monetary policy. Truth be told monetary policy is always a short-term lever to smooth out economic growth rather than the tool for deeper economic policy changes. Similarly, the impact of changes in monetary policy is also less predictable because of many levels that it works through vs. that of fiscal policy.

    Recommend

  • Harry Stone
    Jan 2, 2012 - 11:32PM

    ALways interesting about how hacks like this like to focus on the US and never the problems in PAK or any other place for that matter.

    Nations come and go but the US with all it flaws and shortcomings seems to remain.

    Recommend

  • Nadeem Chaudhry
    Jan 2, 2012 - 11:47PM

    very thought provoking and educational article for ordinary layman which summarizes how the global economy is fueled by debt and how its run….

    Recommend

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